What to Consider When Purchasing or Selling a Business – Part II
Non-Competition Agreements & Employees: Negotiations When Buying or Selling a Business
In Part I of What to Consider When Purchasing or Selling a Business, we discussed the most important consideration in the purchase or sale of a business, which is whether the acquiring purchaser is to purchase the assets or the shares of the business. In this Part II, we will discuss the other two contentious matters that typically give rise to negotiations when buying or selling a business: non-competition agreements and employees.
1. Non-Competition Agreements
In an asset sale of purely goodwill, which occurs when a business sells its client lists and trade-name, it is crucial for the deal to include a non-competition agreement, preventing the seller from opening the same or similar business. Because the entire purchase price is predicated on the goodwill of the seller, there are no hard or physical assets, such as product, equipment or inventory that make up the value of the business. Goodwill of a business is typically intimately tied to the seller, who has generated that goodwill in the marketplace. If he or she is to continue to operate a similar business, the value of the goodwill being purchased is reduced to zero, effectively destroying the purchase.
For example, an insurance broker wishes to sell his or her book of business to a purchaser. The purchaser purchases the client list (goodwill) from the seller for $50,000. The purchaser does so in the hopes that the clients on the purchased client list will continue to use the purchaser as their insurance broker moving forward. Typically in these circumstances, the seller will introduce the purchaser to the clients and indicate that this is his or her successor to incentivize the customers to continue to purchase insurance through the purchaser. However, if the vendor doesn’t sign a non-competition agreement in connection with the goodwill sale, the seller can simply open up shop across the street and continue to sell insurance. Of course, all of its existing clients will come across the street and purchase insurance from the seller, with whom they have a relationship. The purchaser will have purchased goodwill for $50,000 that has been reduced to zero.
For this reason, non-competition agreements are crucial in goodwill sales and are extremely important in hard asset sales as well.
Employees usually represent the other contentious item when negotiating an asset purchase. Under law, when the assets of a business are sold to a new purchaser, all of the employees become successor employers to the purchaser. This means that all of the employees’ liability, such as their work history, vacation pay, termination pay, and severance pay entitlements are transferred to the purchaser. If the purchaser wishes to terminate an employee after 6 months of buying the business, the purchaser must pay the employee termination pay, representing the entire time the employee was employed by the previous business. Without provisions in place to protect the buyer, he or she could potentially have to pay a large bill in termination pay to an employee who was previously employed for many years.
As a result, a purchaser will typically demand that the seller terminate all of the employees’ employment with the business effective the closing date. The purchaser will require that the seller pay the employees all their statutory rights in respect of this termination, such as termination pay, severance pay and accrued vacation pay.
Then, the purchaser will offer employment to the employees on substantially the same terms as the previous employment. The employees will start work for the purchaser effective the closing date, and the purchaser will only be labile to its employees for vacation, termination and severance pay from that day forward.
Because the seller will be saddled with a large payout to his/her employees, the seller may wish to increase the purchase price to reflect these liabilities. As both the seller’s and the purchaser’s interest are fundamentally at odds, the issue of employees typically become a contentious issue when negotiating an asset purchase or sale.
Why You Need a Commercial Lawyer for your Purchase or Sale of a Business
The purchase and sale of businesses represents the crux of our firm, handling several transactions each month. With our combined tax and corporate law experience, we anticipate these complex corporate and tax issues and formulate optimal solutions that forward your interests. With years of experience in all issues of the purchase or sale of a business, we ensure that your interests are protected, you get the highest valuation for your business and pay the least tax.
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If the employer has terminated an employee’s contract as part of the negotiations in a purchase or sale agreement, the employer must pay the employee any severance pay, termination pay, and accrued vacation pay to which the employee is entitled. Due to the substantial cost, the vendor may raise the selling price to compensate for the expense.
-Shira Kalfa, BA, JD, Founder
© Kalfa Law, 2020
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.