Are You Too Focused Working 'On the Business' Instead of 'In the Business?'

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On The Entrepreneurial Mind, Dr. Jeff Cornwall writes that first-time entrepreneurs often make the mistake of obsessing over such things as mission statements, company logos, and business cards (time spent "working on the business") instead of actually launching and running the business ("working in the business").
Cornwall has 4 pieces of advice for entrepreneurs who are inclined to spend too much time prepping to launch a business instead of getting out there and selling their product or service.

While a well-designed business card is nice to have, it is you and your product or service that will convince the customer to spend their hard-earned money on what you have to offer them.
Your actual product will rarely look anything like what you may envision in a business plan. In fact, unless you are looking to raise a large amount of capital from outside investors or bankers, writing a formal business plan is not even necessary. Customers will provide feedback that should inform and shape the new business in its early growth. Real information from actual customers is much more important than guesses you might make in a formal business plan.

Read the rest of Cornwall's tips here.

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More On Limited Liability Companies' Fiduciary Duty

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Now that we have an Indiana Court of Appeals decision describing the fiduciary duty of an LLC to its members, I almost thought to scratch this post. However, Chicago Business Litigation Lawyer Blog's Respected Law Professor's Insights on Corporate Freeze-Out Litigation may still have some benefit to you.

"In Fairness and Good Faith as a Precept in the Law of Corporations and Other Business Organizations, 36 Loy.U.Chi. L.J. 551 (2005), Murdock addresses the fiduciary duty of good faith and fairness that controlling interests of a business owe to minority interests. Noting that this internal duty is a fairly recent legal phenomenon, he surveys caselaw on the subject from around the country that applies to closely held corporations, public corporations and LLCs. Noting that the Uniform Limited Liability Company Act (ULLCA), a model law adopted by several states, doesn't include language that gives members of an LLC fiduciary duties to one another, he praises Illinois for modifying that language to protect members in the updated Limited Liability Company Act."

The Independent Contractor Trap: Don't Misclassify Your Employees

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Many start-up and expanding companies prefer to engage the services of a independent contractor rather than hire an employee because of the high costs relating to employment taxes, health insurance and other benefits.  Recognizing the cost savings of hiring a contractor, businesses will often seek to classify a new hire as a independent contractor believing all that is needed is a few revisions to their standard contract that identifies the person as an "independent contractor" and just like that the company has saved thousands of dollars.  In reality, the company may have created a huge red flag for a potential audit that could result in the obligation to pay susbtantial taxes plus penalties.  To avoid the Employee/Independent Contractor trap, consider the below guidelines for determining whether in fact you have hired an employee rather than engaged an independent contractor.

I.  Why do Businesses Often Prefer to Classify a Person as an Independent Contractor?

Whether because a company may be a start-up or an emerging or larger company is concerned about the difficult economic environment, businesses often prefer to classify a person as an independent contractor for the simple reason of cost.  Hiring an “employee” means the company has to withhold taxes and pay social security, and will have to offer health insurance and possibly other benefits (i.e., vacation/maturity leave, etc.)

II. Can't I Just Label the Person an Independent Contractor?

No, it is a common misconception that employees/companies can avoid the "employee" label by simply stating the person is an independent contractor in a services agreement between the parties.  Moreover, the fact that the person waived any rights as an employee, signed a statement asserting he/she is an independent contractor or is issued a 1099 instead of a W-2 does not give the employer any cover.  The tax authorities (and courts) examine the nature of the relationship between the person and the company, look at the facts as to how the person provides the services, and does not care about labels or other efforts made to classify an employee as an independent consultant.

III. What Distinguishes an Employee from an Independent Contractor?   

There is no single factor distinguishing an employee from an independent contractor.  Instead, courts examine all the facts to determine the degree of supervision, direction and control the company exercises over the services.  If the company controls the manner and means by which the person provides the services, the worker is likely an employee rather than an independent contractor.

      A.  An Employer-Employee Relationship May Exist if the Employer:

            1.  Controls when, where and how the services are to be performed
        
            2. Provides the tools to perform the services (facilities, equipment, tools, supplies)
           
            3.  Engages and requires the person to work exclusively for the employer
           
            4.  Exercises supervision over the person, requiring reports, setting the work schedule, establishing the pay rate, retaining the right to review and approve the work product and/or evaluate the person's performance

            5.  Offers compensation in the form of a salary or an hourly rate, and/or reimburses expenses
 
            6.  Engages the persons who are unskilled or casual workers (therefore requiring supervision).

    B.  Independent Contractors Generally Supervise, Direct and Control the Performance of their Duties.

            1.  When performing the services, the independent contractor is not supervised or subject to the direction of the company, instead controlling its performance of the services.

            2.  The independent contractor generally offers his/her services to the public, operating their own business separate from the company engaging the services.

            3.  Indicia of independence include:
                 
                  (a)  Using own tools, equipment and supplies   
                  (b)  Operating under a business entity (has a business) that assumes risks
                  (c)  Seting fees, project schedule, paying own expenses
                  (d)  Offering services to other companies
                  (e)  Marketing the services
                  (f)   Engaging own employees or third parties to assist
              
For additional guidance, see the following IRS publications: http://www.irs.gov/pub/irs-pdf/fss8.pdf  http://www.irs.gov/businesses/small/article/0,,id=99921,00.html


IV.  What if a Company Misclassified an Employee as an Independent Contractor?

If the IRS determines that your company has misclassified en employee as an independent contractor you need to be prepared to pay substantial taxes and potentially interest and penalties, especially if it was not an honest mistake.

Where the IRS finds that the misclassification was an honest mistake on the part of the employer, and the employer filed proper returns, the employer will be liable for (a) the employer FICA obligation that should have been paid in the first instance, (b) 20% of the employees FICA that should have been withheld, (c) 1.5% of the total compensation paid to the person, (d) any amounts due for unemployment tax, and (e) possibly interest and penalties.

If the employer fails to file proper returns and cannot demonstrate reasonable cause, the liability can be doubled.

But, if the misclassification is found to have been intentional, then look out because the above limits do not apply, and the exposure can run to the individual officers/directors of the company.

Now, on top this, add your state tax liability, and the fact that there may have been obligations under other laws (including relating to health care benefits) that the company violated by misclassifying the employee as an independent consultant.

The classification of an employee as independent contractor is carefully scrutinized by Federal and State tax authorities and is a common red flag giving rise to an audit.  Do not let the potential savings lead you into the independent contractor trap as your company will pay dearly for misclassifying its employees.

Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.
 


     

A Word to Small Business Owners: Don't Be Afraid to Negotiate Contracts

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All too often small business owners readily accept the terms of a contract or are concerned about pushing back on both economic and legal terms because either they fear losing the deal or simply don't fully understand the terms.  As a business owner, you need to recognize that in most circumstances there is an opportunity to negotiate terms of an agreement, and therefore you should not be afraid to seek the best deal possible even if the other party initially seems unwilling to consider your position on key aspects of the contract.  So, here is the advice, Don't Be Afraid to Negotiate. 

Negotiation skills are one of the most important tools a business owner should have in its toolbox.  Therefore, if you receive a contract from a party, read it carefully, and then proactively respond in writing with your comments.  One negotiating trick that vendors often try is to provide a form contract, creating the impression that the terms are non-negotiable -- indeed, if I am representing the vendor, I will often suggest creating a form agreement.  Any contract, even a form, can be revised by an amendment, so do not automatically assume the agreement must be accepted "as is".  The following are among the material terms that business owners should not only fully understand, but seek to negotiate.

1.  Term.   If you want a longer or shorter contact term, then ask for it.  One alternative is to get an option to renew, which should be exercised within a certain number of days prior to expiration of the contract.  The mechanics of the option and financial terms should be clearly spelled out as well. 

2. Fees.  There are many different ways to skin this cat, and you should consider what best works for your business over the term of the agreement.  The financial terms can be based on (a) a set periodic payment, (b) an up front payment and then installments, (c) fees that scale up or even down over the life of the contract, (c) revenues, (d) milestones, or (e) a combination of several different fee structures.  If the payments are based on revenues, then it is essential that the parties clearly define not just the percentage by the term "Revenue."   For example, is it based on Gross or Net, and what is to be included in the Gross and what can be deducted as a legitimate expense when determining Net Revenues?  A Net Revenue contract may refer to overhead expenses, like a businesses' borrowing costs, which can be a killer for a party who is being paid based on Net.  Make sure you understand the definition, and if you don't ask for professional advice rather than assume the definitions are fair or standard.

3.  Financial Reports/Audit.  If the consideration under the contract is based on revenues or certain milestones, require periodic financial reports. In addition, you should have the opportunity to review and audit (i.e., challenge) such reports rather than simply accepting the information provided by the other contracting party.  In addition, provide a dispute mechanism in the event of a challenge, such as CFO's meet and try to resolve, appointing independent third party, or even arbitration -- and if the audit reveals you were in the right, include a requirement that the other party pays your costs.     

4.  Termination of the Contract/Suspension.  Of course the contract will expire at the end of its term, but include other events that will result in termination:  (a) non-payment, (b) material breach, (c) bankruptcy, (d) failure to achieve defined milestones, including financial ones, (e) assignment/sale of the business (see below), (f) departure of personnel if the business relies on certain key employees, or (g) force majeure.  Termination clauses will often allow the breaching party an opportunity to cure a default, provided it is one that can be cured.  In the case of a force majeure event, the contract can be suspended pending passage of the event or terminated if the contract becomes impossible to continue due to the event.  

5.  Assignment/Sale of the Business.  Do you want the contract to be assignable to a third party, including in the event of the sale of the business. This is an important issue for many types of agreements, such as licensing agreements or service contracts.  You can require consent for the assignment, but if you want the contract to be assignable, as an alternative you can propose that it is assignable to an assignee with financial ability to meet the contractual obligations.    

6. Warranties/Limitations on Liability.   Suppliers/service providers will often provide a lengthy provisions denying all warranties and limiting their liability -- and if you are the vendor, you generally want to push for these provisions.  If you are purchasing the the services of a large company, there may be no room to push back on any of the limitations, but whether the other contracting party is a small or large company, there is no harm in trying -- even if they send you the form or the "Master Service Agreement."  For either party, it is all about the bargaining power, and how much the other party wants your business versus how much you need the agreement.  Even if you cannot get the other party to budge, ask at least for an exception for gross negligence, and regardless a court may negate the limitation based on intentional misconduct or even gross negligence.               

7. Dispute Resolution.   Avoid an issues as to how disputes are to be resolved by negotiating the applicable (a) governing law, (b) venue for the dispute (meaning both the tribunal that will handle the matter, such as a court or arbitration/mediation, and the geographic location), (c) if there is to be mediation or arbitration, the procedures, and (d) will the parties impose legal fees and costs on the losing party.

8. Remedies.  Among the remedies you can include are (a) specific performance, which is important if money cannot cure a default, (b) liquidated damages, if you prefer to define the damages to avoid disputes as to proof the proper compensation for a breach, and (c) equitable remedies (other than specific performance), like an injunction.    

9. Non-Compete/Non-Solicitation.  Simple vendor/supplier agreements generally won't include these terms, but many other contracts will, including licensing agreements, consulting/employment, certain service agreements, or more major transactions (like sale of a business) to name a few.  Enforcement, especially as to non-competes, is a key legal issue, and it is highly advisable to have the provisions reviewed by counsel that understands the law in the applicable jurisdiction as it can vary greatly from state-to-state.

10.  Other Terms/Conclusion.   If there are other terms included or, for that matter, missing from the agreement, then make these part of the punch list of issues to be addressed with the other party.  The reality is that the worse response you can receive is "no", and then you can decide how important the provision is from your perspective.  A bad contract is NOT better than no contract.  In a competitive economy, even larger/established businesses are often willing to negotiate and "the last and final", "take it or leave it" or "as is" response may be just a bargaining tactic.

The Lesson: Read the Contract, Understand Each Provisions and Don't Be Afraid to Negotiate the Terms.





Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.


      

Legal Issues When Buying a Business: Don't Overlook These Provisions in the Purchase Agreement.

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As discussed in prior installments of this series on buying a business, there are a number important legal issues you need to consider before signing the purchase agreement.  The first installment discussed the role of the Exclusivity Agreement, the second installment examined the differences between structuring the transaction as stock purchase as opposed to a purchase of assets, the third examined the importance of escrowing a portion of the purchase price to cover any issues that may arise post closing, and the fourth discussed important aspects of due diligence and how to address legal or financial issues in the purchase agreement.  This fifth installment examines several key provisions that should be incorporated in the purchase agreement but are otherwise often overlooked.

The Purchase Agreement is a very flexible instrument giving the parties substantial flexibility not only as to the structure the transaction but with respect to the representations, warranties, disclosures and covenants that the parties can negotiate to include (or for that matter exclude) from the Agreement.  There are a number of standard provisions relating to such matters as legal ownership of/title to the assets, representations as to the corporate status and authority, disclosures as to litigation, financial and tax related representations, environmental issues and post closing obligations.  First, while these provisions may be part of a standard purchase agreement they by no means should be viewed as boilerplate. Even a slight variation in language can alter the meaning and scope of these sections, and thus all representations, warranties and covenants, no matter how standard, need to be reviewed carefully.  Second, below are a number of provisions which are often overlooked but you should consider incorporating in the Purchase Agreement.

1.  Intellectual Property.
   
Of course it is standard to include representations regarding the seller's title and ownership of the intellectual property, but make sure the Agreement:

              (a)  Covers licensed rights as well as often the seller does not own but licenses key IP.  In  the same vein, confirm the licenses are assignable and if consent of the licensor is required that the Seller obtain the consent as a condition of closing.

              (b) Addresses rights to the domain names and company websites and requires transfer of these rights to the buyer as a condition of closing.  It is not unusual for the buyer to forgot about the transfer of the domain and then have to coax the seller into compliance after the sale.

             (c)  IP rights should include not only registered marks or issued patents, but pending applications, unregistered rights, royalties, licenses and, significantly, awards, damages or pending claims and litigation.

             (d)  Incorporates provisions relating to software, requires the turn over of source code, manuals, passwords, license keys and all other documentation.

2.  Litigation

Representations relating to pending or threatened litigation are typical in a Purchase Agreement, but be sure:

            (a)  There are sufficient disclosures about pending and threatened litigation, including the status of such matters.

            (b)  Decide how litigation is to be handled post-closing.  Will your lawyer take over the matter or will the Seller's lawyer continue to handle it; who will be responsible for the legal fees and costs; include a right to periodic updates as to the status of any legal matters; and set forth any rights as to damages, awards, insurance proceeds and to settle the matter and any indemnification in the event of an unfavorable outcome.
            
3.  Financial/Tax Matters

In addition to the typical representations and warranties concerning financial and tax issues, include:

          (a)  Financial

                  (i) Require that the seller update the financial statements on or prior to Closing;
                 
                  (ii) Include a formula for adjusting the purchase price if there are material changes to the financial statement;
                 
                  (iii) Although often used, try to avoid using an earn-out (post-closing payment contingent on certain financial milestones) as they are difficult to negotiate, document and manage once the buyer assumes the reins of the business, and as a result they are a major source of post-closing disputes.  If an earn-out cannot be avoided, make sure you have counsel who has experience negotiating and drafting earn-outs.

         (b)  Taxes

                (i) The representations and warranties should not only cover federal and state taxes, but sales and any other applicable taxes for all relevant jurisdictions.
               
                (ii) The seller should provide all filings and disclose any past, pending or threatened audits/assessments.
               
                (iii) Require the seller provide post-closing assistance for any filings relating to periods of time the seller controlled the business.
             
                (iv)  Include appropriate indemnifications for tax liabilities.


4.  Transition

Is there a switch in your house that you have no idea what it does, and since the seller is long gone you have no way of finding out?  Well, think how that issue is magnified exponentially if you purchase a business and don't have the seller to assist with the transition.  The assistance is important not only as to obvious issues, like computer systems, financial records, and where the keys to the third floor supply closet are located, but making a smooth transition as far as clients/customers, introduction to vendors/suppliers, establishing a good relationship with employees/consultants, ensuring an understanding of business processes and procedures that are essential for operation of the business.  Therefore, the Purchase Agreement can require the meaningful assistance of the seller or even include compensation to the seller for post-closing assistance and continued employment with the company for a reasonable period of time.

5.  Material Adverse Change   

Undoubtedly the Purchase Agreement will include a Material Adverse Change clause essentially providing the buyer with certain rights and remedies (including possibly termination of the transaction) in the event of a material adverse change with respect to the business.  The clause is one of those tricky provisions which, if not properly drafted, can result in substantial disputes.  The key is to avoid ambiguity by incorporating specific criteria as to when the Material Adverse Change clause is implicated, such as decline in sales, the loss of certain amount of or even specifically named customers, a decrease in EBITDA or termination of a manufacturing or supplier relationship.

6.  Employment/Labor Matters  
                       
Provisions relating to Employment and Labor matters are standard, but also make sure the representations and warranties include:

         (a) Existence of confidentiality, invention assignment and non-competes, and get copies for each employee and consultant.

         (b) Confirmation that consultants are truly consultants and not employees (which can give rise to substantial tax liabilities).

         (c)  Details and disclosures regarding any employee plans (stock, pension, etc.) and vesting status f each employee.

         (d)  Disclosures with respect to any collective bargaining any other labor matters.

7.  Operations in Foreign Countries

Establishing the right of the company to operate in any foreign jurisdictions where it does business should be obvious, but compliance with the Foreign Corrupt Practices Act is far less familiar to most people.  The FCPA prohibits various behavior relating to operating in foreign jurisdictions, including paying bribes to obtain contracts, business, etc.  Violation of the FCPA carries substantial civil and criminal liability.  As a buyer, you might not think much about the FCPA, but if you manufacture in China, for example, you better pay attention and therefore incorporate a representation that no unlawful payments have been made by seller or its agents.

8.   Covenants

The Purchase Agreement should contain covenants relating to:

        (a) Non-solicitation of employees, customers and clients and non-interference with existing vendor/supplier relationships.

        (b) In certain circumstances, a Non-Compete that complies with the narrow limitations imposed by applicable state law.

        (c) As discussed in prior posts, clear indemnification and escrow terms to address post-closing liabilities.

        (d) Confidentiality.

        (e) Obligation of the Seller to notify the buyer upon the occurrence of material events arising at any time prior to closing.

        (f)  Resignations of officers, directors, responsibility of the seller as to termination of some or all employees/consultants.

9.  Termination

There will be grounds for either party to terminate the Agreement prior to closing.  The termination provisions should not only provide specifics as to when the right can be invoked by a party, but also the liabilities, if any, resulting from termination and the effect of termination.

10. Survival

Give careful consideration to how long any of the representations, warranties and covenants will survive avter closing.  The seller will push for no or a very short period while the buyer will want them to survive until the chance of any liability no longer exists.  A compromise will almost always be necessary, and remember not all of the provisions need to survive for the same period of time

The above are by no means an exhaustive list of key provisions in a purchase agreement, and they will certainly vary depending on the nature of the business involved -- for example, if you are buying a gas station the environmental disclosures, reps and warranties will be substantial.  What is obvious that you cannot accept a boilerplate purchase agreement and instead the provisions need to be tailored to the particular transaction.

Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters




    

   

A Word to Small Business Owners: Don't Be Afraid to Negotiate Contracts

To contact us Click HERE
All too often small business owners readily accept the terms of a contract or are concerned about pushing back on both economic and legal terms because either they fear losing the deal or simply don't fully understand the terms.  As a business owner, you need to recognize that in most circumstances there is an opportunity to negotiate terms of an agreement, and therefore you should not be afraid to seek the best deal possible even if the other party initially seems unwilling to consider your position on key aspects of the contract.  So, here is the advice, Don't Be Afraid to Negotiate. 

Negotiation skills are one of the most important tools a business owner should have in its toolbox.  Therefore, if you receive a contract from a party, read it carefully, and then proactively respond in writing with your comments.  One negotiating trick that vendors often try is to provide a form contract, creating the impression that the terms are non-negotiable -- indeed, if I am representing the vendor, I will often suggest creating a form agreement.  Any contract, even a form, can be revised by an amendment, so do not automatically assume the agreement must be accepted "as is".  The following are among the material terms that business owners should not only fully understand, but seek to negotiate.

1.  Term.   If you want a longer or shorter contact term, then ask for it.  One alternative is to get an option to renew, which should be exercised within a certain number of days prior to expiration of the contract.  The mechanics of the option and financial terms should be clearly spelled out as well. 

2. Fees.  There are many different ways to skin this cat, and you should consider what best works for your business over the term of the agreement.  The financial terms can be based on (a) a set periodic payment, (b) an up front payment and then installments, (c) fees that scale up or even down over the life of the contract, (c) revenues, (d) milestones, or (e) a combination of several different fee structures.  If the payments are based on revenues, then it is essential that the parties clearly define not just the percentage by the term "Revenue."   For example, is it based on Gross or Net, and what is to be included in the Gross and what can be deducted as a legitimate expense when determining Net Revenues?  A Net Revenue contract may refer to overhead expenses, like a businesses' borrowing costs, which can be a killer for a party who is being paid based on Net.  Make sure you understand the definition, and if you don't ask for professional advice rather than assume the definitions are fair or standard.

3.  Financial Reports/Audit.  If the consideration under the contract is based on revenues or certain milestones, require periodic financial reports. In addition, you should have the opportunity to review and audit (i.e., challenge) such reports rather than simply accepting the information provided by the other contracting party.  In addition, provide a dispute mechanism in the event of a challenge, such as CFO's meet and try to resolve, appointing independent third party, or even arbitration -- and if the audit reveals you were in the right, include a requirement that the other party pays your costs.     

4.  Termination of the Contract/Suspension.  Of course the contract will expire at the end of its term, but include other events that will result in termination:  (a) non-payment, (b) material breach, (c) bankruptcy, (d) failure to achieve defined milestones, including financial ones, (e) assignment/sale of the business (see below), (f) departure of personnel if the business relies on certain key employees, or (g) force majeure.  Termination clauses will often allow the breaching party an opportunity to cure a default, provided it is one that can be cured.  In the case of a force majeure event, the contract can be suspended pending passage of the event or terminated if the contract becomes impossible to continue due to the event.  

5.  Assignment/Sale of the Business.  Do you want the contract to be assignable to a third party, including in the event of the sale of the business. This is an important issue for many types of agreements, such as licensing agreements or service contracts.  You can require consent for the assignment, but if you want the contract to be assignable, as an alternative you can propose that it is assignable to an assignee with financial ability to meet the contractual obligations.    

6. Warranties/Limitations on Liability.   Suppliers/service providers will often provide a lengthy provisions denying all warranties and limiting their liability -- and if you are the vendor, you generally want to push for these provisions.  If you are purchasing the the services of a large company, there may be no room to push back on any of the limitations, but whether the other contracting party is a small or large company, there is no harm in trying -- even if they send you the form or the "Master Service Agreement."  For either party, it is all about the bargaining power, and how much the other party wants your business versus how much you need the agreement.  Even if you cannot get the other party to budge, ask at least for an exception for gross negligence, and regardless a court may negate the limitation based on intentional misconduct or even gross negligence.               

7. Dispute Resolution.   Avoid an issues as to how disputes are to be resolved by negotiating the applicable (a) governing law, (b) venue for the dispute (meaning both the tribunal that will handle the matter, such as a court or arbitration/mediation, and the geographic location), (c) if there is to be mediation or arbitration, the procedures, and (d) will the parties impose legal fees and costs on the losing party.

8. Remedies.  Among the remedies you can include are (a) specific performance, which is important if money cannot cure a default, (b) liquidated damages, if you prefer to define the damages to avoid disputes as to proof the proper compensation for a breach, and (c) equitable remedies (other than specific performance), like an injunction.    

9. Non-Compete/Non-Solicitation.  Simple vendor/supplier agreements generally won't include these terms, but many other contracts will, including licensing agreements, consulting/employment, certain service agreements, or more major transactions (like sale of a business) to name a few.  Enforcement, especially as to non-competes, is a key legal issue, and it is highly advisable to have the provisions reviewed by counsel that understands the law in the applicable jurisdiction as it can vary greatly from state-to-state.

10.  Other Terms/Conclusion.   If there are other terms included or, for that matter, missing from the agreement, then make these part of the punch list of issues to be addressed with the other party.  The reality is that the worse response you can receive is "no", and then you can decide how important the provision is from your perspective.  A bad contract is NOT better than no contract.  In a competitive economy, even larger/established businesses are often willing to negotiate and "the last and final", "take it or leave it" or "as is" response may be just a bargaining tactic.

The Lesson: Read the Contract, Understand Each Provisions and Don't Be Afraid to Negotiate the Terms.





Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.


      

Legal Issues When Buying a Business: Don't Overlook These Provisions in the Purchase Agreement.

To contact us Click HERE
As discussed in prior installments of this series on buying a business, there are a number important legal issues you need to consider before signing the purchase agreement.  The first installment discussed the role of the Exclusivity Agreement, the second installment examined the differences between structuring the transaction as stock purchase as opposed to a purchase of assets, the third examined the importance of escrowing a portion of the purchase price to cover any issues that may arise post closing, and the fourth discussed important aspects of due diligence and how to address legal or financial issues in the purchase agreement.  This fifth installment examines several key provisions that should be incorporated in the purchase agreement but are otherwise often overlooked.

The Purchase Agreement is a very flexible instrument giving the parties substantial flexibility not only as to the structure the transaction but with respect to the representations, warranties, disclosures and covenants that the parties can negotiate to include (or for that matter exclude) from the Agreement.  There are a number of standard provisions relating to such matters as legal ownership of/title to the assets, representations as to the corporate status and authority, disclosures as to litigation, financial and tax related representations, environmental issues and post closing obligations.  First, while these provisions may be part of a standard purchase agreement they by no means should be viewed as boilerplate. Even a slight variation in language can alter the meaning and scope of these sections, and thus all representations, warranties and covenants, no matter how standard, need to be reviewed carefully.  Second, below are a number of provisions which are often overlooked but you should consider incorporating in the Purchase Agreement.

1.  Intellectual Property.
   
Of course it is standard to include representations regarding the seller's title and ownership of the intellectual property, but make sure the Agreement:

              (a)  Covers licensed rights as well as often the seller does not own but licenses key IP.  In  the same vein, confirm the licenses are assignable and if consent of the licensor is required that the Seller obtain the consent as a condition of closing.

              (b) Addresses rights to the domain names and company websites and requires transfer of these rights to the buyer as a condition of closing.  It is not unusual for the buyer to forgot about the transfer of the domain and then have to coax the seller into compliance after the sale.

             (c)  IP rights should include not only registered marks or issued patents, but pending applications, unregistered rights, royalties, licenses and, significantly, awards, damages or pending claims and litigation.

             (d)  Incorporates provisions relating to software, requires the turn over of source code, manuals, passwords, license keys and all other documentation.

2.  Litigation

Representations relating to pending or threatened litigation are typical in a Purchase Agreement, but be sure:

            (a)  There are sufficient disclosures about pending and threatened litigation, including the status of such matters.

            (b)  Decide how litigation is to be handled post-closing.  Will your lawyer take over the matter or will the Seller's lawyer continue to handle it; who will be responsible for the legal fees and costs; include a right to periodic updates as to the status of any legal matters; and set forth any rights as to damages, awards, insurance proceeds and to settle the matter and any indemnification in the event of an unfavorable outcome.
            
3.  Financial/Tax Matters

In addition to the typical representations and warranties concerning financial and tax issues, include:

          (a)  Financial

                  (i) Require that the seller update the financial statements on or prior to Closing;
                 
                  (ii) Include a formula for adjusting the purchase price if there are material changes to the financial statement;
                 
                  (iii) Although often used, try to avoid using an earn-out (post-closing payment contingent on certain financial milestones) as they are difficult to negotiate, document and manage once the buyer assumes the reins of the business, and as a result they are a major source of post-closing disputes.  If an earn-out cannot be avoided, make sure you have counsel who has experience negotiating and drafting earn-outs.

         (b)  Taxes

                (i) The representations and warranties should not only cover federal and state taxes, but sales and any other applicable taxes for all relevant jurisdictions.
               
                (ii) The seller should provide all filings and disclose any past, pending or threatened audits/assessments.
               
                (iii) Require the seller provide post-closing assistance for any filings relating to periods of time the seller controlled the business.
             
                (iv)  Include appropriate indemnifications for tax liabilities.


4.  Transition

Is there a switch in your house that you have no idea what it does, and since the seller is long gone you have no way of finding out?  Well, think how that issue is magnified exponentially if you purchase a business and don't have the seller to assist with the transition.  The assistance is important not only as to obvious issues, like computer systems, financial records, and where the keys to the third floor supply closet are located, but making a smooth transition as far as clients/customers, introduction to vendors/suppliers, establishing a good relationship with employees/consultants, ensuring an understanding of business processes and procedures that are essential for operation of the business.  Therefore, the Purchase Agreement can require the meaningful assistance of the seller or even include compensation to the seller for post-closing assistance and continued employment with the company for a reasonable period of time.

5.  Material Adverse Change   

Undoubtedly the Purchase Agreement will include a Material Adverse Change clause essentially providing the buyer with certain rights and remedies (including possibly termination of the transaction) in the event of a material adverse change with respect to the business.  The clause is one of those tricky provisions which, if not properly drafted, can result in substantial disputes.  The key is to avoid ambiguity by incorporating specific criteria as to when the Material Adverse Change clause is implicated, such as decline in sales, the loss of certain amount of or even specifically named customers, a decrease in EBITDA or termination of a manufacturing or supplier relationship.

6.  Employment/Labor Matters  
                       
Provisions relating to Employment and Labor matters are standard, but also make sure the representations and warranties include:

         (a) Existence of confidentiality, invention assignment and non-competes, and get copies for each employee and consultant.

         (b) Confirmation that consultants are truly consultants and not employees (which can give rise to substantial tax liabilities).

         (c)  Details and disclosures regarding any employee plans (stock, pension, etc.) and vesting status f each employee.

         (d)  Disclosures with respect to any collective bargaining any other labor matters.

7.  Operations in Foreign Countries

Establishing the right of the company to operate in any foreign jurisdictions where it does business should be obvious, but compliance with the Foreign Corrupt Practices Act is far less familiar to most people.  The FCPA prohibits various behavior relating to operating in foreign jurisdictions, including paying bribes to obtain contracts, business, etc.  Violation of the FCPA carries substantial civil and criminal liability.  As a buyer, you might not think much about the FCPA, but if you manufacture in China, for example, you better pay attention and therefore incorporate a representation that no unlawful payments have been made by seller or its agents.

8.   Covenants

The Purchase Agreement should contain covenants relating to:

        (a) Non-solicitation of employees, customers and clients and non-interference with existing vendor/supplier relationships.

        (b) In certain circumstances, a Non-Compete that complies with the narrow limitations imposed by applicable state law.

        (c) As discussed in prior posts, clear indemnification and escrow terms to address post-closing liabilities.

        (d) Confidentiality.

        (e) Obligation of the Seller to notify the buyer upon the occurrence of material events arising at any time prior to closing.

        (f)  Resignations of officers, directors, responsibility of the seller as to termination of some or all employees/consultants.

9.  Termination

There will be grounds for either party to terminate the Agreement prior to closing.  The termination provisions should not only provide specifics as to when the right can be invoked by a party, but also the liabilities, if any, resulting from termination and the effect of termination.

10. Survival

Give careful consideration to how long any of the representations, warranties and covenants will survive avter closing.  The seller will push for no or a very short period while the buyer will want them to survive until the chance of any liability no longer exists.  A compromise will almost always be necessary, and remember not all of the provisions need to survive for the same period of time

The above are by no means an exhaustive list of key provisions in a purchase agreement, and they will certainly vary depending on the nature of the business involved -- for example, if you are buying a gas station the environmental disclosures, reps and warranties will be substantial.  What is obvious that you cannot accept a boilerplate purchase agreement and instead the provisions need to be tailored to the particular transaction.

Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters




    

   

Tech Tools with Ramon's Taste of Tech: Mozy Data "Bridge"

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Ramon is a journalist, technology evangelist, speaker, editor of Smallbiztechnology.com and author of “Technology Solutions for Growing Businesses” (Amacom) and most recently “Technology Resources for Growing Businesses“. Ramon has written thousands of technology articles and news items for Smallbiztechnology.com and other media including: Open Forum, Inc. Magazine, New York Enterprise Report, Black Enterprise Magazine, CNet, Var Business, TechTarget, Entrepreneur.com, Small Business Resources and others. He has also written for technology vendors including Microsoft, FileMaker, and Everest. He is often quoted in the media, including the New York Times, San Francisco Chronicle, Entrepreneur Magazine, Inc. Magazine, WCBS Radio, Crains New York, National Federal of Independent Business, Small Business Advocate Radio Show, Wells Fargo Small Business Roundup, Tech Talk with Craig Peterson and Smart Money.

Are You Too Focused Working 'On the Business' Instead of 'In the Business?'

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On The Entrepreneurial Mind, Dr. Jeff Cornwall writes that first-time entrepreneurs often make the mistake of obsessing over such things as mission statements, company logos, and business cards (time spent "working on the business") instead of actually launching and running the business ("working in the business").
Cornwall has 4 pieces of advice for entrepreneurs who are inclined to spend too much time prepping to launch a business instead of getting out there and selling their product or service.

While a well-designed business card is nice to have, it is you and your product or service that will convince the customer to spend their hard-earned money on what you have to offer them.
Your actual product will rarely look anything like what you may envision in a business plan. In fact, unless you are looking to raise a large amount of capital from outside investors or bankers, writing a formal business plan is not even necessary. Customers will provide feedback that should inform and shape the new business in its early growth. Real information from actual customers is much more important than guesses you might make in a formal business plan.

Read the rest of Cornwall's tips here.

Presented by FreeEnterprise.com - your home for free market news and ideas. The site offers more than headlines - it’s a dynamic conversation about American free enterprise

Internet Marketing for Beginners: Part 2 - Generating Sales

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This article is the second in a series on Internet Marketing for Beginners. In the first article, I discussed setting a proper online goal. A website should either generate sales, leads, or support for an existing customer base. This article will focus on the first goal: Generating Sales.

Some of you may think ALL websites should generate sales. However, in my opinion, only a few should consider that their goal. When I say, “generate sales,” I define that phrase as allowing someone to put a product in a “shopping cart” and paying for it online. The merchant has only to ship it at that point.

The majority of you don’t need a shopping cart. Basically, those who sell high-priced items or services rarely need a shopping cart. Examples would include realtors, repairmen, consultants, etc.

If, however, you do have a product people would buy online, keep reading. A site that generates sales must have some key ingredients to succeed.

First, decide WHAT you want to sell. Not all of your products may be appropriate to sell online. I tell customers to start with their top ten items that meet these two requirements:

1. Have the highest margin (you make the most money on them)

2. Easy to ship

Second, determine if you can compete price-wise online. If you make a custom product, that may not be a consideration. But, if you have many competitors, keep in mind that the average consumer views price as the only online discriminator in most cases. You might have better customer service, higher quality, and faster delivery. However, unless you are able to communicate those differences to potential buyers, they are more than likely going to view you as one of many “apples” in the competitive basket.

Finally, make sure you TRULY want to sell online. The process sounds like an easy road to riches. After all, you are extending your potential sales territory from a few miles to worldwide. However, running an online business takes a lot of work. If done right, you will be working with it daily. While an online store facilitates customers purchasing products from you 24/7, it will not handle complaints, billing questions, or even pack the products into boxes for shipping. That is YOUR job.

In future articles, I will cover how to choose a shopping cart vendor, increasing sales through social media, and how to effectively bundle products. But, next week, I jump into the SECOND goal of Internet Marketing: Generating Leads.

I welcome your comments below!

Eric Spellmann continues to be one of the highest rated speakers at our national ASBDC conferences. His unique view that small business websites should “do” something pushes against the standard “online pamphlet” view of most web design companies. He believes your customer’s websites should be driving qualified leads and sales on a weekly basis. Eric speaks at a number of other national and state conferences nationwide, but enjoys running one of the most successful web design companies in the country. He truly believes in the SBDC mission as it helped him start his own company many years ago. To contact him, visit his website at EricSpellmann.com.

How the JOBS Act Could Result In More Opportunities for Veterans

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Tackling the unemployment rate among veterans has proven to be an ongoing challenge, but what if there was a more effective option that will soon be here to help solve this crisis? What if there was an easier way for citizens of all ages to do their part to help veterans obtain jobs and even raise capital to start their own businesses? Something called the JOBS Act could potentially be the solution that veterans all across the United States have been waiting for. By combining the power of equity crowdfunding and the JOBS Act this could open the door to a whole new world of opportunities for veterans and society as a whole.

Government efforts to incentivize the private sector to hire young veterans have been effective, and we need to keep that momentum going. July’s statistics were very encouraging at 6.9%, but there is still quite a way to go. Veterans, like anyone else, deserve to have stable positions that provide steady income and given the opportunity they bring a lot of invaluable knowledge and leadership skills to the table.

So what exactly is the JOBS Act and how will it help veterans? In short, it's a new bill that was passed earlier this year that will make equity crowdfunding legal beginning January 2013. Simply put, it will allow people the opportunity to legally raise capital from multiple investors to fund the launch of a new business. In other words, instead of having to go through the rigorous and overwhelming process of applying for loans or having countless job applications rejected, entrepreneurial veterans can now raise money from the vast pool of (previously unqualified) citizens, which will enable them to be self-sufficient by funding and launching a company of their own.

Look at current donation-based crowdfunding sites like Rockethub or Kickstarter to get a sense of where equity crowdfunding can take us. These platforms have helped to raise many millions of dollars by harnessing the power of the crowd and small donations. Veterans, perhaps even more than others, have the discipline, heart and drive to be successful business owners, and equity crowdfunding can help raise funds at a time when financing is hard to come by. Investigate sites like crowdfundingroadmap.com and startupexemption.com .

Being part of something that could not only change an individual’s life but change the world at the same time can be exhilarating. Be one of the few people in the country who will have the exclusive privilege to say they supported and helped launch "The Next Big Thing" from the very beginning.


Funding Roadmap is an innovative, networked business planning and due diligence reporting system for funding professionals and entrepreneurs alike. It also includes a video pitching platform, a document repository and deal flow marketplace so entrepreneurs will have an online medium to brilliantly communicate all the essential data – along with their personal passion and commitment.

Ruth. E. Hedges is the creator and CEO of Fundingroadmap.com. and Startups Across America. She has been featured in the New York Times, on ABC’s Home Show, and the Financial News Network did a two-part series on her for their show entitled ‘American Entrepreneur’.

For more information please visit http://fundingroadmap.com and http://www.startupsacrossamerica.com/SAA/

The Independent Contractor Trap: Don't Misclassify Your Employees

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Many start-up and expanding companies prefer to engage the services of a independent contractor rather than hire an employee because of the high costs relating to employment taxes, health insurance and other benefits.  Recognizing the cost savings of hiring a contractor, businesses will often seek to classify a new hire as a independent contractor believing all that is needed is a few revisions to their standard contract that identifies the person as an "independent contractor" and just like that the company has saved thousands of dollars.  In reality, the company may have created a huge red flag for a potential audit that could result in the obligation to pay susbtantial taxes plus penalties.  To avoid the Employee/Independent Contractor trap, consider the below guidelines for determining whether in fact you have hired an employee rather than engaged an independent contractor.

I.  Why do Businesses Often Prefer to Classify a Person as an Independent Contractor?

Whether because a company may be a start-up or an emerging or larger company is concerned about the difficult economic environment, businesses often prefer to classify a person as an independent contractor for the simple reason of cost.  Hiring an “employee” means the company has to withhold taxes and pay social security, and will have to offer health insurance and possibly other benefits (i.e., vacation/maturity leave, etc.)

II. Can't I Just Label the Person an Independent Contractor?

No, it is a common misconception that employees/companies can avoid the "employee" label by simply stating the person is an independent contractor in a services agreement between the parties.  Moreover, the fact that the person waived any rights as an employee, signed a statement asserting he/she is an independent contractor or is issued a 1099 instead of a W-2 does not give the employer any cover.  The tax authorities (and courts) examine the nature of the relationship between the person and the company, look at the facts as to how the person provides the services, and does not care about labels or other efforts made to classify an employee as an independent consultant.

III. What Distinguishes an Employee from an Independent Contractor?   

There is no single factor distinguishing an employee from an independent contractor.  Instead, courts examine all the facts to determine the degree of supervision, direction and control the company exercises over the services.  If the company controls the manner and means by which the person provides the services, the worker is likely an employee rather than an independent contractor.

      A.  An Employer-Employee Relationship May Exist if the Employer:

            1.  Controls when, where and how the services are to be performed
        
            2. Provides the tools to perform the services (facilities, equipment, tools, supplies)
           
            3.  Engages and requires the person to work exclusively for the employer
           
            4.  Exercises supervision over the person, requiring reports, setting the work schedule, establishing the pay rate, retaining the right to review and approve the work product and/or evaluate the person's performance

            5.  Offers compensation in the form of a salary or an hourly rate, and/or reimburses expenses
 
            6.  Engages the persons who are unskilled or casual workers (therefore requiring supervision).

    B.  Independent Contractors Generally Supervise, Direct and Control the Performance of their Duties.

            1.  When performing the services, the independent contractor is not supervised or subject to the direction of the company, instead controlling its performance of the services.

            2.  The independent contractor generally offers his/her services to the public, operating their own business separate from the company engaging the services.

            3.  Indicia of independence include:
                 
                  (a)  Using own tools, equipment and supplies   
                  (b)  Operating under a business entity (has a business) that assumes risks
                  (c)  Seting fees, project schedule, paying own expenses
                  (d)  Offering services to other companies
                  (e)  Marketing the services
                  (f)   Engaging own employees or third parties to assist
              
For additional guidance, see the following IRS publications: http://www.irs.gov/pub/irs-pdf/fss8.pdf  http://www.irs.gov/businesses/small/article/0,,id=99921,00.html


IV.  What if a Company Misclassified an Employee as an Independent Contractor?

If the IRS determines that your company has misclassified en employee as an independent contractor you need to be prepared to pay substantial taxes and potentially interest and penalties, especially if it was not an honest mistake.

Where the IRS finds that the misclassification was an honest mistake on the part of the employer, and the employer filed proper returns, the employer will be liable for (a) the employer FICA obligation that should have been paid in the first instance, (b) 20% of the employees FICA that should have been withheld, (c) 1.5% of the total compensation paid to the person, (d) any amounts due for unemployment tax, and (e) possibly interest and penalties.

If the employer fails to file proper returns and cannot demonstrate reasonable cause, the liability can be doubled.

But, if the misclassification is found to have been intentional, then look out because the above limits do not apply, and the exposure can run to the individual officers/directors of the company.

Now, on top this, add your state tax liability, and the fact that there may have been obligations under other laws (including relating to health care benefits) that the company violated by misclassifying the employee as an independent consultant.

The classification of an employee as independent contractor is carefully scrutinized by Federal and State tax authorities and is a common red flag giving rise to an audit.  Do not let the potential savings lead you into the independent contractor trap as your company will pay dearly for misclassifying its employees.

Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.
 


     

A Word to Small Business Owners: Don't Be Afraid to Negotiate Contracts

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All too often small business owners readily accept the terms of a contract or are concerned about pushing back on both economic and legal terms because either they fear losing the deal or simply don't fully understand the terms.  As a business owner, you need to recognize that in most circumstances there is an opportunity to negotiate terms of an agreement, and therefore you should not be afraid to seek the best deal possible even if the other party initially seems unwilling to consider your position on key aspects of the contract.  So, here is the advice, Don't Be Afraid to Negotiate. 

Negotiation skills are one of the most important tools a business owner should have in its toolbox.  Therefore, if you receive a contract from a party, read it carefully, and then proactively respond in writing with your comments.  One negotiating trick that vendors often try is to provide a form contract, creating the impression that the terms are non-negotiable -- indeed, if I am representing the vendor, I will often suggest creating a form agreement.  Any contract, even a form, can be revised by an amendment, so do not automatically assume the agreement must be accepted "as is".  The following are among the material terms that business owners should not only fully understand, but seek to negotiate.

1.  Term.   If you want a longer or shorter contact term, then ask for it.  One alternative is to get an option to renew, which should be exercised within a certain number of days prior to expiration of the contract.  The mechanics of the option and financial terms should be clearly spelled out as well. 

2. Fees.  There are many different ways to skin this cat, and you should consider what best works for your business over the term of the agreement.  The financial terms can be based on (a) a set periodic payment, (b) an up front payment and then installments, (c) fees that scale up or even down over the life of the contract, (c) revenues, (d) milestones, or (e) a combination of several different fee structures.  If the payments are based on revenues, then it is essential that the parties clearly define not just the percentage by the term "Revenue."   For example, is it based on Gross or Net, and what is to be included in the Gross and what can be deducted as a legitimate expense when determining Net Revenues?  A Net Revenue contract may refer to overhead expenses, like a businesses' borrowing costs, which can be a killer for a party who is being paid based on Net.  Make sure you understand the definition, and if you don't ask for professional advice rather than assume the definitions are fair or standard.

3.  Financial Reports/Audit.  If the consideration under the contract is based on revenues or certain milestones, require periodic financial reports. In addition, you should have the opportunity to review and audit (i.e., challenge) such reports rather than simply accepting the information provided by the other contracting party.  In addition, provide a dispute mechanism in the event of a challenge, such as CFO's meet and try to resolve, appointing independent third party, or even arbitration -- and if the audit reveals you were in the right, include a requirement that the other party pays your costs.     

4.  Termination of the Contract/Suspension.  Of course the contract will expire at the end of its term, but include other events that will result in termination:  (a) non-payment, (b) material breach, (c) bankruptcy, (d) failure to achieve defined milestones, including financial ones, (e) assignment/sale of the business (see below), (f) departure of personnel if the business relies on certain key employees, or (g) force majeure.  Termination clauses will often allow the breaching party an opportunity to cure a default, provided it is one that can be cured.  In the case of a force majeure event, the contract can be suspended pending passage of the event or terminated if the contract becomes impossible to continue due to the event.  

5.  Assignment/Sale of the Business.  Do you want the contract to be assignable to a third party, including in the event of the sale of the business. This is an important issue for many types of agreements, such as licensing agreements or service contracts.  You can require consent for the assignment, but if you want the contract to be assignable, as an alternative you can propose that it is assignable to an assignee with financial ability to meet the contractual obligations.    

6. Warranties/Limitations on Liability.   Suppliers/service providers will often provide a lengthy provisions denying all warranties and limiting their liability -- and if you are the vendor, you generally want to push for these provisions.  If you are purchasing the the services of a large company, there may be no room to push back on any of the limitations, but whether the other contracting party is a small or large company, there is no harm in trying -- even if they send you the form or the "Master Service Agreement."  For either party, it is all about the bargaining power, and how much the other party wants your business versus how much you need the agreement.  Even if you cannot get the other party to budge, ask at least for an exception for gross negligence, and regardless a court may negate the limitation based on intentional misconduct or even gross negligence.               

7. Dispute Resolution.   Avoid an issues as to how disputes are to be resolved by negotiating the applicable (a) governing law, (b) venue for the dispute (meaning both the tribunal that will handle the matter, such as a court or arbitration/mediation, and the geographic location), (c) if there is to be mediation or arbitration, the procedures, and (d) will the parties impose legal fees and costs on the losing party.

8. Remedies.  Among the remedies you can include are (a) specific performance, which is important if money cannot cure a default, (b) liquidated damages, if you prefer to define the damages to avoid disputes as to proof the proper compensation for a breach, and (c) equitable remedies (other than specific performance), like an injunction.    

9. Non-Compete/Non-Solicitation.  Simple vendor/supplier agreements generally won't include these terms, but many other contracts will, including licensing agreements, consulting/employment, certain service agreements, or more major transactions (like sale of a business) to name a few.  Enforcement, especially as to non-competes, is a key legal issue, and it is highly advisable to have the provisions reviewed by counsel that understands the law in the applicable jurisdiction as it can vary greatly from state-to-state.

10.  Other Terms/Conclusion.   If there are other terms included or, for that matter, missing from the agreement, then make these part of the punch list of issues to be addressed with the other party.  The reality is that the worse response you can receive is "no", and then you can decide how important the provision is from your perspective.  A bad contract is NOT better than no contract.  In a competitive economy, even larger/established businesses are often willing to negotiate and "the last and final", "take it or leave it" or "as is" response may be just a bargaining tactic.

The Lesson: Read the Contract, Understand Each Provisions and Don't Be Afraid to Negotiate the Terms.





Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.


      

Legal Issues When Buying a Business: Don't Overlook These Provisions in the Purchase Agreement.

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As discussed in prior installments of this series on buying a business, there are a number important legal issues you need to consider before signing the purchase agreement.  The first installment discussed the role of the Exclusivity Agreement, the second installment examined the differences between structuring the transaction as stock purchase as opposed to a purchase of assets, the third examined the importance of escrowing a portion of the purchase price to cover any issues that may arise post closing, and the fourth discussed important aspects of due diligence and how to address legal or financial issues in the purchase agreement.  This fifth installment examines several key provisions that should be incorporated in the purchase agreement but are otherwise often overlooked.

The Purchase Agreement is a very flexible instrument giving the parties substantial flexibility not only as to the structure the transaction but with respect to the representations, warranties, disclosures and covenants that the parties can negotiate to include (or for that matter exclude) from the Agreement.  There are a number of standard provisions relating to such matters as legal ownership of/title to the assets, representations as to the corporate status and authority, disclosures as to litigation, financial and tax related representations, environmental issues and post closing obligations.  First, while these provisions may be part of a standard purchase agreement they by no means should be viewed as boilerplate. Even a slight variation in language can alter the meaning and scope of these sections, and thus all representations, warranties and covenants, no matter how standard, need to be reviewed carefully.  Second, below are a number of provisions which are often overlooked but you should consider incorporating in the Purchase Agreement.

1.  Intellectual Property.
   
Of course it is standard to include representations regarding the seller's title and ownership of the intellectual property, but make sure the Agreement:

              (a)  Covers licensed rights as well as often the seller does not own but licenses key IP.  In  the same vein, confirm the licenses are assignable and if consent of the licensor is required that the Seller obtain the consent as a condition of closing.

              (b) Addresses rights to the domain names and company websites and requires transfer of these rights to the buyer as a condition of closing.  It is not unusual for the buyer to forgot about the transfer of the domain and then have to coax the seller into compliance after the sale.

             (c)  IP rights should include not only registered marks or issued patents, but pending applications, unregistered rights, royalties, licenses and, significantly, awards, damages or pending claims and litigation.

             (d)  Incorporates provisions relating to software, requires the turn over of source code, manuals, passwords, license keys and all other documentation.

2.  Litigation

Representations relating to pending or threatened litigation are typical in a Purchase Agreement, but be sure:

            (a)  There are sufficient disclosures about pending and threatened litigation, including the status of such matters.

            (b)  Decide how litigation is to be handled post-closing.  Will your lawyer take over the matter or will the Seller's lawyer continue to handle it; who will be responsible for the legal fees and costs; include a right to periodic updates as to the status of any legal matters; and set forth any rights as to damages, awards, insurance proceeds and to settle the matter and any indemnification in the event of an unfavorable outcome.
            
3.  Financial/Tax Matters

In addition to the typical representations and warranties concerning financial and tax issues, include:

          (a)  Financial

                  (i) Require that the seller update the financial statements on or prior to Closing;
                 
                  (ii) Include a formula for adjusting the purchase price if there are material changes to the financial statement;
                 
                  (iii) Although often used, try to avoid using an earn-out (post-closing payment contingent on certain financial milestones) as they are difficult to negotiate, document and manage once the buyer assumes the reins of the business, and as a result they are a major source of post-closing disputes.  If an earn-out cannot be avoided, make sure you have counsel who has experience negotiating and drafting earn-outs.

         (b)  Taxes

                (i) The representations and warranties should not only cover federal and state taxes, but sales and any other applicable taxes for all relevant jurisdictions.
               
                (ii) The seller should provide all filings and disclose any past, pending or threatened audits/assessments.
               
                (iii) Require the seller provide post-closing assistance for any filings relating to periods of time the seller controlled the business.
             
                (iv)  Include appropriate indemnifications for tax liabilities.


4.  Transition

Is there a switch in your house that you have no idea what it does, and since the seller is long gone you have no way of finding out?  Well, think how that issue is magnified exponentially if you purchase a business and don't have the seller to assist with the transition.  The assistance is important not only as to obvious issues, like computer systems, financial records, and where the keys to the third floor supply closet are located, but making a smooth transition as far as clients/customers, introduction to vendors/suppliers, establishing a good relationship with employees/consultants, ensuring an understanding of business processes and procedures that are essential for operation of the business.  Therefore, the Purchase Agreement can require the meaningful assistance of the seller or even include compensation to the seller for post-closing assistance and continued employment with the company for a reasonable period of time.

5.  Material Adverse Change   

Undoubtedly the Purchase Agreement will include a Material Adverse Change clause essentially providing the buyer with certain rights and remedies (including possibly termination of the transaction) in the event of a material adverse change with respect to the business.  The clause is one of those tricky provisions which, if not properly drafted, can result in substantial disputes.  The key is to avoid ambiguity by incorporating specific criteria as to when the Material Adverse Change clause is implicated, such as decline in sales, the loss of certain amount of or even specifically named customers, a decrease in EBITDA or termination of a manufacturing or supplier relationship.

6.  Employment/Labor Matters  
                       
Provisions relating to Employment and Labor matters are standard, but also make sure the representations and warranties include:

         (a) Existence of confidentiality, invention assignment and non-competes, and get copies for each employee and consultant.

         (b) Confirmation that consultants are truly consultants and not employees (which can give rise to substantial tax liabilities).

         (c)  Details and disclosures regarding any employee plans (stock, pension, etc.) and vesting status f each employee.

         (d)  Disclosures with respect to any collective bargaining any other labor matters.

7.  Operations in Foreign Countries

Establishing the right of the company to operate in any foreign jurisdictions where it does business should be obvious, but compliance with the Foreign Corrupt Practices Act is far less familiar to most people.  The FCPA prohibits various behavior relating to operating in foreign jurisdictions, including paying bribes to obtain contracts, business, etc.  Violation of the FCPA carries substantial civil and criminal liability.  As a buyer, you might not think much about the FCPA, but if you manufacture in China, for example, you better pay attention and therefore incorporate a representation that no unlawful payments have been made by seller or its agents.

8.   Covenants

The Purchase Agreement should contain covenants relating to:

        (a) Non-solicitation of employees, customers and clients and non-interference with existing vendor/supplier relationships.

        (b) In certain circumstances, a Non-Compete that complies with the narrow limitations imposed by applicable state law.

        (c) As discussed in prior posts, clear indemnification and escrow terms to address post-closing liabilities.

        (d) Confidentiality.

        (e) Obligation of the Seller to notify the buyer upon the occurrence of material events arising at any time prior to closing.

        (f)  Resignations of officers, directors, responsibility of the seller as to termination of some or all employees/consultants.

9.  Termination

There will be grounds for either party to terminate the Agreement prior to closing.  The termination provisions should not only provide specifics as to when the right can be invoked by a party, but also the liabilities, if any, resulting from termination and the effect of termination.

10. Survival

Give careful consideration to how long any of the representations, warranties and covenants will survive avter closing.  The seller will push for no or a very short period while the buyer will want them to survive until the chance of any liability no longer exists.  A compromise will almost always be necessary, and remember not all of the provisions need to survive for the same period of time

The above are by no means an exhaustive list of key provisions in a purchase agreement, and they will certainly vary depending on the nature of the business involved -- for example, if you are buying a gas station the environmental disclosures, reps and warranties will be substantial.  What is obvious that you cannot accept a boilerplate purchase agreement and instead the provisions need to be tailored to the particular transaction.

Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters