Ten Ways To Avoid A Lawsuit When Selling Your Business

Even though a business owner may take as many precautions as possible, there is always a good chance that at some point they will find themselves involved in a lawsuit, even if they have done nothing wrong.

In most cases, if you end up in litigation, even if you win, it still will be a loss. Lawsuits are disastrous to a business—they cost money, time, personnel resources, and attention, and they create uncertainty, bad relationships, and negative publicity.

So, how do you avoid a lawsuit when selling your business?

  1. Be as open, as honest, as “transparent” as you can. Your broker should learn all the details about your business—be sure to fully disclose anything that you would want to know if you were buying it. Often things disclosed can be negotiated away, but the same negative items “popping up” later can kill a good transaction. Your business broker will be more effective if they know all the facts.
  1. Disclose information to your broker (and your buyer) in writing, not verbally. Make this your standard practice. It’s much easier to prove a writing than a conversation.
  1. Be represented by an attorney from the very beginning before you sign a contract, or, if you do sign a contract, be sure you have at least a five-day attorney review clause allowing your attorney to cancel the contract for any reason or for no reason. Make sure this attorney is a business transaction specialist—a “dealmaker,” not a “deal-breaker.” Require that your buyer is represented by an attorney as well. That way any claims by the buyer that they were unaware, or unsophisticated, or at a disadvantage, or didn't know what they were signing will be groundless. Disclose everything to your lawyer, they cannot repeat it. But, if you keep your lawyer in the dark, they cannot properly represent you.
  1. Be honest. Don't make any statements or representations that diverge from the truth.
  1. Make sure that the seller’s representations and warranties in the contract are reasonable and accurate.
  1. Make mediation a mandatory first step to resolve any post-closing dispute and include a clause that any party who bypasses mediation will not be entitled to their attorney's fees or court costs if they decide to sue before starting a friendly mediator-led dialogue first. And, should mediation fail, be sure that you have an arbitration clause in your contract requiring that all disputes related to or arising out of the transaction or involving the parties to the transaction be resolved through binding arbitration through the auspices of an organization like the American Arbitration Association.
  1. During due diligence, disclose everything you are asked to reveal (with the advice and counsel of your attorney); and disclose everything that would reasonably be a material fact to the buyer in making a purchase and/or valuation decision. In disclosing financial data, have everything checked and approved by an accountant. Provide only actual facts—no “projections,” “pro formas,” “estimates,” or “what ifs.” Be sure that any “add-backs” are labeled as “estimated” and “subject to verification by the buyer.” Do not alter any financial data. Have the buyer sign a certification that they have had the opportunity to review all the books and records of the subject business requested by them, have completed their due diligence process, are satisfied with their investigation, and agree to remove this contingency from the purchase agreement.
  1. A seller must keep in mind that if the buyer fails in the business, the buyer will almost always blame it on the seller and try to get recompense. So, during due diligence, the seller may also want to learn as much about the buyer as possible. If the seller feels that the buyer may not succeed, then it might be better to raise these concerns with buyer so that the deal is totally “transparent.”
  1. Use an escrow agent for a variety of good reasons; but particularly so that you have on record that a professional, licensed, bonded, neutral third-party checked your representations against the public record. They will manage the sale from start to finish and will be sure that all UCC and lien searches are conducted, will contact the sales tax, employment tax, and other official offices for clearances, will prepare, file, and publish any bulk sale transfer notice, will pay off secured creditors and record releases, etc. in a legally correct manner. And all their work will be covered by their errors and omissions malpractice insurance.
  1. At the time of the closing—just before the money and title change hands—require that both the buyer and seller sign a certification that neither party has made any oral/verbal representations, warrantees, or guarantees; that neither party relies on any verbal or oral statements; and, that each party is relying solely statements from the other that are in writing and signed. It makes it very difficult at a later time for either party to make assertions that "he said"/"she said. It protects everyone from unfounded claims in the future.

There are still other things you can do to avoid a lawsuit that your attorney and escrow agent can advise you about directly.

In short, the best practice is "full and complete disclosure" and meticulous honesty. For example, issues can arise regarding tangible property, potential lawsuits, distribution agreements, contract transfers, lease issues, employment matters, etc., etc.  It is always best for the seller to make a complete and full disclosure of this information even before the advertising material is prepared and before any information is sent to a potential buyer. This way the buyer is fully aware of the situation and can conduct their own investigation to assess the risk involved.

Finally, one of the best ways for the seller to avoid a lawsuit is to use the services of an experienced professional business broker, preferably one who is committed enough to their practice to belong to a professional organization of peers, such as the International Association of Business Brokers (IBBA) and/or their state business broker association.

As in most things, the devil is in the details.

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Tim Cunha has five decades of entrepreneurial experience in various fields, including the design and manufacture of computer graphics software and hardware systems, instrument manufacturing, Defense contracting, biotech/pharma, publishing, distribution, and retail.

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