Most people have heard of "buyer beware" but anyone selling their business would be wise to think "seller beware". When someone decides to sell their business they naturally want to find a buyer as quickly as possible for the highest possible price. But business owners and advisors should take care to avoid litigation traps in selling a business.
1. Conduct due diligence on the buyer. Is the buyer adequately financed? Even if the buyer is able to obtain a loan will the buyer have sufficient operating capital to run the business? Moreover, does the buyer have an aptitude for the business? If not, the buyer is less likely to succeed and an unhappy buyer is more likely to file a lawsuit.
Check out the buyer's litigation history, judgments and credit history. A buyer will almost always obtain tax returns from a seller but a seller should also consider obtaining financial information from the buyer.
2. Do not divulge trade secrets and confidential business information without a signed confidentiality agreement. The theft of trade secrets is an increasingly litigated issue. In the business sale context this often happens when negotiations break down and the potential buyer decides they can start their own business. It is important for the confidentiality agreement to include the right to obtain an injunction, damages and attorneys fees in the event of a breach.
3. Avoid signing ambiguous letters of intent. Some letters of intent are binding and others are not. Be sure to have counsel review any letter of intent to make sure it protects your interests.
4. Do not make inaccurate representations and warranties. Sellers often do not carefully consider the representations and warranties they make in the purchase agreement. There are significant risks in making false or negligent representations and warranties.
5. Failure to adequately document the disclosure of adverse material facts. Often a seller will divulge to the buyer adverse material facts that impact the business. After doing so the deal closes despite the bad news. Imagine the frustration then when the buyer sues the seller for breach of warranties and representations, fraud and breach of contract claiming that the seller never told the buyer about the problems. At a minimum, a seller should have the buyer acknowledge receipt of the adverse material facts during the due diligence phase. By doing so the seller can protect against claims down the road that the buyer was never told about problems with the business.
6. Do not draft your own purchase agreement or rely upon a business broker's form agreement. In my experience the only person protected by a broker's form agreement is the broker. The broker will often tell a seller that a lawyer will only slow up the process and add expense. The broker has only one thing on their mind - the commission. Make sure you talk with a lawyer experienced in business sale transactions when drafting the contract. Sure, it does add some expense but it will likely pay off down the road. A well-drafted contract can help you avoid litigation completely or it will provide better protection if and when litigation does occur.
Source: Thanks to Pennsylvania business lawyer Anthony Cerminaro for his post on the topic.
