Finalize the Deal | Closing the Sale of a Business

Just because you have a signed letter of intent (LOI), doesn’t mean you’re ready to close the sale of your business. Before moving on to retirement or that new business opportunity you’ve been eyeing, you’ll have to finalize the deal.

This is the time to lean on the expertise of your attorney, accountant, and business broker (if you are using one). These professionals can help ensure a speedy and seamless closing. But it’s up to you to manage all the moving parts and take your business sale over the finish line. 

Before you can close the deal, you’ll have to:

• Complete the due diligence process
• Set a timeline for receipt of payments from the buyer
• Determine (and negotiate) how you’ll allocate the proceeds of the sale for tax purposes
• Create a purchase and sale agreement
• Close the sale

Don’t Let Due Diligence Catch You by Surprise

Due diligence, the process by which buyers verify the information given during negotiations, begins once an LOI is signed and the buyer has signed a non-disclosure agreement (NDA). It usually takes about 30 days, but more complex transactions can take longer if both buyer and seller agree. (Sellers typically conduct their own due diligence to determine whether the buyer is financially able to close a deal).

If you’ve conducted negotiations judiciously, you’ve withheld the most sensitive information about your business from the prospective buyer. You’ll now have to disclose nearly everything and provide supporting documents.

Most LOIs include contingencies allowing buyers to renegotiate the sale price and terms if unexpected information emerges during due diligence. It could be something as simple as a discrepancy in the number of computer stations or as complicated as an existing lien on business property. As the seller, you aim to remove those contingencies so the sale can proceed.

Buyers will want to inspect all the financial and operating details of the business, so having all your documentation in order is key.

Remember that time isn’t on your side when closing a deal. The economy can tank, a big client can go under, your most critical employees can jump ship, or your buyer’s circumstances could change between when you agree to a sale and when it closes. Any one of these or other events can affect your sale price.

By getting all your documentation ready for inspection early, you can expedite the due diligence process and reduce the chances that unanticipated events will delay or derail the sale or impact the value of your business.

The documents you must have ready include:

• Financial records going back at least three years, including a statement of seller’s discretionary earnings (SDE), tax returns, cash flow statements, P&L statements, an analysis of profits and expenses, credit reports, loan documents, and other financial records pertinent to the business
• Legal documents, including business formation documents; documents pertaining to any pending litigation; contracts; loan and lease agreements; outstanding liens; patent, trademark, and copyright documents; and compliance documents
• Operating information, including inventories of assets and products, customer databases, and procedural manuals
• Employee, payroll, and benefits records
• Marketing files and records related to customer acquisition, logos, websites, and other branding materials

Following due diligence, it’s not uncommon for buyers to return to the negotiating table and ask for price concessions claiming new information has emerged to warrant revisiting the sale price. Be prepared for another round of negotiations to iron out any differences. These negotiations won’t usually derail the business closing sale, but they can result in sale price concessions or credits given to the buyer.

Set a Payment Structure and Timeline

In most cases, sellers request and receive good faith deposits before the start of due diligence. A good faith deposit helps assure sellers that the prospective buyer isn’t just kicking tires and is genuinely interested in reaching a deal.

Now it’s time to firm up the details of how and when the buyer will remit the purchase price balance. In many cases, buyers and sellers agree to payment in full at closing. But buyer and seller might agree to other arrangements, such as installment payments due at predetermined points in the process.

Allocate the Proceeds of the Sale

The IRS requires buyers and sellers to assign a value to each asset included in a sale, called a purchase price allocation. How the purchase price is allocated to different assets has tax implications for buyers and sellers.

Buyers and sellers generally have different interests when it comes to allocating the proceeds of a sale. Where it gets tricky is that both parties must agree on the allocation.

Sellers prefer to allocate as much of the purchase price as possible to asset categories subject to capital gains tax treatment (rather than ordinary income, which is taxed at a higher rate).

Suppose the seller and buyer agree to a purchase price of $1 million. The seller proposes the fixed assets of the business amount to $500,000, and the difference between the asset values and the purchase price—$500,000—be attributed to goodwill. Both fixed, or tangible, assets and goodwill are taxed as capital gains, reducing the taxes the seller must pay on the sale proceeds.

Buyers, on the other hand, get the greatest tax benefit over the shortest period of time by depreciating the assets of the new company. Amortization offers a lesser tax benefit, and the write off from amortization must be taken over a longer period of time. Because goodwill is amortized and not depreciated, buyers generally want the smallest possible portion of the purchase price attributed to goodwill.

If, as the seller proposes in this example, $500,000 of the purchase price is allocated to goodwill, the buyer loses the depreciation write-off on the remaining $500,000, essentially increasing the company’s purchase price in the buyer’s view.

This example is oversimplified, but you can see how buyers and sellers might be at odds over the purchase price allocation. Sellers should work with an accountant to set a purchase price allocation and be prepared to negotiate the allocation with the buyer.

Create a Purchase and Sale Agreement

A purchase and sale agreement details all of the terms of the sale including:

• Purchase price
• Assets and liabilities included in the sale and those excluded
• Payment structure
• Purchase price allocation
• Agreements between buyer and seller, including non-compete and consulting and employment agreements
• Statement of representations and warranties
• Bill of sale
• Assignment of leases, contracts, intellectual property, and stock transfers
• Statement of post-closing rights and obligations
• Responsibilities for paying professional fees

Unless employees have a transferable contract, the purchase and sale agreement should also include the seller’s agreement to terminate employees and pay all final wages and benefits due. Depending on the arrangements made with the buyer, employees will have to be rehired under the new company’s Employer Identification Number (EIN).

Closing Day

The sale doesn’t “officially” close until buyer and seller sign the bill of sale and payment is wired or transferred to the seller. Both must occur before the title is transferred to the new owner.

In some cases, the signing and payment transfer will happen virtually. Sometimes an escrow officer handles getting documents signed, then sending the signed documents to the parties involved. In these instances, it’s likely that paperwork will be signed and delivered as it is completed and closing day will occur over several days or weeks. A third option is to hold a closing meeting where the parties sign and transfer all documents.

The owner/seller, buyer, any third party loan guarantors, attorneys for both parties, the escrow officer (if one is used for the transaction), and any brokers involved typically attend the closing meeting.

The documents delivered and signed at the closing meeting include the payment along with:

• Purchase and sale agreement
• Bill of sale
• Transfer documents for lease and vehicle transfers, patents, trademarks, and other intellectual property
• Any agreements including non-compete and employment agreements
• Closing or settlement statement that details all costs and adjustments paid or credited to the buyer and seller
• Asset acquisition statement and related tax forms

In addition, the seller turns over keys, access and security codes, client and vendor lists, and other essential operating items.

Once they’ve closed, sellers still must take a number of steps to dissolve their business entity and cease operations. They should cancel licenses and permits and their EIN, cancel insurance policies, notify the IRS and state tax boards, and file any necessary forms with the appropriate government agency. Sellers should also pay off any invoices that weren’t assumed by the buyer, pay final wages to employees, pay any final taxes owed, and file final tax returns.

As you manage all the moving parts to take your business sale over the finishing line, lean on the expertise of your attorney, accountant, and business broker. Assembling a team of professionals can help ensure a speedy and seamless closing.