Selling a Business in California

Selling a business in California is a fairly complex—but ultimately rewarding—process. It's one exit strategy that business owners use to realize gains from building and operating a successful business. Because there are so many moving parts to selling a business, clear documentation of the terms of the sale is critical.

In general, there are four stages to selling a business:

• preparation
• negotiation
• due diligence, and
• documentation.

This article presents an overview of some of the factors to consider in each of the four stages of selling a business in California.

For a more general overview, read our article on the eight steps to selling a business.

Stage 1: Preparing to Sell Your California Business

Selling a business isn't that different from selling a car or a house. You need to know what you're selling and how much money you're willing to accept. In addition, you need to clean up and advertise your business.

The following items summarize some actions you should take to prepare your business for a sale.

Choosing Between an Asset vs. Entity Sale

As a preliminary issue, a business owner needs to decide whether to sell the business entity along with all of its assets and liabilities or just the business assets by themselves. For example, a sale of a corporation would be a stock sale and a sale of a limited liability company (LLC) would be a sale of the LLC membership interests.

Buyers Prefer an Asset Sale

Buyers will typically favor an asset sale because they can pick and choose which assets they want without assuming unknown liabilities.

For example, suppose Tuck and Ming Ming buy a moving business from Lenny named "Wonder Movers LLC." The purchase is an entity sale and Tuck and Ming Ming become the new members (owners) of the LLC, inheriting all of the company's assets and liabilities. A year after the purchase, a past customer sues Wonder Movers for some damaged furniture from a move that happened two years ago under Lenny's ownership. Tuck and Ming Ming, as the new owners of Wonder Movers LLC, would be responsible for that lawsuit even though the incident happened before they purchased the company.

Sellers Prefer an Entity Sale

Sellers will favor an entity sale because it's a simpler process and it allows the owner to unload the entire company along with all of the associated liabilities. If you're considering an entity sale, you should check with the California Secretary of State (SOS) to make sure your business is in good standing.

The type of sale you choose could affect your future liability to the buyer, so it's also wise to get advice from an attorney who specializes in mergers and acquisitions for small businesses.

For more information on the differences between an asset and a stock sale, read our article about business acquisitions.

Evaluating the Business's Value

Before you can sell a business you need to have a good understanding of what it's worth. You can get a rough estimate of your business's value by researching the sales price of other businesses within your industry. However, the number you arrive at is only an estimate.

At some point, you'll need to get an expert opinion from a business valuation expert such as:

• an accountant
• a business broker, or
• a business appraiser.

Having this piece of information is going to be critical in every other stage of selling your business.

For more on business valuation methods, read our article on how to value your business.

Gathering Company Resolutions, Documents, and Agreements

As you prepare to sell your company, it's important to clean up and organize all aspects of your business. So, you'll need to make sure that your relationships with vendors, customers, distributors, and others are well documented. You'll also need to review internal company documents, resolutions, and agreements to make sure they tell a clear story of how the business has been run.

Gathering these documents is especially important if you decide to do an entity sale rather than an asset sale. Annual information statements filed with the SOS can be obtained for a small fee by filing a business entity records order form with the SOS bizfile Online.

Preparing a Selling Memorandum to Advertise the Sale of Your Business

A standard form of advertisement used in selling a business is the selling memorandum. This document is used to market a business by presenting accurate information about the operations of the company including its:

• financial health
• management
• employees
• products and services, and
• the purchase price.

You'll want to prepare a selling memorandum for potential buyers to review. Since this document will contain very sensitive information you don't want to distribute it to just anyone. Only serious buyers who've signed a confidentiality agreement—also known as an "NDA" (short for a "nondisclosure agreement")—should receive a copy of the selling memorandum.

Stage 2: Negotiating the Terms of Purchase

Once you've prepared your business for sale, you can list it with a broker or use some other form of advertisement to communicate to potential buyers that it's for sale. Interested buyers and brokers will want to discuss a variety of terms that'll eventually be a part of any sales transaction.

Here are some items you should be prepared to negotiate with potential buyers:

• Purchase price. You can anticipate that potential buyers will want to negotiate a lower price than the price at which you advertise your business. The asking price should be flexible enough to accommodate a healthy negotiation process. Having an appraisal will give credibility and context to your asking price.
• Terms of financing and interest. The purchase price can be paid in a lump sum cash payment or it can be stretched out over time through a payment plan. Often, small business owners have to finance a portion of the purchase price—with, for example, a small business loan. Financing the purchase price typically requires a promissory note along with some form of security agreement with collateral pledged against the future payment of the note. The buyer could obtain financing either through a bank or another lender. Though, you—as the seller—could also finance the purchase (known as "seller financing"). Be aware that California regulates how much interest you can charge a buyer so you should review the state's usury laws.
• Representations and warranties. Both the buyer and the seller will need to make representations and warranties to the other party. A representation is a presentation of facts and a warranty is a promise that the facts as presented are true. For example, the seller will represent and warrant that they're the legal owner of the business and are authorized to sell it. The buyer will represent and warrant that they're authorized to enter into the transaction and know that the purchase agreement is enforceable.
• Commercial lease takeover. If you have a lease on office space, your buyer will probably want to take over the lease. This substitution can be done through a sublease arrangement or by negotiating a new lease with the landlord. Check your current commercial lease to see if it can be subleased or assigned, or when the lease ends.

After you've gone through the process of negotiating the basic terms of selling your business, you and the buyer will sign a document that briefly outlines those terms known as a "letter of intent." This letter of intent (LOI) isn't a binding contract but helps to keep track of what's already been negotiated. This document also makes it easier to produce the final purchase agreement.

Stage 3: Conducting Due Diligence on the Business

Once you have a serious buyer who's signed a confidentiality agreement and an LOI, they'll want some time to inspect your business to make sure everything you have represented checks out. The inspection period gives the buyer the opportunity to inspect the physical state of your business including the building, equipment, inventory, and employees, as well as the financial records, legal contracts, and company books.

In order to ensure a smooth transition for the new buyer, you want to make sure that you disclose everything up front. The following is a list of items you should prepare and make available to any serious buyer:

• company books which include corporate records of organization or incorporation, meeting minutes, company resolutions, ownership certificates, certificates of good standing, and records of company structure
• financial records and tax returns including profit and loss statements and balance sheets
• material contracts with vendors, suppliers, clients, customers, distributors, or any other ongoing business relationship that's a critical part of your business
• accounts receivable reports that detail the future payments the company expects to receive from transactions that have closed prior to the sale of the business; and
• a valuation report prepared by a CPA or business appraiser that justifies your asking price for the business and gives context to the buyer for understanding how the price was determined.

In addition to inspecting the records and physical facilities of your business, a prudent buyer will want to contact business partners who have experience doing business with you. The buyer might ask to speak with vendors, customers, distributors, or other business partners to assess the strength of the various business relationships.

If there are skeletons in the closet of your business, it's a good idea to deal with them in a straightforward and honest manner. The more information the buyer has about potential problems, the better equipped they'll be to handle those problems after you close the transaction.

For more guidance on what'll be investigated when you sell your business, read our guide to the due diligence process.

Stage 4: Drafting a Purchase Agreement for the Sale

A purchase agreement is the primary legal document used for the acquisition of a business. The purchase agreement outlines all of the details of the sale and mirrors the LOI. Depending on how you structure this transaction you might also need:

• a bill of sale
• a promissory note
• a security agreement
• a stock transfer certificate, and
• company resolutions.

The purchase agreement should include all of the following:

• a clear statement of who's buying the business and who's selling it
• whether it's a sale of business assets or an entity sale
• the purchase price and method of payment
• actions that the buyer and seller must take prior to closing
• the closing date
• representations and warranties of the buyer
• representations and warranties of the seller
• future covenants against competition and confidentiality
• default provisions for sales involving seller financing
• boilerplate legal provisions (like choice of law, waiver, notice, and severability)
• exhibits of other relevant documents, such as a bill of sale and promissory note.

Even honest people are sometimes forgetful. By documenting the details of the business sale, a business seller can avoid an expensive and time-consuming legal battle.

What to Do After You Sell Your Business

It's important to follow through with the following items once you've closed the sale of your business depending on the type of sale:

• Closing business bank accounts. Closing a business bank account should be done as soon as all accounts receivables have been processed and no more money will be processed through the business account. The bank will close the account and issue a final check or cash payment of the remaining funds from the account once you provide them notice that you're closing it.
• Canceling general liability insurance. You might want to discuss with your insurance broker the terms of your insurance policy to make sure you don't need to carry a form of tail insurance (insurance for claims reported after your policy ends) to cover any liabilities that could arise following the transfer of your business.
• Winding up the business entity. California requires you to file certain forms with the SOS to terminate (or "dissolve") a business entity. These dissolution forms are available at the California SOS website. If you're selling your business assets and closing down the business, you'll need to legally end your business's existence with the state.

For a list of things to do to wind up your business, see our checklist for closing your business.

Getting Help With Selling Your California Business

Your business is likely one of the most important things to you—both professionally and personally—and selling it is probably bittersweet. You need to take care to arrange for a legal sale that'll compensate you fairly for your company and that won't result in any issues years after the sale is finalized.

To protect yourself, it's a good idea to surround yourself with a team of professionals and advisers that can work with the other side to close the sale. Consider working with a business valuation expert, accountant, tax adviser, or business attorney during the process. Do your research on potential buyers and keep your records organized and ready to present. A business sale is a lengthy process but it can be a rewarding send-off once the ink has dried on the purchase agreement.