Volume 11 Issue 4 -- July/August 2007
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
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
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
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
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.
Published by the law firm of Newland & Associates, PLC
9835 Business Way
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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