Category Archives: Buying/Selling a Business

What is the Texas Business Opportunities Act?

Almost everyone is familiar with the concept of franchises and franchise law but many people are unaware of another statute governing business opportunities called the Texas Business Opportunities Act.  The importance of understanding this law cannot be understated due to the penalties involved – failure to comply is by law a deceptive trade practice in violation of the Texas Deceptive Trade Practices Act. So here is what you need to know.

What is a “business opportunity?”

A business opportunity can be quite literally, anything.  Whether the opportunity falls within the statutory definition is determined by the promises or representations made by the person or entity selling the opportunity.

To fall within the statutory definition of a “business opportunity,” the seller must:

  1. sale or lease more than $500 of products equipment, supplies, or services that the purchaser will use to begin a business;
  2. the seller must represent that the purchaser will or is likely to earn a profit in excess of the amount paid to the seller; and
  3. the seller must:
    1. provide a location or assistance in finding a location for the business;
    2. provide a sales, production or marketing program; or
    3. make a promise to buy back or buy back the products, equipment, supplies, or products resulting from them.

Are there exceptions to the definition of a “business opportunity?”

Yes, there are a number of exceptions to the definition of a business opportunity.  For example, franchises that comply with the federal Franchise Rule can claim an exemption from the Texas Business Opportunities Act.  Other examples of exceptions include the sale or lease of an established and ongoing business, a retailer’s sale of goods or services, a sale or lease to a business enterprise that also sells or leases other products, equipment ,or supplies, and exceptions for certain high net worth individuals.  There are detailed rules and requirements for each exemption that must be carefully scrutinized to ensure the transaction fits within the exemption.

In addition, exemptions are not always automatic.  To claim an exemption as a franchise, the franchisor must file an exemption notice with the secretary of state’s office.

What does the Texas Business Opportunities Act require if you intend to offer a “business opportunity” for sale or lease?

The Texas Business Opportunities Act lists a number of requirements for sellers to comply with in order to avoid sanctions under the statute.  For example, there are record keeping requirements as well as bonding, trust account, and letter of credit requirements.  Most importantly, sellers are required to register the business opportunity with the secretary of state and provide specific disclosures in a disclosure statement provided to prospective purchasers.  The statute also lays out minimum time periods for providing the disclosure statement to a purchaser before they can purchase the business opportunity.

The act also provides specific requirements for the terms that must be included in the business opportunity contract.

What disclosures does the Texas Business Opportunities Act require in a disclosure statement?

Before offering a “business opportunity” for sale, the seller must file a copy of the disclosures with the secretary of state’s office.  The seller must provide a copy of the disclosure statement to each prospective purchaser.  The act requires the disclosure statement to contain, among other things, information relating to the following topics:

  1. A statutorily specified cover sheet.
  2. Names and address for the seller as well as information on the seller’s business.
  3. Information regarding the sales period for the business opportunity.
  4. A detailed description of the services the seller will perform.
  5. Recent financial statements of the seller.
  6. A detailed description of any training services offered by the seller in connection with the business opportunity.
  7. A description of the security maintained by the seller as required by statute.
  8. Information on delivery dates and cancellation rights.
  9. Information supporting any sales or earnings representations made by the seller.
  10. A history of legal actions involving the seller and certain individuals involved in the seller’s business.
  11. Information regarding any bankruptcies or reorganizations involving the seller or certain individuals involved in the seller’s business.
  12. A copy of the business opportunity contract.

What acts does the Texas Business Opportunities Act prohibit?

The act specifically prohibits sellers from the following:

  1. Employing a representation, device, scheme, or artifice to deceive a purchaser;
  2. Making an untrue statement of a material fact or omitting to state a material fact in connection with the documents and information required to be provided to the secretary of state or a purchaser;
  3. Representing that the business opportunity provides or will provide income or earning potential unless the seller:
    1. has documented data to substantiate the representation of income or earning potential; and
    2. discloses the data to the purchaser when the representation is made; or
  4. Making a claim or representation that is inconsistent with the information required to be disclosed by the act in:
    1. any advertising or other promotional material; or
    2. any oral sales presentation, solicitation, or discussion between the seller and the purchaser.

 

You can read more frequently asked questions regarding business opportunities on the Secretary of State’s website.

You can also read more about Texas business opportunities on the Attorney General’s website.

Preparing for Due Diligence When Selling A Company And Why It Is Important

Anyone who has gone through the process of selling a business knows that it can be a time consuming and tedious process.   Anyone who has gone through the process of buying or selling multiple businesses knows that not all sellers put forth the same effort in preparing their businesses for sale.  The amount of effort a seller puts into preparing for the sale goes a long way in determining whether the process is painfully tedious or a mere inconvenience on the road to a prosperous closing.  More importantly, a seller’s lack of preparation could kill the deal or reduce the purchase price.

Why does preparation of the seller matter so much?  I’ll give you two reasons: trust and credibility.

If a seller has taken the time and put forth the effort to properly prepare the company for an acquisition it makes the process much easier because the seller organized and made available the information a prospective buyer will want to review during its due diligence.  This establishes credibility with the buyer.  It establishes confidence that the seller understand its business, the risks a buyer will want to review, and ultimately confidence that the seller has properly monitored and managed those risks prior to the sale.

Imagine a buyer who inquires about a company’s FCPA compliance.  The seller immediately responds with documents including its compliance policy, training, incident reports, investigation results, and performance audits.  The seller also identifies and makes the individual responsible for monitoring its compliance program available for an interview.  This communicates to the buyer that the issue it is concerned about was properly addressed and managed by the seller.  It demonstrates that the seller understands it business, the risks inherent in that business, and that the seller properly managed those risks.

Now imagine if the seller responded that it would look for any documentation it had and provide what it found.  Regardless of whether that seller eventually provides the exact same information as in the scenario above, it immediately creates questions and doubts in the buyer’s mind.  How could the seller not understand this would be an issue that any buyer would inquire about?  Does the seller not understand the importance of this issue?  Did the seller not properly manage the associated risks?  What other issues might this seller have ignored?  What other unknown risks might I be buying into from a seller who doesn’t understand the risks inherent in his business?

Assuming the buyer doesn’t just turn and walk away, this lack of preparation can have a serious impact to the seller. The prospective buyer will undoubtedly ask much more detailed and in depth questions.  The doubt could also lead the buyer to demand a discount on the purchase price because of its questions about the risk exposure.  All of this results from the fact that the seller did not take the time to properly prepare for the due diligence process.

This is an example on the topic of compliance but preparation is just as important for issues related to corporate governance, taxes, legal, and accounting questions.

So how does a prospective seller make sure it is prepared for a buyer’s due diligence?

  1. Identify a due diligence team which includes a lead manager as well as representatives from each core business unit subject to review. These representatives will be the individuals responsible for assembling and organizing all relevant information from their respective units.
  2. Create checklists of action items and materials that you would expect an acquiring company or individual to inquire about.  This is the time to take a critical look at your business and identify any potential risk exposure so that you may address it before it is discovered by a potential acquirer.
  3. Collect and organize all information that you intend to make available to prospective acquirers during the due diligence process so that it is organized, readily available, and easily identifiable.
  4. Prepare a data room or central repository and index all of the information that it contains.  This may be a physical room onsite or at an adviser’s office, or it may be a virtual repository. In any case, you should make sure it is secured and that all access is strictly monitored.
  5. Prepare any confidentiality agreements that you will require from prospective acquirers prior to allowing them access to any data.  These will undoubtedly require negotiation between the seller and prospective buyer but the seller should have a form ready with the key terms it will require.
  6. Prepare a list of qualifications for any prospective buyer.  It is important to verify that the potential acquirer is in fact qualified to do so before allowing it access to sensitive information about your company.
  7. Identify what information you will make available to a prospective buyer and at what stage of the process.  Identify particularly sensitive data that you may want to only make available at the later stages of the process.
  8. Prepare a communication plan identifying who the primary point of contact will be with prospective acquirers and within the company.  You should identify which individuals in the company will responsible for communicating about which topics so that any inquiries may be directed to the appropriate individual swiftly. You may also want to spend time preparing those individuals how to respond to anticipated questions and even develop guidelines or a reference sheet.

Key Issues That Should Be Addressed in a Buy-Sell Agreement for Texas Businesses

Buy-Sell Agreements should be found in every private company with multiple owners.  They are invaluable in any number of situations as a tool to avoid deadlock, discord, receivership, or winding up and termination of a company.  Buy-sell agreements may be separate stand alone documents, they may be part of the entity’s governing documents, or they may be part of other agreements between the entity’s owners.

Buy-sell agreements require a certain degree of foresight and prediction about where the company will be a number of years in the future.  These expectations change over time so the owners should periodically review their buy-sell agreement to confirm that it still meets their needs and expectations.

So what are the key issues that a buy-sell agreement needs to address?

Triggers in Buy-Sell Agreements.

Triggers go to the heart of the buy-sell agreement as they dictate the type of events that will cause the terms of the buy-sell agreement to come into effect.  Common triggers are retirement, deadlock, and death.  Other triggers include the voluntary or involuntary transfer of an ownership interest, resignation, or the termination of employment of an owner-employee.

When it comes to determining what triggers a party chooses to include in a buy-sell I find that it is often best for the party to consider what situations he or she wants protection from.  Some common situations to consider include:

  • Protection from the risk of a divorcing owner’s spouse gaining an interest in the business (Texas is after all a community property state).
  • Protection from the risk of other owner’s combining their interests to the detriment of an individual owner.  The “bully” scenario.
  • Protection from another owner with greater resources buying additional control.  Should owner’s have equal opportunity to increase their share of ownership interests?
  • Protection from the risk of bankruptcy of an owner.  Bankruptcy courts wield a lot of power with regard to disposing of debtor’s property.
  • Protection from disagreement among the owners on whether to accept a purchase offer from a third party.  Should the majority be able to force a sale?
  • Protection from termination of an employee-owner’s employment.  How would the former employee feel if his or her salary is terminated and distributions are not made?
  • Protection from a failure to make distributions.
  • Protection from (or requirement for) the application of a minority or lack of marketability discount to any redemption or cross-purchase.  The application of minority or lack of marketability discounts is a hotly contested issue when not specifically addressed with prior planning.

Valuation Methods for Buy-Sell Agreements.

There are a number of valuation methods for a buy-sell agreement.  In some agreements the valuation is set with objective and specific standards such as multiples of earnings, capitalization rate, or book value.  Other agreements might favor a subjective standard or establishing a methodology over objective numbers. Subjective standards typically require the use of third party professionals to establish the valuation.  In this scenario, the buy-sell agreement should outline the factors that a valuation professional may or may not consider in the valuation as well as the process for selecting that professional.

Which method is best depends upon the nature of the business and often times may vary within the buy-sell agreement based upon the trigger event.  For example, a valuation for purposes of redeeming the interest of a deceased owner could be very different from the valuation method used when one owner is opting out or threatening the sale of his interest to a third party.  In the former scenario it might be more appropriate to allow for a valuation that considers future profits and opportunities, while the latter scenario might warrant application of a discount for lack of marketability or minority status.

Funding of Buy-Sell Agreements.

The best drafted buy-sell agreement can be rendered worthless because of inadequate planning for how the parties will fund the required purchase under that agreement.  One of the most common funding mechanisms is insurance but this funding method is typically only available in limited circumstances such as death of an owner.  So what are the other options?  Borrowing, installment sales, and personal resources are the most common alternatives though each has certain benefits and risks associated with them.

Borrowing the funds to implement a purchase pursuant to a buy-sell agreement necessarily assumes that the borrower (whether another owner or the entity) will be able to secure a loan.  Prudent planning may necessitate clauses in a buy-sell agreement that require sufficient reserves, whether in cash or assets, to increase the likelihood that the purchaser will be able to secure funding necessary to effect the purchase.

Installment sales are another alternative that usually come with the benefit of avoiding the need to qualify for a loan.  This is a significant benefit that can allow for less hassle and an efficient implementation process when the buy-sell agreement is triggered.  However, this structure can carry significant risk for the seller as the payment structure relies heavily on future income.  What happens if revenues decline?  Will the seller be compensated for the additional risk with a higher interest rate on the payments?  If so, what is the appropriate rate?  Will the buyout payments receive priority?  Is the seller going to take a security interest in business property or possibly the personal property of the other owners?

Additional Matters to Address with a Buy-Sell Agreement.

A significant consideration is determining how the purchase and sale will be structured.  There are usually two options: a cross-purchase or a redemption.  In the cross-purchase scenario, the interest is purchased by all or some of the other owners of the entity.  Under the redemption scenario, the interest is purchased by the entity itself.  Each has its own benefits, impacts, and risks to the other owners and prudence dictates carefully considering each scenario to determine how the purchase and sale should be structured.  This is another area where the structure of the transaction may differ based upon the triggering event.

A buy-sell agreement carries with it certain additional requirements to be effective.  For example, a buy-sell agreement that imposes restrictions on the transferability of corporate stock carries with it certain notice and record keeping requirements that must be met for those restrictions to be enforceable.

In addition, effective implementation of a buy-sell agreement may require amending the entity’s governing documents, shareholder or partnership agreements, or other documents related to the entity.

The Benefits of Using a Letter Agreement When Evaluating a New Venture

In a perfect world, whenever people enter into a business relationship they will outline all of the terms of that relationship at the outset.  This usually involves lawyers drafting joint venture, partnership, or company agreements that address every contingency that may occur during the endeavor. In the real world, people run into an opportunity when… Continue Reading