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Business Transfers

Business Transfers – Part 1: Introduction

In this first part of a six-article series on Business Transfers, we will provide a broad topical overview that will be supplemented by future articles. As used in this article, “business transfers” will include M&A (mergers and acquisitions) transactions, stock sales, business (assets) sales, takeovers and buyouts. In contrast to money or “equity raises” by a business (which may involve a change of control), this article will focus on a privately negotiated, non-auction transfer of a business or its ownership.

Events Triggering Business Transfers

Seller motivations for a business transfer include taking money off the table, retiring and/or transitioning the business by planned succession to family or management. For a detailed outline of the planned succession, see Family Business Succession Planning. Buyer motivations may range from financial (i.e., the financial return of the business as an investment) or strategic (such a platform or add-on expansion of product/service lines, geographic areas, etc.). The form of a business transfer is limited only by the creativity of the buyer, the selling owners and their professionals offering guidance to optimize the tax, legal and financial outcomes.


Sellers should address gaps in the management structure, operational weaknesses and legal issues that might trouble a buyer. While all businesses have issues, many can be corrected with advance planning. To maximize price, sales should be planned with as much lead time as possible. To implement the business transfer process, the seller will typically prepare a two to three page “teaser” summary of the business (without identifying it) for potential buyers to make a preliminary evaluation. Those interested in further information are required to sign a confidentiality agreement to protect the seller’s information. As described in Confidentiality Agreement Traps & Trade Secret Destruction, improperly drafted confidentiality agreements may destroy rather than protect confidential information.

Cost Control

To manage costs, the parties may seek a nonbinding letter of intent (see Letters of Intent – Key Aspects and Dangers) with price and terms based on stated assumptions before engaging in extensive legal, accounting, financial and business due diligence. In this situation, the letter of intent describes the assumptions on which the proposed offer is based; subsequent due diligence would also need to confirm the underlying assumptions. The due diligence process, which can be extensive, will be discussed in a future article.


Barring third party problems such as regulatory approvals, consents to key leases and contracts, and legal issues (licensing, antitrust, etc.), a typical private sale will take two to three months from start to finish to complete due diligence, finalize definitive agreements and close the transaction.

Structure Overview

Business transfers are typically structured as an “asset purchase,” “stock purchase” or merger, all of which have different tax and liability implications to be discussed in future articles. In addition to these general structuring issues, the purchase price may include cash, seller notes, contingent consideration (earn-outs) and property. If the property includes buyer stock, the sellers should conduct due diligence on the buyer and may need to negotiate minority owner protective rights. Structuring issues will be addressed in a series of future articles regarding: the effect of different structures; the representations, warranties and covenants of purchase documents; indemnification provisions as risk allocation and contractual limitation of such provisions; and ancillary documents including earn-outs and noncompetition agreements.

Related Articles

Business Transfers – Part 2: Acquisition Objectives

Business Transfers – Part 3: Seller Preparations

Family Business Succession Planning

This blog does not establish an attorney-client relationship and does not constitute legal advice. Legal outcomes are based on the particular facts of a situation and the application of the law to those facts.  Anyone with issues described in this blog should hire an attorney for legal advice based on the relevant facts. The firm has no obligation to maintain the confidentiality of any information received by email or comments.

Business Transfers – Part 2: Acquisition Objectives

This second of the six-part series on Business Transfers will focus on acquisition objectives of the parties to merger and acquisition transactions, including stock sales, assets sales, takeovers and buyouts. This series focuses on a privately negotiated, non-auction transfer of a business or its ownership. To orient readers, we offered an Introduction to Business Transfers in Part 1. In subsequent parts of this series, we will address the following topics:

Part 3 – Seller Preparations

Part 4 – Acquisition Process

Part 5 – Acquisition Methods

Part 6 – Implementation

Due to complexity and length, the topics identified in this series provide only a sampling of the issues we have encountered in Business Transfers.

A.  Possible Seller Objectives

  1. Create liquidity for shareholders
  2. Access to complementary products and markets
  3. Access to working capital, resources and infrastructure
  4. Access to customers and distribution channels
  5. Gain critical mass
  6. Other benefits of major corporate affiliation
  7. Tax minimization

B. Possible Buyer Objectives

  1. Acquire product line or key technology
  2. Acquire creative, technical and/or management talent
  3. Eliminate a competitor
  4. Acquire a new distribution channel
  5. Acquire expertise and entry in a new market
  6. Tax minimization

C. Understanding Objectives for Negotiations

  1. It is critical to understand, identify and prioritize your own objectives.  Since the negotiation process requires compromise, it is vital to know what can be traded and what is non-negotiable.
  2. Determining the other party’s objectives (generally through questions and discussions between management and the broker or financial intermediary) is necessary for a sense of the other party’s objectives and priorities to allow creative negotiations for win-win solutions.
  3. The parties should approach negotiations in the spirit of seeking a mutual solution to the issues before them – the purchase and sale of a business.  Principled negotiations, in which the issues are attacked but not the individuals, are fundamental.

In our next series, we will recommend seller preparations to maximize the company’s attractiveness, buyer interest and pricing. To optimize results, these preparations require significant time and planning.

This blog does not establish an attorney-client relationship and does not constitute legal advice. Legal outcomes are based on the particular facts of a situation and the application of the law to those facts.  Anyone with issues described in this blog should hire an attorney for legal advice based on the relevant facts. The firm has no obligation to maintain the confidentiality of any information received by email or comments.

Business Transfers – Part 3: Seller Preparations

This third of the six-part series on Business Transfers will focus on seller preparations to be undertaken before initiating the sales process. This series focuses on a privately negotiated, non-auction transfer of a business or its ownership. To orient readers, we offered an Introduction to Business Transfers in Part 1 and Acquisition Objectives in Part 2. In subsequent parts of this series, we will address the following topics:

Part 4 – Acquisition Process

Part 5 – Acquisition Methods

Part 6 – Implementation

Seller Preparations for a Business Sale.

Time is the Enemy of a successful business sale. Pre-sale seller preparations are critical for reducing the time between a letter of intent and closing. In addition to enhancing the likelihood of a successful transfer, pre-sale preparations should increase the net “after tax” proceeds to the seller. Depending on the amount of work necessary, pre-sale preparations may require months to years. Launching an ill-prepared sales proposal into the market simply “wastes a bullet” and eliminates potential buyers. Just as you would not put your house on the market without repairs, clean up and staging, you should not put your business on the market with any less effort.

In addition to operational actions ideally implemented years ago to enhance the business’s value drivers, pre-sale preparations should include, at a minimum, preliminary valuation estimates for a “Go – No Go” decision, assembling the Seller Transaction Team and conducting pre-sale due diligence.

Seller Transaction Team. Most sellers have little to no experience in selling a business. A successful business transfer requires multiple advisors because no individual is capable of addressing all issues. Typically, seller transaction teams are comprised of the seller’s CPA, tax adviser (CPA or attorney with tax experience regarding business sales), attorneys with experience in the relevant legal areas, a valuation expert, and a brokerage or investment banking firm to market the business. Sellers may also engage an experienced consultant to manage the transaction team and the process.

“Go – No Go” Decision. Seller’s gating decision to being the sales process must be based on the adequacy of the net “after tax” sales proceeds to achieve seller’s financial objectives. For a “ball park” answer, the seller should obtain preliminary valuation estimates. If the net “after tax” sales proceeds based on estimated valuations are insufficient for seller’s financial needs, the Deal Team should review alternative structures to develop satisfactory outcomes. If a satisfactory outcome is unavailable, the seller need not waste money on the sales process and transaction team fees and charges. In addition to providing a basis for the “Go – No Go” decision, a preliminary valuation offers a reality check for seller’s pricing demands.

Pre-Sale Due Diligence. All businesses have warts. To avoid causing buyers to move to the next transaction due to doubts about the business or seller’s honesty, these warts should be identified and addressed before a buyer begins its due diligence. With sufficient lead time, issues can be corrected or minimized. Preemptive identification of significant issues and possible solutions tends to further a transaction instead of stalling or terminating it. To prepare for buyer due diligence which varies by buyer, industry and specific businesses, a seller should develop its own checklist and have its transaction team conduct due diligence. The following list offers a starting point for sample seller due diligence.



1.         Certified copy of certificate of incorporation of [entity whose stock or business is being acquired] (the “Target”), as currently in effect.

2.         Certified copy of by laws of the Target, as currently in effect.

3.         Access to minute books of the Target.

4.         Access to stock books and stock transfer ledgers of the Target.

5.         List of states and foreign countries in which the Target is qualified to do business, including names and addresses of registered agents and list of states and foreign countries in which the trade names of the Target are registered.

6.         Long-form good standing certificate, including payment of taxes for state of incorporation and every state and foreign country in which the Target is qualified to do business.

7.         List of states and foreign countries in which the Target files tax returns because of the ownership of property or conduct of business.

8.         List of states and foreign countries, if any, in which the Target is not qualified to do business and does not file tax re turns but in which it maintains an office, a stock of goods, employees, or an agent who is a resident of any state in which he or she solicits orders.

9.         Current organizational chart for the Target and organizational, operating divisions, and hierarchy of officers.

10.     All names under which the Target or any predecessor thereof has done business in the past five years.


1.         List of Target’s subsidiaries.

2.         Certified copies of certificates of incorporation and bylaws of each subsidiary, and access to minute books and stock transfer ledgers of each subsidiary.

3.         Information requested in items A.1 – A.9, shown separately for each subsidiary.


1.         Statement of outstanding and treasury shares of common stock, preferred stock (including a complete description of the rights attaching to such preferred shares), and any other securities of the Target and each subsidiary.

2.         Stockholders’ list, giving name and address of each stock holder of the Target and its subsidiaries and of any voting trustees, his or her affiliation with the Target, the type of security held, the date of issue by the Target (the consideration received by the Target therefor), and the number of shares of such security owned by each such stockholder or trust.

3.         List of holders of any options or right to purchase any securities of the Target (including warrants) giving name, number of options held, option prices, date(s) of grant, expiration dates, position in the Target or subsidiary, and number of shares owned (excluding those subject to option).

4.         Copies of all stock option agreements, stock option plans, and warrants.

5.         Copies of all stockholder agreements and all other agreements with respect to securities of the Target or its subsidiaries.

6.         All reports to stockholders of the Target prepared within the past five years.

7.         Indicate whether there are any stockholders or stock certificates whose whereabouts are unknown, or any stockholders from whom it will be difficult to obtain approval of the transaction or stock certificates, as appropriate.

8.         A description of all contractual restrictions on transfer of the Target’s capital stock or assets.

9.         Copies of registration rights or preemptive rights agreements.


1.         All market studies, feasibility studies, analyses, and similar reports concerning the Target prepared within the past five years.

2.         All marketing and other descriptive brochures regarding the Target prepared within the past five years.

3.         All press releases issued by the Target during the past five years and any press clippings that refer to the Target, if available.

4.         Recent analyses of the Target or its industries prepared by investment bankers, engineers, management consultants, accountants, or others, including marketing studies, credit reports, and other types of reports, financial or otherwise.


1.         All currently effective loan agreements, indentures (including industrial revenue bond indentures), debt instruments, and other financing instruments, and all related material documentation, to which the Target is a party.

2.         A list of all mortgages, liens, pledges, security interests, charges, or other encum­brances to which any property (real or personal) of the Target is subject and all related material documentation.

3.         All correspondence with lenders and other debt security holders for the past five years (including all consents, notices, or waivers of default from lenders with respect to borrowings by the Target).

4.         Schedule of all short-term and long-term debt (including capitalized leases, guarantees, and other contingent obligations).

5.         Any presentations given to creditors in connection with obtaining credit or prepared for potential lenders in connection with any proposed financings.


1.         Audited financial statements, both consolidated and consolidating, for the Target and its subsidiaries for the past three fiscal years.

2.         All unaudited interim financial statements of the Target prepared since the date of the most recent audited financial statements.

3.         Separate consolidating statement for significant subsidiaries or divisions.

4.         Brief description of contingent liabilities involving the Target.

5.         Name of accountants and length of relationship with accountants; indicate whether the accountants own any interest in or hold any position with the Target or its subsidiaries.

6.         Management financial report to the directors, or any committee thereof, of the Target prepared during the past five years.

7.         Correspondence with the Target’s accountants prepared or received during the past five years, including all management letters from accountants.

8.         Brief description of depreciation policy.

9.         Brief description of nature of prepaid or deferred income or expenses.

10.     Copy of any sales projections and estimates, and copy of current budget and any budget projections including a discussion of any assumptions used in the preparation thereof.

11.     Brief description of any change in accounting policies or procedures during the past five years.

12.     Copies of all reports by accountants to management of the Target or any of its subsidiaries concerning the Target for the past five years.

13.     Brief description of outstanding commitments for capital expenditures in excess of $[Insert Threshold Amount].

14.     Any documents relating to material write-downs or write-offs of notes, accounts receivable, or other assets other than in the ordinary course of business.


1.         Copies of all federal, state, local, and foreign income and franchise tax returns filed by the Target and its subsidiaries for the past five years concerning the business, assets, or income of the Target or any subsidiary.

2.         All correspondence with the Internal Revenue Service or state or local tax authorities concerning adjustments or questioning compliance.

3.         List of returns and the years thereof that have been audited by federal, state, or local tax authorities, and copies of determination letters related thereto.

4.         List of state and local taxes to which the Target or any subsidiary is subject with respect to the business, assets, or income of the Target or any subsidiary, showing assessment date, date return is to be filed, and date tax due.

5.         Describe and provide copies of all agreement s, consents, elections, and waivers filed or made with the IRS or other taxing authorities, including, but not limited to, those relating to relevant statutes of limitations.

6.         List and describe all pending or threatened disputes with regard to tax matters involving the Target or any of its subsidiaries.

7.         Copies of any tax indemnification, tax sharing, or tax allocation agreements involving the Target and other members of an affiliated group, including any joint venture agreements that have the effect of tax allocation agreements, and a statement setting forth how such agreement was carried out for the past five years.

8.         Copies of all legal or accounting tax opinions received by the Target during the past five calendar years relating to the Target’s tax reporting.


1.         Name, address, and telephone numbers (home and business) of each director and officer of the Target and each subsidiary (and, if applicable, principal occupation), and aggregate compensation at present and for the previous fiscal year.

2.         All liability insurance policies for directors and officers of the Target or its subsidiaries.

3.         Number of persons employed by the Target and by each subsidiary in terms of function (executive, sales, clerical, research, labor, or other appropriate classification).

4.         Name and address of each person who has a power of attorney to act on behalf of the Target or any subsidiary, and copies of such powers of attorney.

5.         List of all labor union contracts and collective bargaining arrangements to which the Target or any subsidiary is a party, the number of employees covered by each such agreement, and the anticipated expiration dates thereof; and furnish copies of such contracts.

6.         Brief description of any “labor unrest” situations, all pending or threatened labor strikes, or other trouble experienced by the Target and its subsidiaries during the past five fiscal years.

7.         List and brief description of the current status of all unfair labor practices complaints lodged during the past three fiscal years involving the Target and its subsidiaries.

8.         Brief description of any pending or threatened request for arbitration, grievance pro­ceedings, labor disputes, strikes or disturbances affecting the Target or any subsidiary, and history of recent union negotiations.

9.         All performance bonus plans adopted by the board of directors of the Target during the past five years.

10.     Brief description and copies of all employee benefit plans, group life insurance plans, major medical plans, medical reimbursement plans, supplemental unemployment benefit plans or welfare plans (for hourly employees) or salary continuation plans, or other perquisites; and a brief description of policy regarding bonuses, salary review, severance pay, moving expenses, tuition reimbursement, loans, advances, vacations, holidays, sick leaves, and other benefits.

11.     For each pension or profit-sharing plan, including multiemployer plans, if any, furnish copies of plan documents, including amendments (and a description of any changes in these plans proposed, agreed upon, or under consideration); actuarial reports, if applicable; trust instruments and trust balance sheets, if any; summary plan descriptions; the latest application for determination to the IRS; any IRS deter­mination letter; and the latest Annual Report on Form 5500, 5500-C, or 5500-K.

12.     Details on any terminated pension plans and unfunded pension liabilities.

a.         List of all employees of the Target who received compensation exceeding $[Insert Threshold Amount] in the last fiscal year, giving name, date of birth, date hired, position, and compensation for the last fiscal year, and, to the extent available, similar information for all other employees and retired employees who are receiving or will be entitled to receive any payment not described previously in item H.9.

b.        Describe all written or oral employment or consulting agreements (other than union contracts) to which the Target or any subsidiary is a party or bound and, if any of the same are in writing, furnish copies thereof (except for employment contracts that can be terminated at will by the Target or a subsidiary without cost or liability).

c.         Brief description of all confidentiality, noncompetition, or similar agreements between the Target or any subsidiary and any of their present or former officers, employees, directors, consultants, or agents. If any of such agreements are in writing, furnish copies thereof.

d.        Brief description of all consulting and management agreements, arrangements, or understandings to which the Target or any subsidiary is a party, and, if the same are in writing, furnish copies thereof.

e.         Description of all defined compensation programs affecting officers, directors, or employees of the Target. State the amount accrued and/or paid during the most recent fiscal year under such programs, and amounts of accruals thereunder through a recent date.

13.     A description of the manner in which the Target fulfills its workers· compensation and unemployment compensation insurance obligations in each state (i.e., insured or self-insured, etc.).

14.     Documents representing or relating to workers’ compensation or disability policies, and any material claims with respect thereto.

15.     Copy of employee handbook or any similar document.


1.         Real Property

a.         List of real estate owned, leased, or used by the Target, statin g whether owned or leased (whether as lessor or lessee) and brief description of property, structures, zoning, estoppel letters, reversions or remainder  lease provisions (including assignment and renewal), use, and location: furnish copies of mortgages, deeds, surveys, maps, profits, rights of way, easements, leases, and other contracts.

b.        Copies of title insurance policies or lawyers’ abstract reports covering real state.

c.         Copies of zoning variances and local permits.

d.        List of agreements with railroads, pipeline agreements, agreements relating to water rights (such as certificates of appropriation), mining claims (patented and unpatented), and royalty agreements.

2.         Other Assets

a.         List of fixed assets, machinery, and equipment (whether owned, leased, or used by the Target), giving for each material asset or group of assets cost, depreciation reserve, method of depreciation, insured value, estimated remaining useful life, condition suitability for use, and (if available) appraised value.

b.        List of automobiles, trucks, and other registered equipment owned, leased, or used by the Target, giving a brief description of equipment and lease provisions (if any), year made, state of registration, registration number, cost, estimated remaining useful life, and insured value.

c.         List of premises at which any assets of the Target are currently located or located from time to time, including (without limitation) terminals, plants, storage facilities, sales offices, and warehouses, and written agreements with respect thereto.

d.        Brief description of portfolio investments of the Target (except in subsidiaries), including cost basis and current value.

e.         All currently effective purchase contracts, leases, or other arrangements concerning material items of equipment used by the Target.

f.         All professional appraisals of any material property of the Target.

g.         List and brief description of all liens, security interests, or mortgages on the property of the Target or any of its subsidiaries, and location and name of office where documents or financing statements relating thereto are filed.

h.        Copies of all material leases of or security agreements for personal property of the Target, including conditional sales contracts, equipment leases, chattel mortgages, accounts receivable, financing agreements, and factoring agreements.

3.         List of all insurance policies relating to the business, assets, or properties of the Target (including directors’ and officers’ liability insurance), giving insurance company, policy number, term of coverage, property or risk covered, appraisal value of covered property (where appropriate), extent of coverage, annual premium, and amount of premiums that are prepaid or are unpaid from prior years. Furnish copies of all such policies.

4.         A description of all insurance claims (over $[Insert Threshold Amount] in amount) currently pending.

5.         Schedule of Target’s loss experience per insurance year.

6.         Copies of title insurance policies for all owned real state.


1.         Schedule of patent registrations and applications identifying each patent by title, registration (application) number, date of registration (application), and country.

2.         Schedule of trademark (service mark and trade dress) registrations and applications identifying each mark and including date of registration (application), registration (application) number, status (that is, registered, renewed, abandoned, Sections 8 and 15 affidavits, submitted, etc.), and country or state where registered. In those instances where registration has not been sought, identify the mark, trade dress or trade name, and its date of first use anywhere in the United States.

3.         Schedule of copyright registrations and applications identifying each copyright by title, registration number, and date of registration.

4.         Manual or other written document detailing the procedures for maintaining the secrecy of trade secrets.

5.         Licensing agreements, merchandising agreements (naming Target as licensee or licensor), or assignments relating to patents, technology, trade secrets, trademarks (service marks), trade dress, and copyrights.

6.         Communications to or from third parties relating to the validity or infringement of Target’s patents, technology, trade secrets, trademarks (service marks), trade dress, and copyrights.

7.         Studies or reports relating to the validity or value of Target’s patents, technology, trade secrets, trademarks (service marks), trade dress, and copyrights, and the licensing or merchandising thereof.

8.         Agreements pursuant to which any patent, trademark, service mark, or trade name has been sold or transferred by or to the Target and evidence of recording thereof.


1.         All standard forms of agreements used by the Target.

2.         All warranty agreements, including all forms of product warranties, of the Target currently in force with respect to completed and executory material contracts.

3.         A list and description of all significant oral contracts and commitments.

4.         All currently effective guarantees given by the Target concerning the payment or performance of obligations of third parties.

5.         All sales agency and distribution agreements.

6.         A list of all contracts and commitments under which a default has occurred or is claimed to have occurred, setting forth the following:

a.         Nature of default;

b.        Name of party in default;

c.         Monetary amount claimed; and

d.        Current status of contract or claim.

7.         A list of all contracts subject to renegotiation (indicating those contracts currently being renegotiated).

8.         All agreements to which the Target is (or was within the past five years) a party and in which any officer, director, employee, or shareholder of any such companies has (or had) an interest (whether directly or indirectly).

9.         Copies of all agreements not to be performed with in three months or involving over $[Insert Threshold Amount] whether or not entered into in the ordinary course of business, except (a) agreements for the sale of merchandise or standard sales order forms entered into in the ordinary course of business, and (b)  agreements referred to elsewhere herein.

10.     Copies of all contracts with advertising or public relations agencies.

11.     Copies of all standard forms of sales and purchase orders.

12.     A list of all significant suppliers (representing in excess of [Insert Threshold Percent] of annual purchases) of the Target, with an indication of the amount paid to each such supplier during the Target’s most recent fiscal year and the estimated number of alternative suppliers.

13.     All executory contracts, as amended to date, with each of the foregoing suppliers, and all related purchase orders.

14.     Brief description of contractual or customary credit terms available from suppliers and manufacturers, and copies of all agreements with suppliers and manufacturers.

15.     List and briefly describe all agreements and arrangements with distributors, dealers, sales agents, or representatives. Furnish copies of all such written agreements.

16.     List and briefly describe all agreements and arrangements whereby the Target or any subsidiary acts as a distributor. Furnish copies of all such written agreements.

17.     List and briefly describe all agreements relating to the supply of [identify critical material(s)] and other raw materials and supplies. Furnish copies of all such written agreements.

18.     Copies of all forms of product warranties or guarantees, if any, given by the Target or any of its subsidiaries.

19.     Copies of all agreements and other documentation relating to the acquisition of any business constituting a part of the Target, or sale or proposed sale of any business owned by it in the past five years.

20.     Copies of joint venture or partnership agreements to which the Target or any subsidiary is a party.

21.     Copies of all franchise or distribution agreements between the Target or any of its subsidiaries and any third party concerning the manufacture, sale, or distribution of the Target’s or its subsidiaries’ products or services. If any such agreements are oral, summarize the terms thereof.

22.     Copies of all agreements not previously listed with suppliers, independent agents, salespersons, or others involving the payment of commissions; or other consideration or discounts with respect to the manufacture, sale, or distribution of the Target’s or its subsidiaries’ products or services. If any such agreements are oral, summarize the terms thereof.

23.     Brief description of any contracts restricting the ability of the Target or any subsidiary to compete in any line of business with any person or entity, or committing the Target or any subsidiary to continue in any line of business.

24.     Advise if there are any facts or circumstances that may give rise to the cancellation or termination of, or claim for damages or loss under, any of the agreements, arrangements, or understandings referred to herein.

25.     List and describe all leases, licenses, agreements, and contracts involving the payment of more than $[Insert Threshold Amount] in the aggregate, currently in the process of negotiation.

26.     Copies of agreements granting to the Target any right of first refusal to acquire any business or assets, or pursuant to which the Target has granted any such 1ights.

27.     List the material term s of all contracts and arrangements for (a) trucking and other delivery and (b) warehouse space.

28.     Copies of all material research and development agreements.

29.     All technology license agreements to which the Target is a party, as licensor or licensee.

30.     Documents relating to the Target’s internal determinations as to whether it can, or should, fulfill a particular contract.


1.         List and brief description of each threatened or pending claim, lawsuit, arbitration, or investigation involving a claim for relief of $[Insert Threshold Amount] or more against the Target, any subsidiary, or any of their respective officers or directors.

2.         List and brief description of any pending or threatened (a) claim or litigation involving alleged violations of laws or regulations for the health or safety of employees or others, (b) governmental or administrative proceeding, (c) equal employment opportunity claim or litigation, (d) antitrust claim or litigation, (e) claim or litigation seeking injunctive relief, or (f) other material claim or litigation to which, in either case, the Target or any Subsidiary is a party.

3.         A copy of all complaints, answers, and other material pleadings concerning any litigation not fully covered by insurance.

4.         All letters from counsel to the Target to accountants relating to litigation or contingent liabilities involving the Target.

5.         All correspondence relating to actual or alleged infringement by the Target of intellectual property rights of others.

6.         All judgments, orders, and decrees to which the Target is subject.

7.         List and brief description of all outstanding judgments, decrees, or orders.

8.         Copy of most recent response to auditors’ request for information about litigation and/or contingent liabilities of the Target.

9.         All material governmental permits, licenses, etc., of the Target.

10.     Any litigation involving an officer or director of the Target concerning bankruptcy, crimes, securities law, or business practice (past five years).

11.     Description of any investigations of the Target, pending or threatened, by any federal, state, local, or foreign authorities.

12.     All correspondence with, reports of or to, filings with, or other material information about any other regulatory bodies that regulate a material portion of the Target’s business.


1.         All internal Target reports concerning environmental matters relating to current or former Target properties.

2.         Copies of any applications, statements, or reports filed or given by the Target or any of its subsidiaries with or to the Federal Environmental Protection Agency, any state department of environmental regulations, or any similar state or local regulatory body, authority, or agency.

3.         All notices, complaints, suits, or similar documents sent to, received by, or served upon the Target or any of its subsidiaries by the Federal Environmental Protection Agency, any state department of environmental regulation, or any similar state or local regulatory body, authority, or agency.

4.         All Target or outside reports concerning compliance with waste disposal regulations (hazardous or otherwise).

5.         Copies of all permits, shipping authorizations, manifests, and waste stream authorizations.

6.         Description of any processes of facilities currently or previously operated by the Target or any subsidiary (or by others on property currently owned by the Target or any subsidiary) that generate or are suspected of generating any toxic or other hazardous material.

7.         All pollution control capital expenditure reports (including budget requests) for the past five years.

8.         All annual reports, manifests, or other documents relating to hazardous waste or pes­ticide management over the past five years.

9.         All documents relating to equipment using PCBs, spills of PCBs, or worker exposure to PCBs, and all documents relating to the existence or removal of asbestos.

10.     Any public records reflecting existing or recent environmental problems.


1.         Brief descript ion of customary sales credit terms.

2.         Brief description of aging of accounts receivable, giving collections since aging date and brief statement of reasons for receivables in excess of $[Insert Threshold Amount] past due.

3.         Names of customers owing in excess of $[Insert Threshold Amount].

4.         Description of basis for establishing bad debt reserve.


1.         List of products and services currently sold by the Target and its subsidiaries, together with applicable prices and discounts.

2.         Brief description of inventory pricing procedure.

3.         List of major sources of supply for [identify critical material(s)], dollar purchases from each in the last fiscal year, and brief description of available alternative supply sources for material items.


1.         All other agreements pursuant to which the Target has acquired securities or has issued (or may be obligated to issue) securities.

2.         All private placement memoranda, prospectuses, or other documentation relating to the offering or acquisition by the Target of securities.

3.         All reports to, documents filed with, and correspondence with the Securities and Exchange Commission for the past five years.

4.         All reports to, documents filed with, and correspondence with any state securities commission.

5.         All agreements and other documentation concerning any sale of material assets (including any agreements in principle) to which the Target is a party.

6.         Copies of all agreements and plans entered into by the Target or any of its subsidiaries relating to the acquisition of, or merger with, a business, or an interest in any business, whether by acquisition of shares, acquisition of assets, or otherwise.


1.         List and brief description of all long-term and short-term indebtedness of the Target and each subsidiary.

2.         List of guarantees or indemnity undertakings given by the Target or its subsidiaries.


1.         List and statement of amounts and other essential terms of any indebtedness or other obligations of or to the Target or its subsidiaries to or from any officer, director, stockholder, or employee.

2.         List and description of assets or properties used by the Target in which any officer, director, stockholder, or employee has any interest.

3.         List of all material transactions between the Target and its officers, directors, stockholders, or employees not disclosed under items P.1 or P.2.

S.         CUSTOMERS

List of major customers and suppliers, showing percentage of sales to each customer or supplier accounting for more than 5 percent of sales or any product line or service within the past fiscal year.


Copies of any recent filings with governmental agencies.


1.         List of all federal, state, local, and foreign governmental permits, licenses, and approvals (excluding those listed elsewhere herein) either held or required to be held by the Target or its subsidiaries for the conduct of their businesses.

2.         All correspondence, reports, and notices relating to laws and regulations administered by any federal, state, local, or foreign governmental agency for the past five years.


1.         List and brief description of any of the Target contracts, leases, security agreements, licenses, authorizations, etc., that may require the consent of any third party (including any governmental agency or instrumentality) to the proposed transactions.

2.         Indicate any other notification required to be given to or consents required from any third party (including any governmental agency or instrumentality) in connection with the proposed transactions.


1.         List of all bank accounts and safe deposit boxes, giving authorized signatories.

2.         List of memberships in trade associations.

3.         List of all requirements and obligations imposed on the Target by the proposed or effective rules and regulations of the Federal Trade Commission or any other governmental agency.

The foregoing list assumes that the Target is a corporation. If Target is a limited liability company, partnership and other entity, references to stock in the foregoing should be revised for the types of equity interests of Target.

As should be evident from the above discussion, Seller preparations require significant time and planning to maximize the likelihood of a successful sale and the sales price.

This blog does not establish an attorney-client relationship and does not constitute legal advice. Legal outcomes are based on the particular facts of a situation and the application of the law to those facts.  Anyone with issues described in this blog should hire an attorney for legal advice based on the relevant facts. The firm has no obligation to maintain the confidentiality of any information received by email or comments.

Family Business Succession Planning

Family Business Succession Planning

As Baby Boomers approach retirement, exit planning and family business succession planning become critical. Family businesses generate almost half of the U.S. GDP and employ the bulk of the U.S. workforce. Despite these impressive statistics, studies estimate that only 30% of family businesses survive the second generation and only 10% survive the third generation. Reasons for this high failure rate include the lack of adequate succession planning by most family businesses and insufficient planning to minimize transfer taxes across generations. This article does not address tax aspects of business succession planning. General “business transfer” topics are discussed here and here.

Broadly speaking, family business succession planning consists of transferring ownership and control of the business while minimizing income, gift and estate taxes. Within these broad conceptual categories are a virtually infinite array of combinations that should be customized for each business and family. For a family business, succession planning must also address the emotional issues and dynamics of the family. After the requirements to protect and continue the business are established, the business succession plan must be coordinated with estate planning to minimize taxes.

Business succession planning issues may be grouped into three broad categories of management, ownership, and tax issues. Adequate planning requires a multi-disciplinary team of professionals including an accountant, attorney, financial/insurance advisor, business appraiser and, for more complex cases, family business consultant.

This overview focuses on non-tax legal issues frequently encountered. It is not intended to be and cannot substitute for legal advice applied to the facts of a particular family business.

I. Succession Planning Overview

A. Basic Outcomes

  • sale to third parties, employees or active family members – see Part III below
  • gifts to family members – see Part IV below
  • liquidation

B. Basic Components of a Succession Plan

  • Identify primary objective
    • Legacy – preserve the legacy family business to (i) infuse future generations with business ambition, family values, relationships and long-term wealth-building goals, and (ii) provide security for valued employees
    • Wealth Management – the business is sold (to family members desiring to own/operate the business or to non-family) and the sales proceeds are distributed to family members for investment in other businesses or passive investments
  • Business Analysis
    • Valuation/Appraisal
    • Mission and strategic plan
    • SWOT (strengths, weaknesses, opportunities and threats) Analysis
    • Cash flow and capital needs of business
    • Liquidity demands arising on owner’s death
    • Effect of owner’s death on customer, creditor and employee relationships
    • Recommended reading – “The E Myth” by Michael E. Gerber
  • Management Issues
    • “Family-first” vs “business first” focus – how should business decisions by the next generation be prioritized between needs of the business and needs of the family?
    • Is a leader available in the next generation who possesses the passion and competence to implement a shared vision for the business?
    • Should non-family run the company?
    • What kinds of incentives are necessary to attract and retain top employees?
  • Ownership Models
    • Owner-Employee – first generation owners frequently work in the business and derive “ownership benefits” from compensation and other deductible perks.
    • Hybrid Ownership – sibling- or cousin-owned companies (typically second- and third-generation) use a hybrid ownership model with some owners active in daily operations and other owners having varying governance/oversight roles
    • Owner-Investor – ownership held in family entities such as limited liability companies (LLCs), limited partnerships, corporations or trusts with governance/oversight policies established by an active board
  • Personal Family Issues
    • Fairness/equalization issues between active and inactive children
    • Financial needs of the senior generation
    • Emotional and family dynamics (including spouses)
    • When does senior generation step-down?
  • Implementation Schedule
    • Begin now to avoid “damage control” succession from disability or unexpected death
    • Planning takes time to properly analyze issues, obtain consensus and commitment of stakeholders (family, employees and business associates), groom successors and implement planning team recommendations
    • Establish schedule with milestones for review and accountability
    • Conduct periodic reviews to adjust succession plan as changes occur

II. Buy-Sell Agreement

A. Critical for Multi-Owner Businesses. The purpose of a Buy-Sell Agreement is to provide business and ownership continuity while minimizing disputes.

B. Definition. Sometimes referred to as a business “pre-nuptial” agreement, a Buy-Sell Agreement is an agreement among the owners of the business to establish:

  • restrictions against undesired ownership transfers
  • procedures for permitted ownership transfers
  • representation on the board or other governing body of the business
  • rights and obligations of owners with respect to a future sale of the business
  • vesting and repurchase rights of a withdrawing employee’s ownership interest
  • confidentiality and noncompetition obligations
  • approval requirements for major transactions
  • dispute resolution procedures

C. Sample Issues Addressed

  • The following events typically trigger a redistribution of ownership:
    • death
    • disability
    • termination of employment (voluntary or involuntary)
    • retirement
    • proposed transfers to third parties
    • involuntary transfers (i.e., bankruptcy or divorce)
    • management impasse or disputes
    • supermajority vote to sell the company (drag-along rights)
    • permitted joinder by other owners in an owner’s sale (tag-along or participation rights)
  • The method(s) for determining the price of ownership interests purchased under the Buy-Sell Agreement should be specified, together with the payment terms (cash or installment payments) and any collateral requirements for deferred payments
  • Insurance funding of purchases by the company and/or the other owners is frequently specified.
  • Mandatory minimum distributions of income to owners to pay income taxes on undistributed S corporation, LLC or limited partnership income taxable to them

D. Integration with Succession Plan. The Buy-Sell Agreement should be consistent with the succession plan.

III. Sale of Business

A. Preparatory Actions. As with selling a house, the business should be in good order before being put on the market. Preparatory actions include:

  • Valuation
    • To facilitate the valuation process, the owner or his/her accountant should submit to the business appraiser:
      • an “adjusted balance sheet” listing the company’s assets at estimated fair market value and eliminating assets and liabilities that will not be transferred (such as cash, any personal vehicles and associated obligations, etc.)
      • a three-year “discretionary income” spreadsheet adding back to the business’ taxable income: compensation paid to the owner(s); depreciation; interest income and expense; expenditures motivated by “tax avoidance” and any other items that are not integral to the business
  • Control expenses – if the most heavily weighted valuation component is capitalization of the business’ cash flow, each dollar of savings will have a multiplier effect on valuation
  • Records
    • Conform financial records to generally accepted accounting principles (GAAP)
    • Obtain a review or audit of the financial statements of the business
    • Bring contracts and other records up-to-date
    • Update SWOT analysis and business plan to reflect focus on current opportunities, competitive advantages and improvement of weaknesses (sometimes identifying additional resources for growth attracts buyers who can provide the resources for an immediate ROI increase)
    • Create reports showing historical and projected business growth
    • Prepare detailed asset schedule and detailed records of completed and pending jobs/sales/transactions
  • Enhance business image
    • Update web site and printed marketing materials
    • Clean up facilities – dust inventory storage to reduce the appearance of obsolescence, upgrade exterior landscaping, etc.
    • Obtain customer and business partner testimonials
  • Information systems (including accounting software) should be “standard” to facilitate buyer utilization
  • Reduce excessive concentrations of suppliers and customers
  • Groom strong employees and qualified managers to reduce dependence of business on current owner(s)
  • Negotiate key personnel employment/retention agreements
  • Execute noncompetition and confidentiality agreements with all personnel/consultants
  • Intellectual property
    • protect trademarks, patents and copyright by registration
    • protect trade secrets by confidentiality agreements and other actions reasonably necessary to preserve secrecy
    • confirm adequacy of licenses for intellectual property used in the business
  • Conduct a “sell-side” due diligence review to anticipate buyer issues and avoid “surprises”
    • maintaining seller integrity/buyer trust is critical
    • review material contracts, leases and loan documents for imminent expiration and for clauses prohibiting assignment, change of control or ownership transfers
  • Identify obligations personally guaranteed by selling owner(s) for refinancing or release
  • Engage legal counsel and accountant experienced in selling businesses
    • Obtain legal review of business structure to minimize owner’s exposure to post-sale liabilities
    • Analyze and, if feasible, settle pending litigation by or against the business
    • Analyze potential environmental liabilities
    • Due to conflicts of interest, the same legal counsel should not represent the buyer and the seller.
  • Determine optimum tax-advantaged sale method
  • Analyze sale alternatives
    • sale of ownership interests or assets
    • full or partial sale, with or without an auction
    • minority equity investment/recapitalization
    • Should any assets or lines of business be retained for post-sale income to selling owner(s)?
  • Identify and contact potential purchasers through existing contacts or, after your attorney’s review of the contract, engage a business broker or investment banker to market business by auction or negotiated sale
  • Analyze potential buyer’s financial and operational capabilities to complete the transaction and to meet required licensing standards
  • Discuss potential sale with key employees and obtain agreement to maintain confidentiality
  • Divide due diligence into phases
    • Phase 1 – summary business information is delivered after the potential buyer has been qualified and a confidentiality agreement has been signed
    • Phase 2 – business information provided after a letter of intent is executed
    • Phase 3 – highly sensitive business information should be made available only after all other buyer closing conditions in the purchase agreement have been satisfied.

Caveat: No confidential business information should be disclosed prior to buyer’s execution of a confidentiality agreement. Even after the confidentiality agreement is signed, extremely sensitive business information should not be disclosed until all other buyer closing conditions are satisfied or waived.

B. Sales Documentation

  • Letter of intent
    • expressly nonbinding major transactional terms for preparation of definitive sales agreements
    • expressly binding provisions for confidentiality of disclosed information, non-solicitation of employees, nondisclosure of negotiations, allocation of costs and dispute resolution.
  • Purchase and Sale Agreement (including obligations to refinance or obtain release of seller guaranties; expect the buyer to require a noncompetition agreement with each selling owner)
  • Consulting and employment agreements with selling owner(s) for continuity and income
  • Security Agreement for deferred payments (including earn-outs)
  • Buyer’s promissory note, personal guaranty and security agreement for Seller financing

C. Sale to Employees

  • Preparatory actions are generally same as described in Part III.A except due diligence may be reduced for key employees who have been involved in the business. Depending on degree of owner involvement in the business, the purchasing employees may have superior knowledge about the business requiring the reversal of business information disclosures
  • Sales Documentation is generally the same as described in Part III.B except representation and warranties of selling owner(s) may be reduced
  • Leveraged buy-out or seller financing may be necessary for purchasing employee(s) to pay the purchase price
  • Sale to an employee stock ownership plan (ESOP) – a defined contribution retirement plan designed to provide employees with an opportunity to invest in employer securities.
  • If less than all of the ownership interests are sold, new owners should be required to execute the Buy-Sell Agreement.

D.Sale to Family Members

  • Preparatory actions are generally same as described in Part III.A except due diligence may be reduced for active family members.
  • Sales Documentation is generally the same as described in Part III.B except representation and warranties of selling owner(s) may be reduced
  • Leveraged buy-out or seller financing may be necessary for purchasing family member(s) to pay the purchase price
  • If less than all of the ownership interests are sold, new owners should be required to execute the Buy-Sell Agreement.

IV. Transfer to Family Members other than by Sale

A. Transfer Methods

  • Direct and Indirect Gifts
  • Redemption of transferring owner’s interest (leaving other owner’s interest outstanding)

B. Non-Tax Issues

  • New owners should be required to execute the Buy-Sell Agreement
  • Fairness/equalization issues between active and inactive owners
    • Equal transfers to children are not required by law.
    • Sale of business to active children at fair market value can provide the most equal treatment (but may not be the most tax efficient or the fairest based on relative efforts of the children)
    • Distribution to inactive children of non-business assets in an amount having equal value to the business
    • What is the value of the business – “fair market value” of the business as a whole or the discounted value of the ownership interests?
    • Insurance proceeds are frequently used to supplement the value of non-business assets as necessary
    • Real estate used by the business may be transferred to inactive children for leasing to the business. Caveat: The property should be transferred subject to a long-term lease with purchase option to prevent “unreasonable” landlord actions
  • Award equity to active children as reimbursement for previously inadequate compensation
  • Protections for selling and inactive owners
    • Retention of Control
    • Limited liability companies and limited partnerships may be used to transfer ownership to children while senior generation retains control
    • Senior generation owns voting shares of a corporation and transfers ownership to children by nonvoting shares
    • Ownership interests may be placed in a trust with voting exercised by a board or committee of trustees
    • Income protection for senior generation and/or inactive owners
    • Issuance of preferred stock with cumulative dividends and/or right to require repurchase by the business on pre-determined terms
    • Installment sale promissory notes
    • Salary continuation, consulting and employment agreements
    • Approval requirements for “major” actions
  • Contractual protections and incentives for key employees
  • Contractual assurance (via Buy-Sell Agreement) of transfer of control to active children on death/disability of currently controlling owner

V. Tax Minimization Techniques.

Although beyond the scope of this paper, various methods exist to reduce federal estate and transfer taxes. Listed below are brief, incomplete summaries of a few techniques for discussion with your attorney and tax adviser.

A. Gifting Ownership Interests

  • Annual gifts valued up to the annual gift tax exclusion amount per donor to each of multiple recipients
  • Gifts valued up to the lifetime gift tax exclusion
  • Gifts of family LLC or family limited partnership interests (the value of the gifted interests are discounted for lack of control and minority ownership, thus permitting gifts of greater percentages of the business within the foregoing gift tax exclusions)
  • Gifts of ownership interests in trust to children and grandchildren
  • Gifts to children and charity with subsequent corporate repurchase from charity

B. Sales of Ownership Interests

  • Installment sale to intentionally defective grantor trust
  • Private Annuity
    • Objective – avoid gift and estate tax
    • Structure – ownership interests are sold to active children in exchange for unsecured promise to make payments to seller for the remainder of seller’s life or for the remainder of seller and his/her spouse’s lives
  • Self-Canceling Installment Note (SCIN)
    • Objective – avoid gift and estate tax
    • Structure – an installment note in which the remaining payments are canceled on seller’s death
  • Charitable Remainder Trust – seller donates ownership interests to a charitable remainder trust for the benefit of seller (and his/her spouse) followed by a cash sale to the business of the ownership interests; the cash funding of the trust provides retirement income to seller (and his/her spouse) while contemporaneously reducing seller’s ownership interest in the business.
  • Grantor Retained Annuity Trust (GRAT) – seller retains the right to receive fixed annuity payments for a term of years or until his death. At the end of the term, the seller receives no additional benefits from the trust, and remaining property (remainder interest) in the trust is either distributed to beneficiaries or held for their benefit. Only the value of the remainder interest is subject to gift tax.

This blog does not establish an attorney-client relationship and does not constitute legal advice. Legal outcomes are based on the particular facts of a situation and the application of the law to those facts.  Anyone with issues described in this blog should hire an attorney for legal advice based on the relevant facts. The firm has no obligation to maintain the confidentiality of any information received by email or comments.

Letters of Intent – Key Aspects and Dangers

Parties frequently sign an “agreement in principle,” “term sheet,” “memorandum of understanding” or “letter of intent” (LOI) which are synonymous terms for a summary of points forming a basis for continued negotiation of a business acquisition, merger or other business transfer or a commercial transaction, joint venture or other business arrangement.

I. Letter of Intent Benefits

A. Start regulatory review periods (e.g., Hart Scott Rodino pre-merger antitrust notification filings).

B. Cost-Effective “Go – No Go” Decision. LOIs are relatively inexpensive means for confirming major deal terms before incurring the substantial expenses of due diligence and purchase and financing documentation.

II. Letter of Intent Risks

The LOI may be construed as a binding purchase and sale agreement if it is improperly drafted or if it is improperly characterized in subsequent announcements or other actions of the parties.

A. Vague Tests for Binding LOI. The legal standard in determining if the parties intended to reach an agreement is an objective test – would a “reasonable person” believe that an agreement had been reached based on all of the evidence? The subjective intent of the parties (their actual understandings) is not determinative and, in any event, their understandings would be conflicting in a dispute. Since reasonable persons may reach different conclusions, this imprecise standard leads to unpredictable outcomes and litigation.

  1. An enforceable agreement requires agreement on essential terms. T.O. Stanley Boot Co. v. Bank of El Paso, 847 S.W.2d 218, 221 (Tex. 1992).
  2. Parties may agree on some of the contractual terms, understanding them to be an agreement, and leave other contract terms to be made later. It is only when an essential term is left open for future negotiation that there is nothing more than an unenforceable agreement to agree. A party cannot accept an offer to form a contract unless its terms are reasonably certain. Oakrock Exploration Co. v. Killam, 87 S.W.3d 685, 690 (Tex. App.–San Antonio 2002, pet. denied) (citing T.O. Stanley Boot Co., Id at 221).
  3. Texas courts will construe several separate instruments relating to the same matter together, even if executed at different times, to determine if their cumulative effect constitutes a binding agreement. Board of Ins. Comm’rs v. Great Southern Life Ins. Co., 239 S.W.2d 803 (Tex. 1951).

TIP – Rather than forcing a court to determine the “intent” of the parties who are now making contradictory claims, the LOI should clearly and plainly state its nonbinding or binding effect. Simply stating that a document is a “letter of intent” or “agreement in principle” is insufficient. While most parties subjectively intend an LOI to be a preliminary road map for further negotiations, occasionally a seller wants the LOI to be a binding purchase agreement to fix the purchase price, avoid seller representations and warranties, and eliminate the buyer’s opportunity for due diligence. Sometimes the buyer, as in the Texaco v. Pennzoil case discussed below, wants the LOI construed as a binding agreement. In that case, the buyer (Pennzoil) wanted its LOI to acquire Getty Oil characterized as a binding agreement in order to sue Texaco for tortious interference with contract. Some commentators believe that Pennzoil fared better from the litigation than if it had successfully purchased Getty Oil.

B. Binding LOI without Subsequent Purchase Agreement.

In Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex. App. 1987), writ of error refused 748 S.W.2d 631 (Tex. 1988), cert. dismissed, 485 U.S. 994, Pennzoil won a $10.5 billion judgment against Texaco for tortious interference with Pennzoil’s “handshake” agreement to acquire a controlling interest in Getty Oil for $5.3 billion. Although the judgment was later settled for $3 billion cash, Texaco was forced to file for bankruptcy. A definitive merger agreement for this multi-billion dollar transaction was never signed or even negotiated. However, the court found that a merger agreement had been reached based on a 5-page Memorandum of Agreement and a Getty Oil press release that it had reached an “agreement in principle” with Pennzoil. Other evidence of an agreement included a provision in the subsequent agreement between Texaco and Getty Oil where Getty affirmatively disclaimed making representations regarding the “Pennzoil Agreement” and Texaco indemnified the Getty Oil trustees for any claims arising out of the Pennzoil Agreement. In addition, the Getty-Pennzoil press release announcing the “agreement in principle” included multiple statements worded as covenants or agreements such as: (i) Getty shareholders will receive; (ii) Pennzoil will contribute; (iii) the parties will…. These statements were used to determine that Getty and Pennzoil had reached a “binding agreement” notwithstanding the reference in the press release that the agreement in principle was subject to execution of a definitive merger agreement and stockholder approval.

TIP – References to an “agreement” and obligatory statements should be avoided in subsequent emails, press releases, announcements or other descriptions of the LOI.

C. Binding LOI in Addition to Binding Purchase Agreement.

In Kelly v. Rio Grande Computerland Group, 128 S.W.3d 759 (Tex. Civ. App. – El Paso 2004, no writ) the selling shareholders entered into a “Letter of Intent” providing favorable employment terms for the largest shareholder to serve as President after the closing. However, the purchase agreement omitted these and several other provisions. When the largest shareholder was not retained as the President or even as an employee, he sued the purchaser for breaching the “agreement” contained in the LOI. The purchase agreement contained the following general merger clause:

“Entire Agreement. This Agreement merges all previous negotiations between the parties hereto and constitutes the entire agreement and understanding between the parties with respect to the subject matter of this Agreement. No alterations, modifications or change of this Agreement shall be valid except by a like instrument in writing and signed by each party to this Agreement.”

TIP – A subsequent purchase agreement should specifically list superseded LOIs, agreements and writings in addition to containing a general merger clause.

III. Binding and Nonbinding Provisions. Most LOIs contain binding and nonbinding provisions. Typically, the “transaction” terms are expressly stated to be nonbinding and the “deal protection” provisions are expressly stated to be binding. As a partially binding agreement, these types of LOIs present challenges in clearly stating the intent of the parties.

A. Structuring for Clear Intent.

  • Include an introductory paragraph stating that (1) the provisions listed in “Part A” are not binding agreements unless and until the parties sign definitive agreements regarding and that (2) the provisions in “Part B” are binding on execution of the LOI.
  • List Binding and Nonbinding Provisions under Separate Headings in the LOI such as: “Part A – Nonbinding Provisions” and “Part B – Binding Provisions”
  • Under each heading, restate the intention (the following provisions of this Part [A/B] [are/are not] binding on the parties)
  • List the types of closing conditions typical for the type of transaction in the nonbinding provisions of Part A. Invariably, the buyer will want a “due diligence” closing condition (although the standard of satisfaction with the due diligence results may vary).
  • Reiterate at the end of the LOI which provisions (e.g., those in Part A) are not intended by the parties to be binding and which provisions (e.g., only the provisions in Part B) are intended to be binding.

B. Nonbinding Provisions. Although nonbinding, these provisions are the most important from business and cost control perspectives. These provisions vary based on the type of transaction but typically state:

  • The nature of the transaction – stock or asset purchase, merger, etc.
  • Price and type of consideration
  • Seller financing – terms of promissory notes and/or earn-out
  • Purchase price adjustments based on working capital, cash equivalent, or inventory levels at closing.
  • Buyer’s pricing formula subject to due diligence confirmation of seller statements
  • Post-closing employment and consulting arrangements
  • Post-closing noncompetition and nonsolicitation terms
  • Post-closing purchase price holdback/escrow
  • Closing conditions
  • Due diligence and applicable standard for buyer’s satisfaction
  • Approval requirements
  • Interim conduct of business (may be binding or nonbinding)
  • Interim compensation of employees
  • Applicable financing condition(s)

C. Binding Provisions. Binding provisions may include:

  • A “reasonable or best efforts” obligation to negotiate
  • No-shop/exclusive dealing clauses
  • Interim conduct of business (may be binding or nonbinding)
  • Confidentiality agreement of buyer
  • Governing law
  • Dispute resolution
  • Responsibility for expenses
  • Expiration/deadline for returning fully executed counterpart

IV. Sample Provisions

A. EBITDA Definition for Earn-out (Nonbinding). Transaction provisions defining critical terms may reduce future disputes when drafting the definitive agreement. For example:

“EBITDA” shall mean the earnings of Newco before deductions for interest, taxes, depreciation and amortization determined on a consistent basis with [GAAP consistently applied of/the federal income tax filings made by] the [Seller] prior to the purchase and sale (i) increased by the sum of (i) any [bonus] amounts paid or accrued to be paid to [Selling Owner/Key Employee of Newco] or other members of Newco’s senior management and (ii) any amounts paid or accrued to be paid to [Acquirer], any member of Newco’s board, any direct or indirect portfolio company of [Acquirer], or any direct or indirect affiliate of a Newco board member (each an “Acquirer Affiliate” and collectively “Acquirer Affiliates”), and (ii) after adjustment of the purchase and sales prices of any goods or services Newco sells to or purchases from any Acquirer Affiliate to reflect the amounts that Newco would have realized or paid if dealing with an independent party in an arm’s-length commercial transaction. EBITDA will be determined by [Seller/Acquirer] promptly after the close of each full year after the closing. If [Acquirer/Seller] objects within 30 days of receipt to the calculations, an independent CPA will make a final determination of the amount.

B. Post-Closing Operations (Nonbinding). These transaction provisions relating to Earn-outs must be carefully tailored to each transaction to address financial, accounting and operational issues (to be discussed in a future post relating to Earn-outs).

C.  Equity Protective Provisions (Nonbinding). If the purchase consists of only a controlling interest in the Seller or the Seller retains any equity ownership in the post-closing business, the LOI should summarize the equity protective provisions to be included in the definitive purchase agreement.

D. Confidentiality (Binding). Incorporating a separate Confidentiality Agreement by reference maintains the brevity of the LOI while permitting sufficient length in a separate document to address the issues described in posts on this website discussing “Confidentiality Agreement Traps.”

E. Due Diligence Procedures (Binding). “Subject to executing a confidentiality agreement satisfactory to Seller, the Seller shall permit Acquirer and its employees, consultants and representatives who require such information in order to analyze, investigate and possibly facilitate the proposed transaction (collectively “Personnel”) to have reasonable access to information regarding the Seller and its business; provided, however, until the Seller decides that the closing is assured, Seller may elect to withhold competitively sensitive information (including without limitation customer names, quantity of work and other business matters) and may elect to provide disclosures using symbols, code names and descriptive information in lieu of actual information. Acquirer shall use best efforts to not interfere in any material respect with the operations of the Seller’s business. Acquirer and all of its Personnel must observe the following procedures regarding access to the physical premises of the Seller unless otherwise approved in writing by the Seller:

  • The timing and duration of visits to any premises of the Seller shall be mutually agreed in advance.
  • Representatives of the Acquirer agree to converse only with such employees of the Seller as Seller approves in writing.
  • Acquirer shall send no more than three people at a time to visit any premises of the Seller.
  • Due diligence shall be conducted at the premises of the Seller only in [Seller/Owner’s] presence.”

F. Expiration Clause (Binding). An expiration clause should be included in each LOI since (i) an offer [consisting of the Binding Terms] remains open until it is either accepted or notice of withdrawal of the offer is given, (ii) a tight deadline may inhibit the ability of the other party to “shop the deal,” and (iii) in contrast to a written notice of withdrawal of the offer, an automatic expiration provides a non-confrontational means of terminating the offer without jeopardizing future negotiations.

G. Exclusive Dealing/No Shop Clause (Binding). This clause prevents Seller from seeking, negotiating or agreeing to other offers for a time period sufficient to provide Acquirer a reasonable amount of time to negotiate a definitive agreement.

H. Option Consideration (Binding). Under Texas law, generally a purchaser cannot enforce a “contract” in which it has no obligations. Adding a clause containing purchaser’s promise to pay Seller $100 on demand provides “legal consideration” to make the binding portions of the LOI enforceable when signed by Seller.

This blog does not establish an attorney-client relationship and does not constitute legal advice. Legal outcomes are based on the particular facts of a situation and the application of the law to those facts.  Anyone with issues described in this blog should hire an attorney for legal advice based on the relevant facts. The firm has no obligation to maintain the confidentiality of any information received by email or comments.