Ohio Practical Business Lawyer & Attorney : Teri Rasmussen : Lane Alton & Horst Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

The central legal document in the purchase and sale of any business is the Purchase and Sale Agreement. It fleshes out the details behind the key points mentioned in the "letter of intent" and contains the procedures needed to meet or carry out the respective requirements of buyer and seller. Although, customarily, the purchaser is responsible for providing the initial draft, sellers should not assume that the provisions of the Purchase and Sale Agreement (sometimes referred to as the "PSA") require little of their attention.

If an attorney has not yet been consulted for assistance with the transaction, NOW would be an excellent time to remedy that. PSAs vary considerably and, depending upon whether viewed from the perspective of buyer or seller, some language will be more beneficial than other. In addition, provisions appropriate in one deal may actually be harmful in another. For a more in-depth look at the overall process and documentation involved in the purchase and sale of a business, view my seminar PowerPoint presentation Buying and Selling a Business - Legal Insider's Practical Guide. To read my blog post about choosing whether to structure the transaction as an "asset" or "stock" deal, click here .

Regardless of how the transaction is structured, perhaps the most important, and often the most intensely negotiated, part of the PSA to both sellers and, especially, buyers are the "Representations and Warranties", sometimes simply referred to as "Reps and Warranties". A seller's representations and warranties are essentially assurances from the seller and/or seller's shareholders about the nature, scope. and condition of the business. As such, they operate in tandem with a prospective purchaser's due diligence activities, but should definitely not be viewed as a substitute for that. Because liabilities come automatically with the purchase in a stock/equity deal, reps and warranties are particularly important in those transactions. When the deal is largely or entirely seller-financed, a seller's representations and warranties may become somewhat less important because the buyer will have the ability to offset remaining payments due against any problems; however, even here the content of what is said still matters.

For prospective purchasers, there are three main reasons for focusing on a seller's Reps and Warranties:

• Due Diligence. Reps and warranties are often utilized as a device for obtaining disclosure of crucial information about a company and its business and financial affairs. In this way, they can help aid and organize other due diligence activities. In addition, reps and warranties can also help reduce any transitional "learning curve" after the purchase by providing the buyer with much useful information about how the business operates.
• Exit Hatch. Reps and warranties can also serve as a basis for terminating the transaction if due diligence activities of the prospective purchaser reveals false or inconsistent information prior to Closing
• Damages. Reps and warranties establish what is being bought by providing a detailed depiction of the comapny and its business/financial affairs as it will exist at Closing, thus giving the buyer some assurance that the buyer's expectations of what is being purchased will in fact be that. If the reps and warranties turn out not to be true, that can give the buyer the right to refuse to pay the balance of the purchase price or to demand indemnification from the seller.

From a seller's pont of view, the main reason to pay attention to the "reps and warranties" they are asked to make is that it may affect their abilty to receive the full purchase price bargained for if the reps and warranties prove to be incorrect in any way. Depending upon how the agreement is written, this can be true even if the seller didn't know a particular rep and warranty was incorrect.

So what seller reps and warranties should be included? It depends on the individual transaction, but generally all or most of the following will be included;

• Organization and Good Standing - Seller is properly formed from a legal standpoint
• Authorization; Enforceability - Corporate resolution or other appropriate company or shareholder/owner action authorizing the sale has been taken and nothing else must be done for the deal to be enforced against the seller
• No Violation - Seller is not prohibited from selling by any agreement with any other party or any court order
• Title to Assets; Permitted Encumrances - Key provision for both buyers and seller because it defines what is being sold and its value after taking into account debt to creditors.
• Condition of Assets and Facilities - Extent of specificity will reflect s buyer's areas of concern. materiality and knowledge qualifiers may be appropriate, but should be carefully evaluated.
• Financial Statements - Essentially intended as assurance that Buyer can rely upon the accuracy and completeness of financial statements provided by the seller during the due diligence period. Which financial statements and whether they must be "audited" or merely "reviewed" financial statements depends upon factors such as availibility, relevance to the buyer's commercial valuation of the acquisition and the burden and expense to the seller which the buyer wishes to impose and the seller is able and willing to bear
• Environmental Matters - pertinent when real estate is involved
• Customers and Suppliers - References key contracts and provides assurances that they are valid and enforceable
• Litigation - Provides assurance that except as disclosed on a schedule, the company is not involved in any pending or threatened litigation
• Taxes - promises that taxes are paid current or reserved for in the financial statements
• Compliance with Law - Company is not in violation of any state, federal or local law

In a typical transaction, there will be exceptions or matters that need to be disclosed to make reps and warranties accurate. As a compromise between a buyer trying to minimize post-sale risks and a seller reluctant to make absolute blanket reps and warranties, the exceptions or limitation to the reps and warranties are set out on schedules referencing particular reps and warranties and attached to the PSA. Because these schedules alter the scope of the rep and warranty, it is important for the buyer to carefully review the contents of these exhibits.

While all parts of the PSA are important and should be carefully reviewed, the content and language of the seller's reps and warranties can have the most impact on both parties. Thus both buyers and sellers should take extra care to be certain that these reps and warranties properly reflect the deal as they understand it. (And, yes, a good attorney can really help you here..... :-))

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The most fundamental decision to be made in buying or selling a business is whether the transaction should be done as an asset acquisition or a stock deal.  (Of course, with an LLC, it would be a "membership interest" deal instead of stock, but the concept is basically the same.) 

• In an asset acquisition, the seller is the company and the buyer is another entity, often one created by the buyer for the express purpose of acquiring the tangible and intangible real and personal property of the selling company such as machinery, equipment, intellectual property, vehicles, customer lists, and even contracts. 

• In a stock deal, the seller is the company's shareholders and the buyer is buying the right to control the company's assets rather than directly purchasing the assets themselves.

In the case of privately held businesses, sellers are typically counseled to prefer stock deals while buyers are generally strongly encouraged to structure transactions as asset acquisitions.  Why?  What are the advantages and disadvantages to each?

Stock Deals.  Sellers generally prefer stock deals because gains from the sale of the business will be taxed at the more favorable capital gains rate.  Buyers, however, will find that they cannot write off the purchase price as quickly as they could in an asset acqusition and may want to lower the amount they are willing to pay as a consequence. 

One way to bridge the tax treatment gap between buyers and sellers in a stock deal is to allocate a portion of the purchase price to an "employment" or "consulting" agreement with the selling shareholders.  Although the selling shareholder(s) will have to pay ordinary income tax on the amounts received under these agreements, the buyer can claim the amounts as a deduction which may offset other tax disadvantages of structuring the transaction as a stock deal. 

Structuring a transaction as a stock deal is deceptively easy.  All that is necessary is the conveyance of the shareholder's stock certificate to the new owner.  Unlike an asset acquisition, there is no need to re-title vehicles or real property in the name of the new owner.  In addition, there is no need to specifically assign contracts, permits,  licenses, patents, and other intellectual property to the new owner.  Nor must any consents be obtained from any third parties to the transaction unless other agreements such as loan agreements require it.. 

However, from the buyer's standpoint, due diligence in understanding the nature of the financial and business affairs of the company being purchased is especially crucial when doing the deal as a stock purchase.  Because all of the company's liabilities will follow the new owner in a stock deal, such liabilities as employee benefits, tax, environmental and product warranties can inadvertently add considerably to the actual acquisition purchase price in the form of unanticipated expenses after the sale if not fully understood.

Asset Acquisitions.  The main reason buyers should insist upon an asset acquisition in most cases is that it avoids accidentally acquiring unwanted (and perhaps undisclosed or even unknown) liabilities of the selling company.  Suppose, for example that someone has been hurt by a product manufactured by the selling company the day before the transaction closes or perhaps the seller has neglected to mention a vendor or other creditor is owed money.  If the transaction is structured as a stock deal, all of these obligations automatically follow the new owner.  If done as an asset acquisition, the buyer's risk is substantially reduced, if not eliminated.  If the parties wish to have the purchaser of the business assume certain obligations, then those can be specified in the Purchase and Sale Agreement governing the transaction.  

Structuring the transaction as an asset acquisition also generally has beneficial tax benefits for buyers not available in a stock deal.  Assets can be "marked up" to the purchase price and the new owner can enjoy the benefits of depreciation.   If the assets involved include real estate, the adverse tax consequences to sellers  of an asset acquisition may be lessened.

Another useful aspect of an asset acquisition is that certain assets can be excluded from the sale.  This can be helpful in owner-operated businesses in which there may be emotional attachments to certain property.  It can also allow a buyer to avoid paying for items duplicative of property already owned or of little value to the ongoing operation of the company as the buyer intends it.

Documenting the Deal.  While the Purchase and Sale Agreement (sometimes called the PSA) is fairly similar regardless of the method chosen, there are some key distinctions.  If structured as an asset acquisition, the company sells the tangible and intangible personal and real property to another entity, often one created by the prospective purchaser for the particular purpose of buying those assets.  Although, technically, shareholders are not parties in an asset acquisition, they are often required to sign the PSA anyway to stand behind the representations and warranties being made concerning the assets and the company being sold.   If instead, the transaction is structured as a stock deal, the parties to the agreement will be the existing shareholders, not the company, as sellers and the new owners; the company whose shares are being sold is not a party to the transaction. 

In asset deals, PSAs will sometimes specifically mention particular obligations being assumed by the purchaser.  It is also possible in an asset acquisition that the seller will want to retain certain property and the PSA will then specify the "excluded assets" from the deal.

Choosing How to Structure the Transaction.  Asset acquisitions ARE generally more complicated and employees must be "re-employed" by the new company to avoid successor liability issues.  If a buyer is a longtime employee of a company or otherwise extremely familar with the company, the extra protection against unknown liabilities offered by an asset acquisition may not be worth the greater complexity.  In addition, the older the company being purchased is, the more severe the adverse tax consequences for the purchaser in doing a stock deal rather than an asset acqusition; with newer, younger companies, the tax benefits of an asset acquisition may not matter as much to prospective purchasers. 

It is also possible that a company may have beneficial tax attributes such as a net loss carryforward that the purchaser may wish to acquire and which can only be obtained through a stock transaction.  Beneficial employment or insurance ratings might also persuade the prospective purchaser that a stock deal might be the better structure.

On the other hand, a seller dealing with a minority or dissident shareholder may prefer an asset acquisition because it can be accomplished without needing unanimity of all shareholders.  Under Ohio law, generally the approval of the selling company's board of directors and a two-thirds vote of the shareholders is all that is required.  So long as the purchase price is reasonable, the minority or dissident shareholder has no recourse.  In a stock deal,  the minority or dissident shareholder could simply refuse to sell. 

Every deal is different.  Both buyers and sellers must evaluate a number of factors to determine which way their particular transaction should be done.  Advisors such as CPAs and attorneys can often assist in this task, as well as providing useful advice about other aspects of the transaction.

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