Buying a New Business? Don’t Forget to Review all Contracts

The purchase of a new business is one of the most significant transactions you will ever make. It’s an exciting yet stressful time with many lucrative opportunities. However, if you don’t carefully pay attention to due diligence or gloss over something critical, the whole deal could go wrong or, worse yet, you could be buying a long-term liability or a headache that ends up costing you money for nothing or less than nothing in return.

You must review all of the seller’s contracts when buying a business. The best way to do this is to hire a seasoned business lawyer who knows the due diligence required, the federal, state, and local laws that apply, and has the resources to help get you the advice and counsel you need for specialty issues.

Your attorney can point out any holes in the contracts and determine the associated risks and costs, as well as the potential to improve or modify those contracts either before or after the purchase. Now is also a good time to evaluate any vendor contracts coming up for renewal to determine if you should proceed with those.

The Importance of Clear Agreements

Aim to draft clear transaction letters of intent and agreements from the start. Be sure to identify significant material terms and expected boilerplate language. Taking these steps will memorialize each party’s expectations of the terms.

Preventing Miscommunications

Always put your agreements in writing. Even if you make a deal over the phone, consider drafting a detailed contract that can be signed. This way, each party is fully aware of the agreement’s terms. By signing the agreement, each party states that they understand what it contains and agrees to abide by it. If there are ever any disputes, either party can go back to the written contract to determine how the dispute should be handled.

Frequent Transactional Disputes 

While there are a lot of valuable pieces of data that you’ll gather during the due diligence process, don’t assume that everything looks as perfect as it appears on paper. Instead, have your own business attorney review each contract, especially vendor and employee contracts and handbooks.

Coming in as a new owner creates an excellent opportunity to learn the lay of the land and decrease your chances of unpleasant surprises or litigation in the future.

Whether you are the buyer or the seller, the legal support offered by an experienced business attorney will be an invaluable part of your journey.

Be aware of the following common transactional disputes that might arise during the sale or purchase of a business:

Vague Terminology in Purchase-and-Sale Agreements

Be sure to use well-defined terminology in purchase and sale agreements. Even if key language is well-defined, there may be words or phrases open to debate, interpretation, or various calculation methods. For example, there may be several ways to calculate a single item contained in the agreement. As such, the agreement should stipulate how the calculation is made. Definitions and key phrases should be fully explained within the agreement.

Earnout Calculations

Earnouts are a consideration provided to the seller arising from the purchased business’s post-closing performance. If the seller meets or exceeds the defined financial and operation goals, they receive the earnouts. However, earnout qualifications and calculations are frequently multifaceted and create opportunities for future conflicts between sellers and buyers long after the sale. Disputes may arise regarding the earnout period, calculations, intervening economic impacts, or the appropriate data sources or accounting methodologies.

Working Capital 

The seller retains all the cash or the cash that exceeds the business’s working capital necessities. This ties to the price being paid and the valuation method used to determine the company’s value. If working capital is included in the purchase, the seller and buyer must agree on how much working capital is part of the company being bought and, therefore, will be left in the company at closing. These issues shouldn’t end a deal, but they give rise to disputes that have to be worked out. After examining all factors, the parties should be able to reach a practical mutual agreement. A specific formula to develop a working capital requirement should be adopted in the transaction when needed.

Valuations of COVID-19 Affected Businesses

Business valuations can lead to disputes, especially now, considering the known and unknown effects of the COVID-19 pandemic. For example, when obtaining a professional business valuation or marketing your company, you cannot hide any factors that the pandemic has had or could have on the business. Undisclosed or hidden factors that are material to the evaluation of the business can turn into a claim for fraud, especially when the buyer will require the seller to represent and warrant that all the disclosures are complete and accurate and all material information has been identified and provided.

Sellers should be honest in depicting how their business currently functions and how it will continue to function navigating the murky waters beyond the pandemic. Of course, no seller can predict the future. Still, they should provide any information that might matter to the buyer or could be critical in how the business does in progression.

Hire an Experienced Business Attorney

Whether you are the buyer or the seller, the legal support offered by an experienced business attorney will be an invaluable part of your journey. If you want a smooth transaction, the intelligent choice is to seek legal help. With a well-versed business lawyer by your side, you can have the assurance that going forward with the sale is the right thing to do. Your lawyer will review all contracts and help you draft contracts, ensuring that both parties understand the language. To ensure the most success while buying or selling a business, enlist the help of a business attorney.

Doug Griess and John Snow of Hackstaff & Snow, LLC, are top Denver business attorneys with expertise spanning various industries. Specializing in business law, litigation, intellectual property, tax law, and dispute resolution, John Snow and Doug Griess offer an in-depth understanding and knowledge of general corporate rules and regulations and are a trusted resource for business owners throughout Colorado.