Once an LOI has been signed by the buyer and seller of a small business, the period of being “under contract” begins. During this 30-90 day period, the buyer will perform some due diligence on the business, go through underwriting with a bank, and ultimately start negotiating the final legal documents to close the deal with the selling business owner.

Purchase Agreement

The purchase agreement contains the “juice” of the transaction. This document can run from 6 to 30 pages, depending on the attorney drafting the agreement. It will contain basic legal information, such as the parties to the contract, the price of the acquisition, and the closing date. It will also include a number of other clauses:

Representations and Warranties: The selling owner will often provide representations and warranties to the buyer. This could range from representations as simple as “I have the right to sell this business” to warranties as complex as “I will cover any repairs to vehicles purchased for the first 90 days, provided they cost more than $15K but are capped at $125K”.
Transition Period: If a separate consulting agreement is not included, then the purchase agreement may include provisions for the selling owner to stay on for the first 30 days pro-bono and the next 60 days at a $55/hr consulting rate.
Jurisdiction: Should there ever be legal troubles, there will normally be an agreement on the venue in which they will be resolved. This is typically either Delaware (standard) or the state in which the transaction is occurring.
Funding: The purchase agreement will often outline the sources in which the selling owner will be compensated for the business. This will include cash at close, any hold-back for working capital, seller financing, and earn outs.

Non-compete

Given that most owners are selling a local small business, the buyer will want to ensure that the selling owner will not compete against him or her. The typical small business owner has built up relationships with clients for years. The strength of their relationships with clients would make it easy for them to poach the clients for a new venture.

As part of a non-compete agreement, there are typically two main terms:

Time: For how long does the owner agree to not compete against the buyer?
Location: Where does the owner agree to not compete against the buyer?

Typically it’s a 3-5 year non-compete in a 100-mile radius around the business. However, there may be carve outs for servicing friends and family with work. For instance, an auto shop owner may agree to not compete against the buyer for 5 years in a 50-mile radius, with the exception of doing repair and maintenance work for related family members.

Non-solicit

Aside from customers, owners often have strong relationships with their employees. They may have hired them straight out of trade school or college. If they wanted to bring them over to a new venture, they’d be able to do so with relative success. Additionally, small businesses are only successful so far as they have great clients and great employees. Poaching employees can significantly impact the business’s ability to generate revenue and profits.

A non-solicit prevents owners from soliciting their previous employees after selling the business.

Promissory Note

Many of the transactions we see include a promissory note between buyer and seller for 5% to 60% of the purchase price. This note is commonly referred to as seller financing.

Promissory notes have a number of terms to be negotiated:

Term: For how long is the promissory note valid?
Interest: What is the interest rate of the promissory note? How is that interest calculated?
Guaranty: Is the note unsecured? Is the note secured by the stock of the buyer’s entity? Is the note secured by a personal guarantee from the buyer of the business?
Prepayments: Is there a penalty for early payments on the promissory note?
Standby: Is the buyer allowed to make payments during the term of the bank loan?

Lease Agreement

In addition to the above documents, there will often be a lease drafted between the buyer and seller or the buyer and the landlord. This agreement should include several terms:

Term: Ideally, the lease is for 10 years or, at the very least, has extensions until the 10-year mark. The reason for this often comes from the lender. They want to ensure that the business has a place to operate during the duration of the business’s loan payments.
Penalty Fee: Most leases have a penalty for late payments. This penalty can be a fixed amount or percentage, or it can be compounding (e.g., “5% compounding monthly for amounts outstanding”).
Security: Is the lease secured by the business? If so, is it subordinated below the SBA 7(a) loan?

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