Common Mistakes in Small Business Purchase Agreements

I get it, when you buy or sell a very small business, you don’t want to spend an arm and a leg on lawyers to draft all the necessary documents. Thus, many people look to templates or whatever forms their business broker has and go ahead without a lawyer or accept very simple purchase and sale agreements without thinking twice about it.  I advise against this.  You are likely to spend a large sum of money and can’t afford to lose that investment.  If you are the seller, you want a return on the business you built without legal issues and liabilities down the road. Even a small business purchase has a lot of moving parts and you need a properly drafted purchase agreement.  I’ve seen many of these super simple agreements and these are the common mistakes I see in those small business purchase agreements:

No distinction is made between an Asset Sale or a Stock Sale

The agreement may make a vague reference to the “Business” being sold, but the rest of the agreement does not make clear whether all of the assets of the business are being sold or whether the shares or other equity in the entity that owns the business is being sold.  It makes a big difference.  If you buy all of the stock of the corporation that owns the business, you automatically step into the shoes of the corporation and take on all of the rights and obligations of the corporation.  This is a dangerous position to be in unless you are 100% percent sure what all of those obligations are.  To circumvent this broad liability, business purchasers often prefer to buy just all the assets that constitute the business.  In other words, all the furniture, accounts, receivables, websites, domain names, trademarks, leased locations, and clients that taken together represent the business.  Everything that, if you own it, enables you to continue the business.

Imke Ratschko Small Business Lawyer

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The Assets to be sold are not identified properly

The agreement may make a vague reference to “all the assets”, but is otherwise silent and does not further identify these assets.  There should be a definition of what the “Purchased Assets” are.  And even if you buy “substantially all the assets,” there are always some that are excluded.   For example, in most cases, cash and bank accounts of the seller are excluded.  This needs to be specifically provided for in the agreement and defined as “Excluded Assets”.  If you leave this vague, you may get into a dispute later about what is and what is not included.

Another classic mistake: The assets are defined as “the assets listed in Exhibit A” but then Exhibit A is nowhere to be found and is not made part of the final executed purchase agreement.

Buying all the assets often also includes the lease for the business location. Now, you can’t just step into the shoes of the seller as the prior tenant.  You have to review the existing lease and see if an assignment of the lease requires the consent of the Landlord.  It most likely does.  In that event, you can’t obligate yourself to buy the business or pay the purchase price without getting that Landlord’s consent.  This should be a condition of the purchase agreement.  If you forget to make that a condition of the purchase agreement, you may end up without a location to conduct the business in, but still be obligated to take the rest of the assets and pay the purchase price.

Along the same lines, you want to provide who gets credit for the security deposit held by the landlord.  Is that part of the purchased assets or not?  If not, Seller usually gets back the security deposit at closing.

The Representations and Warranties are not sufficient

There should be proper warranties and representations regarding the assets you are buying or selling. While the extent of Seller’s representations and warranties can sometimes be heavily negotiated, I would not accept any term that says that the assets are accepted “as is” or something similar.  At a minimum, you should have a representation that the equipment and other tangible assets are free of any liens and that they are in good working order. If contracts are part of the Purchased Assets, you should be guaranteed that they are valid and enforceable and that all amounts outstanding have been paid.

Closing Deliveries are not Defined

The closing is the day when the business changes hands and the purchase agreement is consummated.  Many purchase agreements just refer to a “Closing” but then do not clearly spell out what has to be exchanged on that day.  It should be made very clear.  The Purchaser usually has a list similar to this: 1. Payment of the purchase price in immediately available funds, i.e. certified check or wire transfer; 2. If the purchase price is paid in installments, a fully executed promissory note for the remaining installments; 3. Executed copies of whatever other agreements are part of the closing, for example, an assignment and assumption agreement assigning all of the seller’s rights under certain contracts to the purchaser.

The seller may have to deliver: 1. A bill of sale which is the instrument that officially transfers the assets; 2. the consent by the Landlord to the assignment of the lease; 3. Executed copies of whatever other agreements are part of the closing.

Bottom Line:

I do not recommend selling or purchasing a business without the advice of a business lawyer, such as myself.  The heart of every business purchase, the purchase agreement, is a complicated agreement that needs to be customized to your particular situation.  A form template will never do.  To better understand what is involved in such a transaction, also see “5 Steps of Buying a Small Business in New York