Every day, small business owners make mistakes by failing to disclose issues when selling their businesses, risking potential legal entanglements.
“Selling a business is not unlike selling a house. In California, there is a duty to disclose. Although a broker representing the buyer or seller has fiduciary obligations, by law, the onus of disclosure falls on the seller,” says Gregory M. Gentile, a partner at Ropers Majeski Kohn & Bentley PC.
Smart Business spoke with Gentile about pitfalls owners should avoid when selling businesses.
What can a seller do to mitigate the risks of selling a business?
Finding the right broker and/or consultant to help sell or market your business is a crucial step to success. Many times, owners seeking to list their business select the first person they meet. This can cost time and money.
Within a few months, you may see no results and have to go on a search all over again. Take time to interview the broker and focus on a realistic outcome. A reputable broker can prepare a sound market analysis and aggressively list the property to attract willing buyers.
The seller can also expect a reputable broker to have a well-drafted representation agreement. It is important that the seller review the agreement carefully and understand his or her obligations.
What are the contractual responsibilities of the seller?
Using a broker to market the business does not relieve the seller from due diligence. The seller is required to disclose all material conditions that may affect the prospective buyer’s decision to purchase the business. The seller can expect the broker to set forth these obligations in the listing agreement. It is very important for the seller to carefully review the listing agreement to ensure his or her awareness of these obligations that the broker places, by contract, on the seller, and the potential downsides if the seller fails to abide by them. If any part of the agreement is questionable, it is important to ask questions; and if necessary, consult with an attorney.
What provisions in the listing agreement should a seller be most concerned about?
Many listing agreements have one or more provisions requiring that the seller affirmatively disclose. There may also be provisions that seek to relieve the broker of any liability if the seller fails to disclose. For the seller, this means to be complete and accurate with any information provided to both the broker and the prospective buyer. Any material fact that may reasonably influence a buyer’s decision to purchase the business must be disclosed.
The listing agreement may have indemnity provisions favoring the broker. For instance, if the agent or broker gets sued or is required to defend a claim brought by a buyer, the broker can seek indemnity (recovery of damages) against one or more of the parties to the transaction, and such damages include, by contract, any attorney’s fees and costs incurred by the broker’s attorney in defending any claim. This can be substantial and financially devastating.
Many agreements have arbitration provisions. Such a provision in a listing or purchase agreement will pre-empt a lawsuit in superior court, which means that the parties must go to judicial binding arbitration if there is a dispute. Arbitration has the potential of being expensive since arbitrators charge hourly for their time.
The agreement can also contain an attorney’s fee provision. If the seller fails to disclose, and the broker has been forced to hire an attorney and prevails against the seller, the seller will be required to pay the monetary damages, the broker’s attorney’s fees and costs, including expert fees (if any are incurred, and they usually are) and the arbitrator’s fees, which can be substantial.
Selling one’s business can be financially rewarding, but it is also a complex transaction with many pitfalls for the seller. It is important to do your homework and select a reputable business broker. Further, be sure to read and understand the contracts presented by the broker, ask questions and, if necessary, consult an attorney. ●
Gregory M. Gentile is a partner at Ropers Majeski Kohn & Bentley PC. Reach him at (408) 918-4554 or [email protected].
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