Although we call it a meeting, most closings today occur virtually. The closing documents are sent to the parties for signatures and then back to the escrow agent for release on closing day. The most crucial of these is the purchase agreement, which represents the parties’ binding commitment to transfer ownership of the business.
“Closing” occurs when the purchase agreement signed and new ownership of the business takes effect.
It’s almost time! The buyer has done their due diligence, you’ve done yours, the price and terms of the deal have been settled, and the purchase agreement has been finalized. Next up: the closing.
You might think that the closing goes something like this:
Your lawyers organize the final documents in the days beforehand. You and the buyer have a short “closing call” to sign and agree that the closing has occurred. The buyer wires the funds after the call and once you receive them, it’s official: you sold your business.
We hope and wish that every closing was this simple. Unfortunately, that’s not always the case. This article explores this final, perilous step in selling your business, how it’s often the most stressful for buyers and sellers, and how to mitigate problems that inevitably arise.
The following is a summary of the M&A transaction and how closing fits into the process.
The letter of intent (LOI) includes a summary of the key terms of the transaction and is used as the basis for the purchase agreement. The LOI also often defines the rules of the process until the closing, including any time frames, deadlines, or other obligations that must be adhered to along the way – so don’t let the buyer rush you along.
Due diligence begins once the LOI is signed and typically lasts 30 to 60 days. Experienced buyers use due diligence to begin planning for a smooth handover. They’ll collect information to aid them in drafting an effective transition and integration plan. The more prepared you are, the faster the process will unfold.
The purchase agreement sets forth the key terms of the purchase and sale. If it’s signed before closing, it must contain a thorough set of pre-closing covenants and conditions, such as extensive termination rights for the buyer, all of which your M&A advisor can navigate. If the purchase agreement is signed at closing, it’s far less complicated for both parties.
The closing is – or should be – an anticlimactic event nearly every time. Ideally, the attorneys hold a pre-closing call to ensure all documents are ready to be signed. Then, the documents are signed virtually and the buyer wires the money to the seller. Once the funds are received, the closing is official.
An M&A attorney will earn every penny of their fee – they’ve been through the process countless times and will help eliminate surprises.
The transition period – also known as the training period or integration period – begins immediately after the closing. The buyer is largely responsible for this period, but you must be ready to help them. The terms of the transition are heavily negotiated and can cover anything from a few weeks to several years.
Only after the transition period is complete can you rest and let go. This can be a difficult time for sellers who must now accept the business is no longer theirs. Closing a chapter of one’s life is tough, and you must be ready for the emotional release.
There are often dozens of additional or ancillary documents to be signed at closing – sometimes more than you were expecting. The list below is not exhaustive but it indicates the kinds of paperwork sellers can expect to see:
This is the governing document that includes a breakdown of the purchase price and how it’ll be paid, representations and warranties, post-closing covenants, indemnification, and many other aspects of the deal. The purchase agreement is either signed before the closing or on the day itself.
The representations and warranties are worded in the affirmative in the purchase agreement, with any exceptions listed in the Schedules to the purchase agreement. Going through these can be a time-consuming process for the seller if there are many.
For example, you may be required to sign a representation stating that you own all assets currently being used in the business. Then, you would list any assets you don’t own, such as leased equipment (the exception), in the Schedules.
The purchase agreement will also refer to ancillary agreements, which are shorter, more specific agreements such as transition services agreements, assignment and assumption agreements, intellectual property assignment agreements, real estate leases, employment agreements, consulting agreements, and so on.
The nature and type of these agreements vary from deal to deal, but there are usually several of the following:
The closing statement is prepared by the attorneys or escrow firm and contains a breakdown of debits and credits for both the buyer and seller. The statement can be used by the buyer to break down how the purchase price will be paid.
For you, it outlines how the purchase price is paid and the amount of cash delivered at closing, less any expenses to be paid, and can be used to estimate your net proceeds. It also calculates any cost adjustments or prorations between the buyer and seller.
The closing statement is prepared by the attorneys or escrow firm and contains a breakdown of debits and credits for both the buyer and seller.
This document details new lease terms between the owner of the business’s real estate, whether it is the seller or a third party, and the buyer of the business. This is almost always a separate agreement from the purchase agreement.
If there is an agreed-upon amount to be held in escrow for a period after closing, the escrow agreements will detail how much will be held, under what conditions the parties can draw from the account, and how long the account will be activez. This is often prepared by the escrow firm and reviewed by your attorney.
When selling your business, there are no guarantees until the closing is official. In most cases, the buyer can back out right up tp the moment before closing if they wish to. While this may make some entrepreneurs uneasy, the buyer may feel the right up to the moment of, as you can usually change your mind at the last minute, too. An element of blind trust is needed to calmly, successfully close the deal.
A personal dinner with the buyer’s family can go a long way toward building trust. Show them your ethical and personal commitment, and any cold feet will soon warm up again.
Trust is the glue that holds the deal together until closing and you must do everything you can to build and maintain it. The best way to build trust is to communicate with your buyer. You should talk regularly to address each other’s concerns and ensure there are no surprises on the way to the closing.
You can, but few buyers will agree to this. The reality of doing so is complicated and the time spent negotiating the purchase agreement and deposit is often better spent driving toward the closing.
To receive a non-refundable deposit, the purchase agreement will have to be fully negotiated and then signed, and it’ll need to contain many conditions to the sale, which are time-consuming to negotiate. For example, the closing may need to be contingent on the buyer obtaining financing, or obtaining approvals from third parties, such as landlords or governmental agencies.
The only time you should ask for a non-refundable deposit is if the buyer is asking you to train them before the purchase agreement is signed. Serious buyers will understand, window shoppers will back down.
Other issues need to be addressed, such as whether the buyer would be required to close in the event of a terrorist event, natural disaster, or major regulatory changes happen in the industry. Would a non-refundable, pre-closing deposit commit them in such cases?
Such an agreement is not only time-consuming, it may cost each party significant legal fees and is often more trouble than it’s worth.
Most parties choose instead to move toward closing as swiftly as possible to eliminate risk instead of minimizing it. When buying or selling a business, many things can go wrong, so your only choice is to maintain trust and keep going.
The faster you move, the better.
The best way to gauge the buyer’s commitment is to assess how much time, effort, and money they’re investing in moving toward the closing. The formula is simple – the more they invest, the more serious they are. If their attorney puts significant time into negotiating the agreements, then you know they’re serious, as no likes to throw good money after bad.
Most letters of intent contain a covenant (a legal promise) that requires you to continue running your business as usual. If you make major changes to your business between the LOI and closing and the buyer disagrees with them, they may back out of the deal.
If you decide to make any major changes, inform the buyer and obtain their input before finalizing your decision. If you need to decide on discretionary marketing campaigns, for example, consult with the buyer first and provide updates regularly. Be as transparent as possible regarding any changes you make.
It’s also a good idea to share any positive news with the buyer to help combat any intrusive doubt. For buyers, no news can be bad news, so keep them up-to-date and excited about the sale.
For buyers, no news can be bad news, so keep them up-to-date and excited about the sale.
You still own the business during this time, but the buyer has committed to acquiring it. This makes you a steward of their future business, and they’ll ideally begin to feel like the owner and may want to begin weighing in on important decisions.
During this time, you’re still autonomous, but you should work closely with the buyer and communicate as much as possible. Any decisions that have a significant impact on future business operations should be coordinated with them.
The key to eliminating surprises is clear and constant communication. A lack of communication between parties creates questions and doubts. You should check in regularly to make sure the closing is on track and free from hitches.
No matter how well-planned the sale, last-minute problems always arise. It’s best to expect that something will happen and be prepared to solve it through healthy and cooperative working relationship. At the same time, stay flexible and not too wedded to particular outcomes.
The period between signing and closing should be kept as short as possible. The shorter this transition phase, the fewer things can go wrong.
Buyers often request that you begin the transition period before closing occurs. You should avoid doing this at all costs. If you must train the buyer early, only do so with the advice of an experienced M&A attorney. In that case, the purchase agreement should be signed, and the buyer should be willing to submit a non-refundable deposit as payment for the training period.
An escrow agent is a third party responsible for holding all monies and documents until all conditions of the escrow are fulfilled.
Multiple adjustments and prorations may be required at the closing, such as lease payments, utilities, and property taxes, to account for timing differences between when bills are paid and when the change of possession occurs. Escrow can assist in making these adjustments.
Escrow is often required if third-party financing is involved, such as bank financing, and serves several important functions in the sale.
The primary duties of the escrow agent include:
It’s best practice to perform a dry run of the closing to ensure all parties are aligned on the closing requirements and to prevent surprises. Your M&A advisor can walk you through the steps. Minor problems are often discovered in a dry run, and addressing them before the real closing helps ensure it unfolds as smoothly as possible.
If you can, schedule the closing meeting in the morning, during business hours, when all parties are available and banks are open. There may be last-minute details that need to be tied up and the last thing you want is to create frustration by dragging out the closing to the next available day.
Most buyers and sellers attempt to close a transaction on the last day of the month. This usually results in a normal close and creates more accurate estimates for the closing balance sheet and the net working capital true-up.
Hope for the best and push for speed and a timely closing – but expect delays. Buyers must allow enough time for completing diligence, obtaining consent and regulatory approval, and finalizing dozens of other tasks that are often dependent on third parties. The tentative closing date will need to be pushed back if any of these are delayed.
It’s always best to assume closing will be delayed and be pleasantly surprised if it’s not.
As the seller, your closing meeting can be an emotional event. I’ve seen stoic business owners break down at the closing table after months of straightforward negotiations. Expect the unexpected regarding your emotions, and those of your colleagues and closest clients.
This is a milestone on the entrepreneurial road and you must prepare to meet it. Don’t get blindsided on the day. Talk to other owners who’ve been through the process so you have an idea of what to expect.
Following is a summary of tasks that both buyer and seller must perform before closing day.
There are several important actions the buyer should take as early in the process as possible. They may be under significant stress will welcome your understanding and assistance.
Here’s a short list of the buyer’s pre-closing tasks:
Here’s a short list of the seller’s pre-closing tasks:
Here’s a summary of actions both the buyer and seller typically take before closing:
Sellers and buyers have multiple tasks to complete separately and jointly before the sale can close. This can be a stressful period for both parties.
When it comes to signing the purchase agreement, there are two options:
In a simultaneous sign and close, the purchase agreement is signed at closing. Simultaneous sign and close arrangements are simpler to negotiate because there’s no time gap between the two events.
The downside to these is that the buyer could back out at any point before closing, for any reason. But remember – closing on the sale of your business ultimately depends on trust, right to the end. There is rarely a contractual guarantee that the buyer or you will close until it happens, even if the purchase agreement is signed in advance.
In a separate sign and close, the purchase agreement is signed on a certain date and the closing doesn’t occur until a later date.
By signing the purchase agreement, the parties agree to transfer the ownership of the business at the closing, which occurs at a point in the future. Actual change of possession and ownership doesn’t occur until the closing, even though the purchase agreement may be signed beforehand.
On the surface, a separate sign and close sounds ideal. What better way to address trust issues than by requiring the parties to commit to the deal before closing?
The main problem is the awkward time lag. The purchase agreement must address many potential problems that can occur between signing and closing and whether the buyer would be obligated to close in each scenario.
For example, the purchase agreement must address what would happen if the following occurs:
Negotiating what would happen in these scenarios is expensive and time-consuming. In addition, covenants that require you to continue operating your business in a specified manner, or in the normal course of events, would also need to be negotiated in the purchase agreement.
A separate sign and close is ideal for addressing trust issues, but it can be difficult to negotiate. Almost anything can happen in the interim.
Negotiating such a purchase agreement becomes a much more complicated affair. Not only does it take longer, but it costs each party far more in legal fees. They must decide if the additional time and money are justified. In most cases, it’s not.
There are rare occasions where a separate sign and close setup is justified, such as when the closing must be delayed for reasons beyond the parties’ control, obtaining trading licensing or other approvals, for example. Regardless, negotiations will be time-consuming and the investment should be carefully weighed.
If a separate sign and close is agreed upon by the parties, they must negotiate extensive conditions (contingencies) to the sale in the purchase agreement. This language specifies conditions in which the buyer can back out before the closing.
Unfortunately, the interests of the buyer and seller are opposed in this regard. You’ll prefer to keep the conditions narrow in scope, while buyers prefer that they’re broad.
Additional agreements must be agreed to that address covenants that prohibit you from carrying out certain actions before the sale, such as reducing inventory levels, hiring new employees, or terminating certain advertising or marketing campaigns, further complicates the negotiations.
The MAC (material adverse change) clause has an extensive body of commentary surrounding it. This is a detailed clause defining what an adverse change in the business is and should be subject to intense and time-consuming negotiations.
Several months may pass between the completion of due diligence and the closing. During this time, closing requirements are created and obstacles to closing are cleared so that ownership can be transferred.
Many tasks must be completed during the interim, such as:
On the day of closing, the agreed-upon actions and closing deliverables are completed, including payment of the purchase price. With the fulfillment of all closing conditions, legal ownership of the business is transferred to the new owner and the closing is official.
When does the change in ownership occur?
While the purchase agreement represents the parties’ binding commitment to transfer ownership of the business, closing occurs when the new ownership actually takes effect.
This happens when 1) the seller and buyer sign the bill of sale (in the case of an asset sale) or stock certificates (in the case of a stock sale) and 2) the buyer wires or transfers payment to the seller. Only when both have occurred can the sale be said to have officially closed.
Who must sign the documents?
The seller and buyer generally appoint one official signer who signs all of the documents on the company’s behalf, and the individual owners each sign a consent or corporate resolution, authorizing the signer. It’s therefore not necessary for all owners to sign the closing documents.
Are most closings done in person or virtually?
Most closings now occur virtually. The closing documents are sent to the parties digitally for signatures and back to the escrow agent for release on the closing date. Some old-fashioned escrow agents require physical copies, so the documents may need to be sent to the parties via FedEx or overnight mail. If the parties wish to, they can conduct the closing in person.
You must understand whether your transaction includes a post-closing escrow holdback or any post-closing adjustments to the purchase price. If so, this can significantly impact the purchase price you receive and your net proceeds.
For middle-market businesses, it’s common for the parties to negotiate a post-closing escrow. This allows the buyer to recover damages or working capital adjustments.
With an escrow holdback, a portion of the purchase price is withheld by a third party – typically an escrow firm. If no claims are made by the buyer, this money is released to the seller after the escrow period expires, which usually ranges from 12 to 18 months. The purpose of the escrow is:
The result is that the purchase agreement can be adjusted up to the escrow amount (in most cases). Exceptions to this limitation are fraud and certain fundamental representations that are not limited to the cap on the reps and warranties.
Following is a partial list of your primary obligations after the closing to help ensure a smooth transition:
Once the transition period has expired, you may choose to close your entity. If so, I recommend asking your accountant and attorney to prepare a list of actions you must take to cease legal operations. You can also use the checklist provided by the IRS for winding down your operations.
The following is a partial list of typical actions necessary to cease the legal operations of your company:
Post-closing problems and disputes can be broken down into three general areas:
Financial disputes are most common in two elements of the transaction – earnouts and the net working capital adjustment.
Misunderstandings and disputes regarding earnouts are common, although you likely know this if you’ve already agreed to one. Earnouts are subject to manipulation by the buyer and if they wish to manipulate the earnout, they often can.
Clear and open communication is key to eliminating any potential misunderstandings and disputes.
To prevent this, the best approach is to maintain an excellent relationship with the buyer. The next best method is to keep the earnout agreement as simple and clear as possible and base it on financial metrics higher in the profit and loss statements, such as revenue or gross profit. The clearer the agreement, the less likely it will be interpreted differently by either party.
Another common dispute regards the net working capital adjustment. The best way to prevent this is to retain a firm to perform a quality of earnings (QoE) analysis before closing. They’ll be intimately familiar with how your net working capital was arrived at and can offer tips to ensure a proper calculation.
Another common dispute surrounds unanticipated liabilities or operating problems that may crop up after the sale. These can include any of the following:
It’s critical that all known liabilities are disclosed and responsibility for the liability is clearly allocated in the purchase agreement. An excellent method for minimizing such disputes is to maintain a collaborative working relationship with the buyer and assist them the moment these issues arise.
The stronger your relationship, the less likely the buyer is to make an issue out of them, and the quicker you can reach a resolution.
Legal disputes can include breaches of post-closing covenants, breaches of representations and warranties, or other indemnification claims.
Nearly every purchase agreement contains post-closing covenants that require the parties to do something (affirmative covenants) or not do something (restrictive or negative covenants).
One of the most common affirmative covenants requires the buyer to continue providing similar benefits to employees. Another may require the buyer to retain a certain level of insurance that covers you if the you’re holding a note or remaining as landlord.
If an event occurs that should have been insured and the buyer has dropped the insurance, this may also have serious implications for you.
If the buyer fails to maintain employee benefits, some may take legal action. Depending on state laws.
The most common restrictive covenants for the seller are non-disclosure, non-competition, and non-solicitation agreements. If you plan on staying involved in your industry in some capacity after the sale, you must inform the buyer as soon as possible, and carve out that activity in the purchase agreement.
The earlier you disclose your intentions, the better. Buyers become suspicious if you only speak up at the last minute.
Almost every purchase agreement contains pages of detailed representations and warranties (reps and warranties) made by both parties. The reps and warranties are used to allocate risk between the parties and are a common source of dispute.
Reps and warranties are so common that most purchase agreements include a basket or a deductible that must be met before the buyer can file a claim against the seller. This operates like an insurance deductible and prevents a buyer from making minor claims until a certain minimum has been met.
Reps and warranties are also subject to time limitations and expire after a specified period, although the limit varies based on the type of representations.
The best way to prevent disputes is to be as forthcoming as possible about any potential issues in your business and to maintain an excellent working relationship with the buyer after closing. It’s nearly impossible to sweep problems under the rug when selling your business. The buyer will have recourse after taking possession and will likely use it if they discover anything untoward.
Another area of potential dispute is the allocation of post-closing responsibility for liabilities that were disclosed but weren’t clearly allocated amongst the parties. For example, lines may be blurred regarding product warranty claims.
The best approach to disputes is to prevent them from happening in the first place. As you may have noticed, maintaining a strong relationship with the buyer is the best way forward. Disputes are less likely to spiral out of control between parties with a strong relationship.
If a dispute gets out of control and the parties can’t resolve it, then the purchase agreement will prescribe how to proceed.
The purchase agreement may require the parties to first mediate the disputes before seeking arbitration or litigation. Working capital adjustment disputes are usually governed by a separate dispute resolution process, which may be a binding decision by an independent accounting firm jointly selected by both parties.
Disputes from breaches of reps and warranties are also often limited in the purchase agreement. The purchase agreement will typically specify that indemnification is a buyer’s sole and exclusive remedy, and the reps and warranties constitute the only representations you’re making about the company. The primary exception to this is fraud.
“Parting is such sweet sorrow,” wrote Shakespeare. But don’t get all brooding on us. You built a business over years – perhaps a lifetime – successful enough to tempt a major buyer, unsettle a competitor, or dazzle a wealthy individual. You altered many lives in the process, and now it’s time to reap the rewards.
Whether you and the buyer will now be co-workers, or you’re heading to the beach, or you’re busy scribbling your next idea on the back of an envelope, it only remains for Morgan & Westfield to wish you the best of luck.
Here’s to the next adventure!
