Newland's Business Notes

Selling (Getting Out Of a Business)

Volume 11 Issue 4 -- July/August 2007

In our last newsletter, which was entitled “Investing (Coming Into a Business),” I noted that many business relationships were started on the basis of the Biblical values of “faith, hope, and charity.” Reliance on these Biblical tenets also exists with regard to those who sell businesses. 

Let’s look at the following example. Years ago, I. M. Doap (“Doap”) and Bob Head (“Head”) formed a company that installed communications systems in buildings.  The company, Doap-Head, Inc., prospered in spite of its name, and made many advances in the business of wiring buildings for communications. 

Eventually, their success reached the attention of a larger company known as A. Choir, Inc. (“Choir”).  Choir had gone national and had dubious business credentials but its founder, Mr. A. Choir, had been very successful in purchasing other businesses. Choir was interested in purchasing Doap-Head.

Of course, the principals of Doap-Head had no way of knowing that Choir was financially over-extended and owed multiples of millions of dollars to many creditors. 

As the negotiations for the purchase of Doap-Head progressed, Choir used its standard business practice which was to seek an outright sale of the assets of Doap-Head to one of Choir’s business entities.  In exchange for the sale of the assets of Doap-Head, Choir provided a promissory note to the sellers.  Such a transaction is commonly known as “seller financing,” because the seller in effect finances the purchase by agreeing to take the promissory note, instead of cash, in payment for the assets.

Because Doap-Head’s attorney was not sophisticated in business matters and relied on a lot of faith and hope, he did not advise Doap-Head to obtain a security interest in the assets sold by Doap-Head to Choir. In other words, the assets of Doap-Head could have served as collateral for the seller financing.

In this situation, however, Choir went into bankruptcy six months after the sale and the promissory note provided to Doap and Head was not secured.  This meant that they were unsecured creditors in the bankruptcy proceeding and got what many people get in such situations – little or nothing for their claim. 

If Doap-Head had obtained a security interest in the assets until the promissory note was paid, then the sellers likely could have received back the assets as secured creditors in the bankruptcy proceeding.  As simple as it sounds, obtaining a secured interest in the assets that are sold, whether they’re physical or intangible assets, is something often overlooked by sellers of business assets. 

The scenario plotted above is very simple and it would seem that almost any seller would want to maintain a secured interest in the assets until the promissory note had been paid. Of course, if Doap-Head had insisted on receiving cash payment, the principals would not have to worry, in many cases, about the bankruptcy situation described above.

The message is, if the seller is going to provide seller financing, a security interest should almost always be obtained in the underlying assets!

During the negotiation of sales of businesses or even separations of former business associates, attention needs to be given to a variety of other issues such as covenants not to compete and continued employment of the seller’s principals in the purchaser’s business.  For example, many times, the purchaser of the assets or stock of a business wants to ensure that the former manager/owner continues in some capacity for a period of time.  The structuring of these aspects of a sales agreement requires very detailed attention. 

Surprisingly, many times even the most basic question — what is to be sold – assets or stock — is ignored until negotiations are fairly far along.  In addition, consideration needs to be given to inventories, accounts receivable, equipment, land and, of course, the terms and conditions of the sales agreement.  These and many more issues are covered in the Business Purchase Checklist available on our Web site. 

Before you provide seller financing, it is important that your security interest be fully protected so that if the purchaser fails, you have the ability to get the assets back. 

If you need help in negotiations for selling a business or the documentation for a sale of a business, contact Newland & Associates.

Copyright 2007

Published by the law firm of Newland & Associates, PLC
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Manassas, VA 20110
Call us at (703) 330-0000 for a full range of business law and tax-related services.

While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.

Redistribution or other commercial use of the material contained in Newland's Business Notes is expressly prohibited without the written permission of Newland & Associates, PLC.

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