This is a basic primer on an area of corporate commercial law. What should one consider when buying a business? If the business is a corporation, the aspiring business owner needs to decide whether to buy the assets or the shares. Owning the shares give you indirect ownership of the assets of a corporation but it also means you get the debts as well. It is for this reason that many people buy assets. Tax issues also enter into the decision so it is important to get input from an accountant. With share ownership, you may wind up with unanticipated liabilities (ie tax liabilities, future law suits etc.). This can happen despite the "due diligence". ("Due diligence" is the examination of the accounting records and various searches that you, your lawyer and your accountant do prior to closing the purchase). Also, it is usually easier to do "due diligence" with an asset purchase. Many people enter into a "letter of intent" as a preliminary to negotiating an agreement to buy a business. A letters of intent is a written agreement setting out the preliminary understanding of the buyer and seller, who intend to enter into a more detailed agreement. Although letters of intent can be legally binding, usually they are not enforceable in the event that there is a change of mind by either party. Many might ask why go through the trouble and expense of negotiating a letter of intent and then later, an agreement.
The advantages of a non binding letter of intent are that they:
- clarify each party's position before involved and costly negotiations and due diligence
- clarify areas that need to be resolved, so that negotiations on the subsequent binding agreement can focus on those areas
- add stability to the process because parties are less likely to abandon the deal after the time and expense of negotiating a letter of intent
- facilitate obtaining necessary approvals (eg in a franchise business purchase, the head office has to approve the buyer) and the necessary financing to buy the business
The disadvantages of a non binding letter of intent are that they:
- add to the cost
- delay the work of negotiating and drafting the eventual agreement
- can cause harm to certain businesses (ie ones dealing with confidential information like software developers) if the deal does not go through and details are leaked to the public
- can lead people to lock into their positions when it comes time to negotiate the binding agreement so that legitimate issues which come to light after the letter of intent become difficult to deal with.
Buying a business involves many other considerations and I hope to deal with them in upcoming articles.
Michael E. Cobb is a lawyer at the law firm of Cobb & Jones LLP. Should you have any questions for Ask A Lawyer, please direct them to the Simcoe Reformer or ask a lawyer of your choice.