Buying or selling a business can be complex, and different things are important in different industries. While it’s not remotely possible to discuss all matters that should be considered, here are some of the major issues to keep in mind:
Valuation
Types of transactions
Sales taxes
Allocation of asset purchase price
Various contract provisions
Bulk sales laws
Confidentiality
The seller should ensure all potential buyers sign a confidentiality agreement before providing proprietary information.
Listing of Assets and Liabilities
Asset Sales
Assets being purchased must be clearly listed.
Vague language (e.g., “all equipment, furniture, and supplies”) invites disputes.
List any liabilities the buyer assumes; specify no others are assumed.
Stock Sales
Do not rely solely on book reviews or general asset references.
Attach detailed lists of assets and liabilities to the agreement.
Valuation
Valuing a business is subjective and open to negotiation. Common methods include:
1. Market-Based Valuation
Based on sale prices of similar businesses in the area.
Often determined through business brokers.
2. Asset-Based Valuation
Considers book value and liquidation value.
Provides minimum thresholds but rarely dictates the asking price.
3. Earnings-Based Valuation
Considers historical financials, cash flows, debts, and projected revenues.
May use industry-specific multipliers or ROI calculations.
Adjustments in Price Based on Performance
Buyers may include performance clauses to protect against revenue drops.
Clauses adjust promissory notes based on business performance.
Sellers may negotiate reciprocal clauses for increased revenues.
Types of Transactions
Taxable Transactions
Sellers pay income tax on gains exceeding the asset or stock basis.
Buyers prefer asset purchases to avoid liabilities and achieve stepped-up basis.
Corporate sellers may prefer stock sales to avoid double taxation.
S Corporation Exception:
Asset sales may avoid double taxation unless converted from a C corporation within 10 years.
Tax-Free Transactions
Occur when stock is exchanged for acquiring corporation’s stock (mergers).
Buyer inherits seller’s low basis.
Sales Taxes
Imposed on tangible property sales in asset transactions.
Not imposed on stock sales.
Custom software usually excluded.
Seller generally liable unless otherwise stated.
Allocation of Purchase Price
Parties should agree on allocation in the purchase agreement.
Buyer favors allocations to assets with faster tax depreciation.
Seller’s liability for sales tax influences allocation.
Buyer Preferences
Maximize allocation to equipment and fixtures (short depreciation periods).
Minimize allocation to intangibles (15-year amortization).
Goodwill Considerations:
Must allocate something to goodwill to preserve trademarks.
Covenant/Agreement Not to Compete
Buyers insist sellers agree not to compete.
Enforceable in Illinois within a specified geographic area.
Allocations to non-compete agreements are deductible for buyers but taxed as ordinary income to sellers.
Hold Backs
Buyers may require escrow holdbacks to cover adjustments or unpaid liabilities.
Sellers aim to minimize these amounts.
Bulk Sales Law
Applies to asset sales when:
The business involves inventory or manufacturing.
Sale isn’t in ordinary course of business.
Over half of inventory and equipment are sold.
Protections:
Buyers require seller’s creditor lists or pay creditors directly.
Successor Liability
Buyers continuing the seller’s business may face liability for pre-closing claims.
Include indemnification clauses.
Verify insurance coverage.
Due Diligence
Buyers should engage accountants to examine records and verify liabilities.
Time limits on due diligence protect sellers.
Illinois resources:
Good standing checks
UCC searches for liens
Litigation search services
BBB complaints check
Environmental health inquiries
Assignment of Leases and Contracts
Buyer should make closing contingent on lease or contract assignments.
Ensure terms and rents remain unchanged.
Licenses & Permits
Seller must confirm all licenses and permits are transferable.
Buyer checks transfer fees and qualifications.
Intellectual Property
Seller should warrant ownership and indemnify buyer against claims.
Key Steps in the Transaction Process
1. Sign a Letter of Intent
Outlines major terms.
May include exclusivity periods.
Not binding unless explicitly stated.
2. Execute a Business Purchase Agreement
Specifies transaction details: parties, price, assets, closing date.
Includes legal provisions: contingencies, non-compete clauses, closing obligations.
Tailored agreements protect interests.
Reasonable liquidated damages clauses are enforceable in Illinois.
3. Open Escrow
Neutral third-party holds funds.
Prepares documents under joint instruction.
Funds may accrue interest under Illinois law.
4. Conduct Due Diligence
Buyers examine financial, legal, and operational records.
Sellers provide timely, thorough disclosures.
Confidentiality agreements protect sensitive information.
Financing Options
Bank loans are increasingly hard to obtain.
Seller financing is common and must be properly documented.
Compliance with State and Local Laws
Attorneys must ensure compliance with licensing, permits, and regulations.
Alcohol Beverage Control licensing is complex; mistakes impact profitability.
Legal assistance recommended for licensing processes.
Final Thoughts
Every step in buying or selling a business requires customized legal documents to maximize protections and reduce risks.
Mansoor Ansari J.D., LL.M. (TAX)
Frequently Asked Questions
What is the difference between an asset sale and a stock sale?
In an asset sale, the buyer purchases individual business assets and assumes only specified liabilities. This allows the buyer to avoid unknown obligations. In a stock sale, the buyer purchases ownership in the company and inherits all assets and liabilities, including hidden ones. Asset sales are more common for buyers seeking clean title.
How is the purchase price of a business typically allocated?
The purchase price is allocated among assets such as equipment, inventory, goodwill, and non-compete agreements. This allocation affects tax outcomes: buyers prefer allocations to assets with shorter depreciation periods, while sellers may face ordinary income tax on non-compete payments and capital gains on goodwill.
Why is a confidentiality agreement necessary during the sale process?
A confidentiality agreement protects the seller by preventing potential buyers from disclosing or misusing proprietary business information. It ensures that sensitive financial, operational, and customer data remains secure during negotiations and due diligence.
What are common methods used to value a business?
Valuation methods include market-based (comparing similar sales), asset-based (assessing book/liquidation values), and earnings-based (evaluating past and projected profits). Each method has advantages and may be weighted differently depending on the nature of the business and industry.
What legal risks do buyers face after purchasing a business?
Buyers may encounter successor liability, meaning they could be responsible for claims related to the seller’s operations before closing. To mitigate risk, purchase agreements should include indemnification clauses, detailed due diligence, and confirmation of insurance coverage.
