Lawyers in Business Purchase and Sale

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Planning for Business Transitions: Selling, Acquiring, and Merging

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Navigating the complexities of business transitions – whether it is transferring, selling, acquiring, or merging a business – is a multifaceted process. In Quebec, Canada, and internationally, these transactions require thorough preparation and skilled guidance. Partnering with a professional team is essential for effective due diligence, tax optimization, and creating a sound legal structure to facilitate your business dealings.
Many small and medium sized business (SMEs) in Quebec and Canada are family-run, and planning for succession is often a key consideration. For businessowners without a direct succession plan, selling the business can be a strategic step towards enjoying a well-deserved retirement.

If you are considering an acquisition, the process begins with a detailed analysis to confirm its feasibility and benefits. Once you decide to proceed, the next steps include signing a confidentiality agreement and a letter of intent, setting the state for negotiating the terms and conditions of the transaction.

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Understanding Confidentiality Agreements in Business Transactions

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During business negotiations, particularly when buying or selling a company, confidential information is often shared. This could include financial data, operational strategies, trade secrets, or even specific production techniques. For instance, a buyer interested in a toy manufacturing company needs to know about production costs and techniques before making an offer. However, revealing this information poses risks to the seller. In some cases, sellers might also require confidential information from buyers, like financial statement or proof of financial capability.

To safeguard both parties, a confidentiality agreement, also known as a Non-Disclosure Agreement or « NDA », is crucial. This agreement ensures that any sensitive information exchanged during the negotiation process is not disclosed, communicated, or misused. Therefore, it is advisable to sign a confidentiality agreement early in the discussions to protect the interests of both the buyer and the seller.

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Letter of Intent

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Once a confidentiality agreement is in place and before deeper due diligence is conducted, it is common for both the seller and buyer to sign a letter of intent. This document outlines the preliminary terms and conditions of the proposed transaction, setting the foundation for final negotiations. The letter of intent serves not only to facilitate these negotiations but also to explicitly express the mutual interest of both parties in either buying or selling the business.

Key Clauses in Letters of Intent for Business Transactions

1. Exclusivity of Negotiation Clause

An Exclusivity Clause to prevent the seller from negotiating with other buyers during a specified period.

2. Purchase Price Clause

This clause addresses the proposed purchase price in the letter of intent, without necessarily fixing it. It often includes a Price Revision Clause to accommodate changes based on due diligence findings. Additionally, sales agreements can include a provision for paying the purchase price in installments. In this situation, the buyer makes an initial down payment, followed by the remaining balance as per a pre-agreed schedule.

To secure the unpaid balance of the purchase price, sellers have several options. One common method is using the shares themselves as collateral. In such cases, a trusted third party, like a business lawyer or notary, holds the share certificates and only releases them to the buyer once the full payment is made.

Furthermore, to ensure the purchase price payment, legal mechanisms like registering a mortgage on property in the Registre foncier, or on the business’s movable property in the Registre des droits personnels et reels mobiliers of Quebec, may be employed. This provides additional security for the seller to safeguard the agreed payment terms.

3. Payment Terms

Payment terms include the date, frequency, and mode of payment. It may be stipulated that part of the transaction will be financed through the issuance of a new category of shares redeemable by the company at a specified date or through payments spread over several years.

4. Non-Binding Clause

This clause in a letter of intent clarifies that the document is not legally binding. While the letter signifies the intent to negotiate, it does not legally commit either party to finalize the transaction, contrary to a promise to purchase or sell. Despite its non-binding nature, the role, and implications of such a clause have been widely debated in legal circles. It is crucial to understand that even with anon-binding clause, the document could still hold moral or ethical obligations both the buyer and the seller to negotiate in good faith.

Given the complexities and potential implications, it is strongly advised to have a lawyer review the letter of intent before signing. This ensures that all parties fully understand their commitments and the extent to which their actions, words, or responsibilities could be construed as part of the negotiation process.

5. Closing Clause

In a letter of intent, it is standard to include closing clauses that depend on certain key conditions being met. These conditions might include obtaining bank loan approval, the issuance of necessary operating permits, or the successful transfer of a lease. These clauses ensure that the transaction can only proceed once these critical requirements are fulfilled.

6. Non-Compete Clause

In many business transactions, particularly ins ales, it is logical and often essential of the buyer to request a Non-Compete Clause. This clause aims to prevent the seller from establishing a competing business or redirecting customers to a new venture after the sale. It is a safeguard to protect the buyer’s investment and the integrity of the acquired business.

7. Indemnification Clause

This clause outlines predetermined compensation that parties may claim if one side abruptly ends negotiations without a valid reason or acts in bad faith. It provides a measure of security and accountability, ensuring that both parties engage in negotiations with serious intent and integrity.

8. Resolutive Condition

Inserting resolutive conditions in a letter of intent is a wise practice for scenarios where certain events might warrant ending negotiations. For example, it can be stipulated that discussions will terminate if an incident occurs that seriously damages the company’s brand reputation. This condition acts as a safeguard, allowing parties to withdraw from negotiations if unforeseen, significant negative events occur. Each of these clauses plays a crucial role in structuring the letter of intent and protecting the interests of both parties involved in a business transaction. It is important for business owners to understand these clauses and consult with legal professionals to ensure that their interests are adequately safeguarded in any potential deal.

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Legal Implications of a Letter of Intent

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Understanding the distinction between a letter of intent and a formal offer is crucial in the context of business transactions. A letter of intent is a written expression of the parties’ intention to negotiate a deal. It generally outlines the terms and conditions the parties wish to negotiate further but does not bind them to conclude the transaction.

In contrast, an offer is a formal and definite proposal that, once accepted, obliges the parties to fulfill the transaction. For example, if Jean-Paul and Julie sign a letter of intent of the salle of Julie’s toy factory, Jean-Paul can walk away from the dela after due diligence without legal consequences. However, if Jean-Paul directly makes an offer to buy the factory and Julie accepts it, Jean-Paul is legally bound to go through with the purchase.

It is important to note that sometimes a document titled “Letter of Intent” might actually constitute an offer, with binding legal and financial consequences. This distinction is not always clear-cut and depends on the specific wording and context of the document. Therefore, to avoid unintentional commitments and to clearly understand the implications of these documents, it is advisable to seek the expertise of a lawyer handling business sales, mergers and acquisitions. They can help ensure that a letter of intent accurately reflects its non-biding nature and advise on the legal ramifications of any transaction-related documents. Consulting with a legal expert before signing any document in the context of a business transaction is essential to protect your interests and to understand the potential legal and financial consequences of your actions.

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Due Diligence

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With the confidentiality agreement and letter of intent signed, it is now time to move on to the next stage of the process. Due diligence is a crucial step in the business acquisition process. This step allows the buyer to conduct a thorough investigation to identify risk factors in the business in order to avoid unpleasant surprises and gain negotiation leverage when discussing the final terms of the upcoming transaction. Due diligence includes technical (e.g., production), accounting, legal, environmental, economic, tax, and commercial reviews.

In general, during a due diligence review, a business lawyer will scrutinize the following points (this is not an exhaustive list):

• Real estate leases;
• Mortgages on the company's assets;
• Company's titles and rights to its assets;
• Important contracts involving the company (suppliers, customers, logistics, loans);
• List of key customers and suppliers;
• Employment contracts or collective agreement;
• Company's insurance coverage;
• Company's documents (articles of incorporation, bylaws, shareholder list, resolutions adopted);
• Legal and tax structure of the company;
• Company's records with tax authorities (Canada Revenue Agency, Revenu Québec);
• Operating permits used in the business operation;
• Regulations (municipal, environmental, AMF);
• Complaints and violations against the company (CNESST, administrative labor tribunal, office of consumer protection);
• History of past or ongoing litigations;

This crucial step in the purchasing process can be lengthy, tedious, and costly. Indeed, the amount of information to analyze can be excessively significant. That is why experts often say that it is at this stage of the process that the buyer's instinct is either confirmed or disproved, thus avoiding potentially disastrous financial consequences. Despite the significant costs it may incur, due diligence is an essential investment for the buyer who wants to have a clear and informed mind. Often, the buyer recovers some of the costs through the negotiation of certain elements discovered during the investigation or simply by avoiding stepping into a financial abyss.

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Choosing Between Asset Purchase or Share Purchase

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The structure of the transaction is a crucial decision that often involves intense negotiations between the seller and the buyer. The choice between an asset sale or a share purchase comes with a lot of advantages and disadvantages that conflict with the interests of the seller and the buyer. First, from a tax perspective, it is usually more advantageous for the seller to sell their shares and for the buyer to acquire the company's assets. Furthermore, from a legal perspective, it is generally less risky for the buyer to acquire the company's assets. Of course, each transaction is a unique case, which is why the lawyer must weigh the tax and legal advantages and disadvantages each time to achieve the most optimal transaction for their client. For example, in some situations, a business lawyer may propose a hybrid transaction to their client, consisting of both company shares and asset elements.

Asset Purchase

The main benefit for the buyer is undoubtedly limited liability, as they do not continue the legal existence of the company. When the buyer purchases the company's assets, they simply acquire its assets. Therefore, they are not bound by the company's debts, contracts, or lawsuits.

For tax reasons, the buyer often prefers to purchase assets to take advantage of tax depreciation on acquired assets and reduce their annual tax bill. Obviously, to benefit from these exemptions, the buyer must qualify under tax laws in advance. Finally, the acquisition of asset elements is a challenging method that involves the sale and transfer of the titles of each of the assets. And, as with any more challenging method, it comes with higher costs.

Share Purchase

One of the main advantages of a share purchase transaction is that it is simpler and less costly than an asset sale operation. Indeed, depending on the applicable laws governing each company, the transfer of shares is usually done through the completion of certain common formalities.

For tax considerations, the seller often prefers to sell their shares. Indeed, the seller can take advantage of certain tax exemptions, such as the capital gains exemption, which can save them thousands of dollars in taxes. Of course, to benefit from these exemptions, the seller must qualify under tax laws in advance.

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Merger

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A merger is the operation by which two or more entities combine their assets to create a new company. It is not surprising that companies use mergers as a means to grow when considering the numerous benefits it brings. Among these benefits, we can mention increased market share, synergy of skills, and economies of scale.

The merger of companies is a complex operation that requires extensive planning. Indeed, the parties must agree on the share capital structure, governance, employment contracts, suppliers, the company's name, regulations, and the legal regime of the new company to be created (this list is not exhaustive). Of course, each merger is unique and requires a personalized approach based on a multitude of factors, including the strength between the parties, the industry, and the economic and financial environment.

In the context of a merger, the lawyer's mission is to ensure that the structure of the planned transaction is as advantageous as possible for their client. They can prepare a shareholder agreement to settle or anticipate most potential disputes. They can prepare a unanimous shareholder agreement to withdraw certain powers from the board of directors or to protect minority shareholders. A business lawyer can also negotiate the share capital composition to protect their client against a loss of influence in the future company. Therefore, an experienced lawyer by your side who masters both the legal and financial issues of the merger operation and the objectives pursued by the client is a profitable investment.