Buyers often want (or need) the seller to stick around after the sale is completed to transition key relationships with customers, suppliers, and lenders, or to provide training and know-how regarding business operations. Often this is documented in an employment agreement where the business re-hires the seller as a W-2 employee, or a consulting agreement where the seller provides services as an independent contractor.
In either case, buyers usually want to prevent competition with the former owner by placing restrictions on his or her ability to exploit relationships developed over time with customers, suppliers, and staff. This often is documented as a noncompetition or nonsolicitation provision.
A noncompetition agreement is a broad restriction that essentially prevents someone from working in a particular industry. Under Oregon law, noncompetition agreements are difficult to enforce against employees of a company. Noncompetition provisions in employment agreements signed on or after January 1, 2008 are voidable (unenforceable) unless:
•The employer tells the employee in a written job offer at least two weeks before the employee starts work that the noncompete is required, or the noncompete is entered into upon a bona fide advancement, AND
•The employee is exempt from Oregon minimum wage and overtime laws, AND
•The employer has a “protectable interest” (access to trade secrets or competitively sensitive confidential information), AND
•The employee makes more than the median family income for a family of four as calculated by the Census Bureau (currently about $65,000).
In addition, noncompetition agreements contained in employment contracts are only enforceable for up to two years after termination of employment.
When it comes to the sale of a business, however, the above restrictions do not apply. This means that buyers may insist on much broader terms when negotiating the duration and scope of noncompetition restrictions against the seller.
Nonsolicitation agreements are less restrictive in that they don’t prevent future work in the same industry. Instead, they are more narrowly tailored to prevent unfair competition by the seller. In the context of a business sale, nonsolicitation agreements typically prevent the seller from contacting, marketing to, or doing business with, customers or clients of the business for a reasonable period of time after the sale. Often they include similar restrictions preventing the seller from soliciting employees or contractors of the business to jump ship, and some agreements may go even further by preventing the seller from doing business with company suppliers or vendors.
As with all contracts, the devil is in the details. Whether you are the buyer or the seller, it pays to spend some time with your business attorney to make sure that the noncompetition or nonsolicitation restrictions are appropriate and do not contain hidden loopholes for either side.
Sellers must exercise caution in several areas when negotiating the sale of a business. For example, buyers often want to prevent the seller from setting up a competing business to lure away customers or clients. Typically this means signing a noncompetition agreement or a nonsolicitation agreement.
Watch Out for Noncompetition & Nonsolicitation Agreements
A noncompetition agreement prevents the seller from working in the same industry for a period of time, and within a defined geographic area. A nonsolicitation agreement doesn’t prevent the seller from working in the same field, but prevents him or her from doing business with company clients, customers, and sometimes vendors or suppliers for a specified period of time. In addition, nonsolicitation agreements often prevent the departing seller from recruiting employees or contractors to leave the business.
Remember Personal Guarantees
Another area of potential risk involves personal guarantees signed by the seller on behalf of the business. For example, if a business is sold midway through a commercial lease and the lease is guaranteed by the seller personally, the landlord may not be willing to release the seller until the lease expires. Sellers need to make sure that the buyer is legally obligated (and financially able) to step up.
Protect Intellectual Property
Yet another area of concern involves the need to protect intellectual property and trade secrets during and after the negotiation of a business sale. Often businesses use nondisclosure agreements during the pre-sale activities, including a buyer’s due diligence. Buyers may insist that seller’s maintain confidentiality of sensitive business information after the sale has been consummated. And savvy business owners place confidentiality and nondisclosure provisions in employment and independent contractor agreements to prevent their valuable information from ending up in the wrong hands.
We’ll address each of these risks in more detail over the next few postings.
Today’s post is from guest blogger Eric Williams, a business broker and consultant who helps owners of small-to-midsized companies maximize the value of their business. Eric is the owner of CoDiligent, LLC.
Many entrepreneurs believe they should be rewarded for success to the greatest extent possible, and pay as little taxes as allowed. After all, they have taken considerable risk to start and grow their business. This is reasonable. In fact, the late Supreme Court Justice Learned Hand opined,
Anyone may arrange his affairs so that his taxes shall be as low as possible; he is
not bound to choose that pattern which best pays the treasury. There is not even a
patriotic duty to increase one’s taxes. Over and over again the Courts have said
that there is nothing sinister in so arranging affairs as to keep taxes as low as
possible. Everyone does it, rich and poor alike and all do right, for nobody owes
any public duty to pay more than the law demands.
However, sometimes in pursuing the goal of giving less money to Uncle Sam by taking every possible tax deduction, business owners unwittingly hurt themselves financially.
It is not uncommon for small business owners to lower their income tax liability by reporting “gray” expenses: things that, while business-related, are completely discretionary and are not necessary for the successful operation of the business. For example, a business owner may report meals, golf, sports events, and other entertainment activities with partners, employees, or customers who may also be friends. While they may discuss business to justify the deduction, the activity may have been totally discretionary. Another example might be attending an industry association conference in a tropical location in January that the business owner wouldn’t have chosen to go to had it instead been held in frigid Minneapolis.
When a business broker or investment banker packages a business they will re-cast the financial statements to show discretionary or non-recurring expenses added back. Yet, just because a business sale intermediary makes these adjustments, it doesn’t necessarily mean that buyers will agree to such adjustments when they conduct their own analysis to estimate cash flow and corresponding value. For every dollar you spend on gray expenses you’ll save a fraction of that dollar in taxes, but you may also be giving up multiples of that dollar in business valuation. If you are within 24 months of putting your business on the market, you may want to focus on reducing all unnecessary expenses, rather than maximizing tax deductions.
The final post in our Business Killers assessment focuses on the sixth mistake that business owners make when running their company: failing to anticipate and plan for changing federal and state tax laws.
Answer the following questions to see if your company is vulnerable.
• Has the owner determined his or her financial goals?
• Is the owner proactively planning to deal with changing tax laws?
• Is the owner working with financial experts?
• Will any of the owner’s retirement income be tax-free?
• Does the owner have a written exit plan for the business?
The more “no” answers, the greater the risk. How does your company look?
Many owners assume that you can’t beat Uncle Sam. Thus, they fail to appreciate that tax planning is an important part of an exit strategy. And like most aspects of that exit strategy, the more time you have to plan, the more likely you are to achieve the results you want. The amount of tax owed from the sale of a business depends upon whether the sale proceeds are taxed as ordinary income or capital gains. Profits from the sale of business assets likely will be taxed at capital gains rates, but money paid to an owner for transition consulting services probably will be taxed as ordinary income.
It’s not too early to begin working with your team to estimate the likely tax bite from a sale of the company and come up with a plan to pay those taxes. This will allow you to leave the business on your timetable, with your retirement funding intact.
Today’s post focuses on a fifth critical mistake that business owners make when running their company: failing to adequately fund a retirement.
Answer the following questions to see if your company is vulnerable:
• Does the owner have investments other than his or her business?
• Will the business assets account for less than 25% of the owner’s retirement planning?
• Has the owner created income from more than four sources other than the business?
• Do any of the owner’s retirement assets have guaranteed returns?
• Has the owner had his or her retirement income projected or analyzed to identify shortfalls?
• In the past year has the owner spent more than one hour planning for retirement?
The more “no” answers, the greater the risk. How does your company look?
Changing technology and an increasingly global economy mean that competition in any business is never far away. While a business can be an important source of wealth to fund retirement, it shouldn’t be the only egg in your basket. Owners need to have a successful business and an adequately funded retirement. Unless you’re independently wealthy already, that probably means you shouldn’t reinvest every dime back into the business.
For example, every business owner should have a tax deferred retirement plan which lets them set aside some of the business income and grow it tax-free. And these are not limited to traditional qualified retirement plans. Solopreneurs can use a SIMPLE (Savings Incentive Match Plan for Employees of Small Employers IRA, a SEP (Simplified Employee Pension), or a Solo 401(k) plan.
If, like many owners, you do everything you can to reduce taxable income, then you are also minimizing the amount of Social Security wages that you’ll receive when you retire. Talk to your tax advisor and financial planner to see if you are being pennywise but dollar foolish.