LEGAL ASPECTS OF SELLING A BUSINESS IN MICHIGAN
INTRODUCTION
If you are selling a business in Michigan, it is crucial to select an experienced business attorney who will effectively advise you throughout the transaction. The attorney should understand the industry that your business operates in, and properly draft and negotiate the various agreements that will document the transaction. In this blog post, I discuss the legal aspects of selling a business in Michigan.
LEGAL ASPECTS
1.) Protecting Confidential Information
A buyer will typically conduct due diligence on a business before it proceeds to consummate the purchase.
Legal due diligence is the process of investigating and evaluating a business or its assets in connection with an acquisition. The purpose of legal due diligence is to confirm certain items regarding the business, understand whether any third-party consents or other actions will be required in connection with the acquisition, and assess the potential risks of the acquisition.
Legal due diligence can be extensive or narrowly tailored. As part of its legal due diligence, buyer’s counsel will typically prepare and furnish legal due diligence request lists to seller’s counsel. The content of such request lists will vary depending on the size and nature of the business being acquired but will usually ask for information regarding: (i) entity governance, management, ownership and operations; (ii) financial matters; (iii) tax matters; (iv) real and personal property matters; (v) intellectual property matters; (vi) contract matters; (vii) litigation; and (viii) employment and benefits matters.
This information can be of a confidential and sensitive nature, so a seller should ensure that its disclosure of information will be afforded confidential treatment. A seller can do this by requiring the buyer to enter into a confidentiality agreement with seller. The confidentiality agreement should broadly define confidential information and contain provisions on: (i) permitted use and restrictions on disclosure; (ii) standard of care; (iii) return or destruction of confidential information; (iv) term and termination; (v) remedies; and (vi) non-solicitation and non-competition.
2.) Letter of Intent
Most business sale transactions involve a letter of intent, which is a preliminary document in the sale of a business. A properly drafted letter of intent should clearly indicate whether it is binding or non-binding, describe the basic terms of the proposed transaction, and set the expectations of the parties prior to expending the time, cost and energy drafting and negotiating the acquisition agreement. Letters of intent usually include a basic description of the proposed transaction and terms on: (i) purchase price; (ii) conditions to closing; (iii) closing date; (iv) primary and ancillary agreements; (v) exclusivity; and (vi) term.
3.) Transaction Structure and Tax Considerations
A business acquisition can take many forms, including (i) asset purchase, (ii) equity purchase and (iii) merger. Each form has its own benefits and drawbacks. The buyer typically determines the transaction’s form in most acquisitions, but this will depend on the parties’ specific business objectives and respective bargaining power. For a description of the different forms of business acquisitions, along with their benefits and drawbacks, please see my blog post: Legal Aspects of Buying a Business in Michigan.
4.) Preparation and Negotiation of Transaction Documents
An acquisition agreement is the definitive agreement that documents a business acquisition. Acquisition agreements typically contain: (i) a description of the transaction, including its structure, what is being acquired, and the amount, form and timing of consideration to be paid; (ii) representations and warranties, which are statements of past or existing facts and assurances made by the parties to the transaction; (iii) covenants, which are promises to take certain actions; (iv) closing conditions, which detail what must occur before the parties are obligated to close the transaction; and (v) indemnification provisions, which allocate risk for any breach of the representations, warranties and covenants by imposing financial responsibility on the party responsible for such breach.
The representations and warranties are often the most heavily negotiated provisions in an acquisition agreement. Buyer will prefer broad language, whereas seller will prefer more limited language with knowledge and materiality qualifiers. The representations and warranties will reference certain disclosure schedules attached as an exhibit to the acquisition agreement. Disclosure Schedules either list (i) exceptions to the acquisition agreement’s representations and warranties, or (ii) other information. The disclosure schedules are prepared by seller's counsel.
Indemnification provisions are also heavily negotiated in an acquisition agreement. From a seller’s perspective it is important that these provisions contain certain limitations, such as baskets and caps. A basket functions similar to a deductible and requires damages to reach a certain threshold amount before a buyer is entitled to indemnification from the seller. A cap is a maximum dollar limit on the seller’s indemnification obligations to the buyer. Appropriate indemnification limitations will depend on the facts and circumstances of the specific transaction and are subject to negotiation between the parties.
Legal issues in a business sale transaction often arise from seller lacking a necessary understanding of what must be disclosed and thus insufficiently preparing the disclosure schedules. If certain representations and warranties are breached, seller may have to make indemnification payments to buyer. Working with an experienced business attorney can help ensure that the disclosure schedules are properly prepared and minimize the risk of legal issues arising at a later time.
Acquisition agreements also typically contemplate certain ancillary agreements, which can include: (i) promissory notes; (ii) escrow agreements; (iii) transition services agreements; (iv) employment or consulting agreements; (v) termination agreements; and (vi) non-compete and non-solicit agreements.
No two acquisitions are the same. Each acquisition will have its own unique terms. It is critical that the agreements be carefully and thoughtfully drafted to properly reflect the transaction’s business terms and achieve the seller’s specific business objectives.
5.) Consents and Notices
When a business undergoes a change of control or sells all or substantially all of its assets, the parties may need to obtain consents from or provide notices to third parties doing business with the business. Whether such consents need to be received or such notices need to be given will depend on the structure of the transaction and the terms of each individual contract which the business is a party to.
For example, if a seller leases its place of business from an unrelated landlord, the lease agreement will need to be reviewed for restrictions on assignment. Some leases define an assignment to include a change of control in tenant. If such restrictions exist, landlord’s approval may be required to approve the lease assignment.
If a seller is a corporation that sells all or substantially all of its assets outside the ordinary course of business, the seller’s shareholders and board of directors must approve the sale. There is no bright line test as to when substantially all of the assets of a corporation are being sold. Instead, this inquiry is based on the totality of the circumstances, and must take into consideration the type and character of the assets being sold and the nature and extent of the assets being retained. Under Michigan law, a corporation has not disposed of all or substantially all of its property and assets if it retains a significant continuing business activity representing at least 25 percent of total assets at the end of the most recently completed fiscal year, and 25 percent of either income from continuing operations before taxes or revenues from continuing operations for that fiscal year, in each case of the corporation and its subsidiaries on a consolidated basis.
If a seller is a limited liability company that sells all or substantially all of its assets outside the ordinary course of business, such sale may be authorized only by a vote of the members of the LLC unless otherwise provided in an operating agreement. Manager approval may also be required depending on the terms and conditions set forth in the articles of organization and operating agreement. The articles of organization and the operating agreement must be carefully reviewed to determine what level of member or manager approval is required.
6.) Post-Closing Matters
Depending on the complexity of the transaction and the terms of the acquisition agreement, certain post-closing matters may need to be addressed.
For example, the acquisition agreement may contain provisions on purchase price adjustments that need to be finalized within a certain period of time after closing, such as earnouts. An earnout is a provision that allows a seller to receive a higher purchase price if certain items are achieved by the buyer after closing.
An experienced business attorney will help a seller understand the various post-closing matters and track such matters in an organized manner.
CONCLUSION
At Dawisha Law, PLLC, we work closely with clients who are selling their businesses and walk them step-by-step through the sale process. If you are selling your business, contact us today and let us advise you throughout the process.
DeLone Dawisha
Principal and Founder
Dawisha Law, PLLC
248-904-5123