How To Sell a Corporation: Everything You Need to Know
How to sell a corporation includes the steps to value the business, market it, find a buyer, conduct due diligence, and negotiate the final sale.3 min read
2. Representations and Warranties
Updated November 25, 2020:
Types of Corporation Sales
The sale of the business can be structured in one of the following ways:
- An installment purchase, in which the buyer finances the remainder of the cost after a down payment of 20 to 50 percent of the sales price. This agreement could include either monthly or quarterly payments and is subject to interest. This is often a secured loan with collateral such as stock or company assets. Stock is the preferred choice since it allows the seller to regain the business quickly if the buyer defaults on the loan. For small transactions, consider getting a personal guarantee on the loan so that the buyer's personal assets are used as collateral.
- A balloon payment allows the buyer to delay payment for months or years. At the end of the agreement, the seller will receive a so-called balloon payment for the full amount. This is obviously a riskier proposition for the seller than a loan with a monthly payment schedule.
- A stock sale may be offered in lieu of cash if a publicly-traded corporation buys your business. This can be risky if the stock in question is less liquid than it appears. You must either register shares with the SEC, which carries expensive fees or hold them for two years before you can sell them at the mercy of the market. Make sure the stock can be sold quickly if you need to do so. Check the average daily trading volume. If it's far less than the amount you are being offered, think again. If you do opt for a stock deal, make sure you receive at least part of the purchase price in cash.
- An earn-out is a bonus the buyer pays the seller for future sales (not profits). This is often calculated as a percentage of the increase over the current sales level. This strategy allows you to command a higher selling price for your business, especially if you have high confidence in the new owner.
- A covenant not to compete is a fee the seller pays the buyer in exchange for a pledge not to open a competing business within a specific time frame (often five to seven years). In exchange, the buyer receives the specified amount amortized over 15 years on their tax return. This allows both the buyer and seller to minimize their shares of taxes on the sale.
- An employment agreement lets the buyer deduct payments for the business as a payroll expense, which the seller must declare as income. This type of agreement may allow for certain perks and benefits along with a perpetual salary for the seller. Make sure this agreement is rendered separately from the sales agreement. This prevents the buyer from firing the seller for non-performance.
- A consulting agreement keeps the seller on for a specified time period as an independent consultant. This agreement should also be separate from the sales agreement. Establish an hourly rate at which excess hours should be billed and retain the right to subcontract the work. These payments are also tax-deductible.
Most sales agreements combine a variety of these strategies to create a customized contract that benefits and protects both the buyer and the seller, preserve cash flow for the business, and allows both parties to share the tax advantages. Regardless of the funding structure, you must make sure that any buyer for your company provides security in the form of collateral.
Representations and Warranties
Representations and warranties are assurances and factual statements about a company that is included in the sales contract. Misrepresenting an aspect of your company in these statements will result in a failed sale. You'll usually need to include promises that the buyer received accurate financial information, ensure that taxes are filed up to date, indicate any outstanding tax balances, prove ownership of assets listed in the contract, and promise that liens and other challenges have been disclosed. In this section, do not make statements tied to the future. A good contract attorney can ensure your list of representations and warranties will stand up in court.
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