Bob was a senior employee at an inspection services company (“Company”) that specialized in inspection and testing services for oil and gas pipeline and storage companies. Company was owned by an individual (“Seller”) who had been in the business for years, but ran the Company in an informal way characteristic of many single-owner businesses. Seller wanted to retire from the business to pursue his hobbies and Bob proposed purchasing the Company from Seller. Seller agreed. Bob sought advice and investment from his friend Peter, an accomplished and successful businessman who had sold his own energy manufacturing company several years ago. Peter agreed to provide acquisition funding for Bob to buy the business and advise Bob in the purchase and operation of the Company in exchange for a share of the equity in the new business.
Peter approached Aaron Ball for legal advice on the acquisition as he had served as Peter’s lawyer in connection with the sale of Peter’s company. Aaron first helped Peter and Bob outline their own agreement about how Peter would provide the purchase funds, what ownership and management each would have in the new company following the purchase, and the timing and circumstances under which Peter would recoup his original investment. At the same time, Aaron advised Peter and Bob that they should purchase the assets of the Company rather than the Company itself, since buying the assets would not subject the buyers to the historic liabilities of the Company arising prior to the closing. Next, Aaron developed a due diligence plan and a list of documents and other information both Aaron and the buyers should review prior to buying the Company assets.
Part of the problem in buying a small business is the emotional attachment the seller has for their company.
This often manifests itself with the seller overvaluing his business and trying to place too many conditions on how the business will run after the closing. Further, single-owner businesses have rarely been through a sale before and are unaccustomed to the due diligence process (frequently not understanding why buyer’s can’t just “take their word for it”). They might have run the company like their own “personal piggy bank” and so a detailed examination of books, records and operations sometimes feels to the seller like a personal investigation. To further complicate things, small business owners often rely on legal counsel who are either personal friends or general practitioners, both of whom are unaccustomed to working in this area and, if so, only infrequently. Unfortunately, Bob and Peter found all of these things to be true with the Seller. In this case the Seller mixed personal and business assets and sought advice from a local attorney whose primary focus was estate planning.
When faced with this situation Aaron knew, from experience, that one of the biggest hurdles was educating the Seller and his counsel about the potential legal risks to the buyer and why extensive due diligence was necessary. Both Seller and his counsel were also unfamiliar with post-closing working capital adjustments and risk allocation provisions. Seller also assumed that, despite the sale, he could continue to keep his personal office and belongings at the main business location and, by contrast, he believed his responsibilities to the Buyer would be over at closing. Aaron and the buyers knew Seller’s cooperation both before and after the closing was critical to the smooth transition of existing customers. Aaron drafted agreements tying payment of a portion of the purchase price both to Seller’s cooperation with the sale (before and after closing) as well as establishing an escrow to cover unexpected liabilities and “bad receivables” that characteristically arise within the first year after closing.
Just as Aaron had predicted after closing some of the receivables sold in the transaction did not pan out and unexpected liabilities not disclosed during due diligence cropped up after closing. Buyers were able to successfully cover all of those expenses through deductions against the escrow. Further, holding back some of the purchase price also encouraged the Seller to cooperate in securing customer transitions both before and after the sale. Buyers were able to not only successfully transition the Seller’s old business, but improve and build on the existing customer base with enhanced marketing and improved service. Today, Buyers’ business is more profitable and more successful as a result of the important steps taken with Aaron’s help before and after closing.