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Legal Issues When Buying an Arizona Business - Frequently Asked Questions

by Richard Keyt, Arizona transactions and business attorney

Have you found an Arizona business for sale that you would like to buy or are you thinking about buying a business for sale in Arizona?  Buying a business may be the most expensive investment you ever make, especially if you do not do your homework and do not have properly drafted legal documents that protect your investment.  In theory, buying a business is relatively simple.  The buyer signs a purchase contract, pays the money, takes possession and begins operating the business.  Alas, if only it were that simple. 

When you spend a lot of money to purchase a business, you should make sure that your purchase documents give you the legal protection that the investment deserves.  This article answers questions frequently asked by prospective buyers about legal considerations arising from buying an Arizona business.

Table of Contents

1. What are Two Common Methods of Buying a Business?
2. What is an Entity Purchase?
3. What is an Asset Purchase?
4. Should I Buy an Entity or the Assets?
5. Is there a Tax Benefit to an Asset Purchase?
6. Which Sales Method Do Sellers Usually Prefer?
7. How Do I Determine Which Sales Method to Use?
8. How Can the Buyer Minimize Post-closing Problems?
9. What is Adequate Due Diligence?
10. What About Real Estate Due Diligence?
11. Can a Buyer Cancel a Purchase if there is a  Problem?
12. Can a Buyer Close if Problems are Not Resolved?
13. What Legal Documents are Used in a Business Purchase?
14. Can You Explain the Common Purchase Documents?
15. Can an Arizona Business Broker Prepare the Contracts?
16. Is Earnest Money Required to Have a Binding Contract?
17. What is an Escrow?
18. Is an Escrow Necessary?
19. Arizona Business Buyer's Additional Legal Issues
20. KEYTLaw's Business Purchase Document Preparation Service
21. KEYTLaw's Business Purchase Document Review Service

What are Two Common Methods of Buying a Business?

Almost all purchases and sales of businesses involve either a purchase of the company that owns the business (an "entity purchase") or the purchase of the assets of a business (an "asset purchase").

What is an Entity Purchase?

An entity purchase occurs when the buyer purchases the interest of the people or entities that own the company that owns the business.  Most businesses today are owned and operated by a corporation, limited liability company or a partnership.  An entity purchase occurs if the buyer buys all of: (i) the stock of a corporation, (ii) the membership interests of a limited liability company, or (iii) the partnership interests of a partnership. 

When an entity purchase occurs, the buyer steps into the shoes of and replaces the prior owner(s) of the entity that owns and operates a business.  The public may or may not know that there is a new owner.  The title to all the assets of the business remains in the name of the entity.

What is an Asset Purchase?

An asset purchase occurs when the buyer purchases all or some of the assets of a business.  The buyer does not acquire any ownership interest in the company that owns the business.  The owners of the business remain the same.

Should I Buy an Entity or the Assets?

Most businesses are purchased using the asset purchase method.  The primary reason prudent buyers insist on an asset purchase is because they do not want to acquire liabilities of the entity that they are not willing to assume.  The general rule with respect to an asset purchase is that the buyer is liable only for liabilities of the seller specifically assumed in the purchase agreement.

A buyer that buys all the stock of a corporation (or other entity) that owns a business indirectly bears the burden of all liabilities of the corporation (or the entity), known and unknown.  The entity is not affected by the sale of the owners' interest, which means that the company remains liable for all of its contracts, employee issues, lease obligations, tort liabilities such as claims for negligence and products liability and all other obligations of the entity.

When you buy the assets of a business, you should negotiate with the seller as to what liabilities of the company, if any, you will assume and be liable to satisfy after closing.  An asset purchase agreement should expressly state the liabilities of the seller for which the buyer will be liable and that the buyer is not liable for any liabilities of the seller that are not expressly assumed in the asset purchase agreement. 

Is there a Tax Benefit to an Asset Purchase?

Another reason to use an asset purchase rather than an entity purchase is to obtain a stepped-up tax basis in the purchased assets, which may result in greater tax write offs for the buyer.  When you purchase an entity, the tax basis of the entities assets may be unaffected and retain their fully or partially depreciated values.  In general, the seller and the buyer may allocate the purchase price among the purchased assets and the allocation between unrelated parties will be respected by the IRS.

Which Sales Method Do Sellers Usually Prefer?

Most of the time sellers prefer to sell their ownership interest in the entity rather than sell assets of the entity because they can report their entire gain on their tax returns as capital gains.  With an asset sale, the tax basis of the assets sold may have been fully or partially depreciated and/or subject to recapture which results in the seller reporting large amounts of ordinary income.  If the seller is a corporation, the stockholders may suffer double taxation when the corporation first reports and pays tax on the gain from the sale and then distributes the after tax proceeds to the stockholders who must report the net amount on their personal tax returns and pay a second tax.

How Do I Determine Which Sales Method to Use?

The interests of the buyer and seller are exactly the opposite when it comes to their preferred method to sell a business.  Sellers generally prefer the entity purchase, and buyers generally prefer the asset purchase.  Ultimately, the method is negotiable and the agreed on by the parties. 

How Can the Buyer Minimize Post-closing Problems?

The three most important things a buyer can to do to minimize the risk of post-closing problems are:  (i) adequate due diligence before becoming obligated to purchase, (ii) document the transaction with properly drafted legal documents, and (iii) obtain personal guaranties of the selling entity's obligations under the purchase agreement unless you are certain that the selling entity will always have the assets to satisfy any breaches of the purchase agreement and related documents. 

What is Adequate Due Diligence?

Adequate due diligence depends on the facts and circumstances of each particular purchase.  Buyers should consult with their advisors, including their accountant and attorney, to determine what constitutes adequate due diligence for their purchase.  There is no substitute for adequate pre-closing due diligence.  A prospective buyer of a business must investigate all important aspects of the business and owner's operation of the business because what the buyer does not know can come back to haunt the buyer after closing.

Adequate due diligence should include the following at a minimum:

1. Investigate all entities involved in the transaction and confirm that the entities exist and are in good standing.  It is very common for people to operate a business under a name that is different from the actual legal name of the entity or to operate as an entity after the government has revoked the entity's legal existence.  Confirm the exact name of all entities involved in the transaction and make sure that all documents reflect the correct name(s).  Parties to a transaction should always demand and receive a certificate from the proper governmental authority that shows that the entity exists and is in good standing with its state of formation. 

   To confirm if a purported Arizona corporation or limited liability company exists and is in good standing, contact the Arizona Corporation Commission and order a Certificate of Good Standing.  You can do a preliminary search for Arizona entities on the ACC's website.  If an entity is not formed in Arizona, you must confirm its existence and get a Certificate of Good Standing or equivalent from the state in which the entity was formed.  If an out of state entity is qualified to do business in Arizona, you can obtain a Certificate of Good Standing for the entity from the ACC.

2. Obtain written evidence of proper authority for an entity to sign the purchase agreement and related documents and to consummate the transaction.  Whenever you are dealing with an entity, you must always remember that the entity may avoid liability if it can prove that the person who signed the agreement in question did not have proper authority to legally bind the entity.  The buyer's obligations under a purchase agreement should be contingent on obtaining written evidence from the selling entity that the person who signed the agreement on behalf of the entity was authorized to do so and that the governing authority for the entity approved the transaction.  Proper written evidence of authority consists of:

(i)  for a corporation:  resolutions adopted by the Board of Directors signed by all of the directors or certified to by an appropriate corporate officer that approve the transaction and authorize an officer to sign on behalf of the corporation, or

(ii) for a limited liability company:  a copy of the company's Operating Agreement that shows either the signer has authority to bind the company without the need for member approval or, if member approval is required, appropriate resolutions adopted by the members that shows that the members approved the transaction and authorized the manager to sign on behalf of the company.

3. Perform a judgment, lien and bankruptcy search on the sellers and all entities involved.  Arizona law provides that a purchaser of an asset owned by a seller that has outstanding judgments and liens takes the asset subject to the judgments and liens.  Most buyers know that if you buy land that is subject to a deed of trust, the buyer acquires the land subject to the lien and must satisfy it or risk losing the land.  The same principle applies to buying tangible and intangible assets.  If I buy all the inventory of ABC, Inc., and the inventory is subject to a security interest of XYZ Incorporated, I must satisfy the lien or XYZ may seize the inventory I purchased and sell it at a public or private sale to pay the debt.

At a minimum, buyers should check for judgments, liens and bankruptcies on file with each of the following government agencies:

(i) for judgments:  Check the superior court in the county in which the party resides and in each county in which the party does business to see if there are any lawsuits on file in which the party is or was involved.  If there are lawsuits, you must investigate each to determine if any judgments were issued by the court against the party.  If you find any judgments or other pertinent information, make copies and review the documents carefully.  See the Maricopa County Superior Court's online case history.

(ii) for judgments and liens:  Check the documents recorded with the County Recorder in the county in which the party resides and in each county in which the party does business to see if there are any judgments or liens recorded in which the party is named.  If you find any recorded judgments or liens, or other pertinent information, make copies and review the documents carefully.  See the Maricopa County Recorder's online document search engine.

(iii) for liens on personal property (tangible and intangible):  Check the Uniform Commercial Code financing statements and related documents on file with the Arizona Secretary of State.  Arizona law provides that creditors protect their lien claims against debtors by filing a UCC-1 financing statement with the Arizona Secretary of State to give notice to the world of the existence of their lien.  See the Arizona Secretary of State's online UCC lien search engine.

(iv) for bankruptcies:  Check the U.S. Bankruptcy Court for the District of Arizona to see if each party is currently in bankruptcy or filed for bankruptcy in the past.  If a party is currently in bankruptcy, consult with an Arizona bankruptcy attorney to determine what steps, if any, you should take to protect your position as a result of the bankruptcy.

If a party resides outside Arizona, you should perform similar investigations in the state and county where the party resides.

4. Verify all representations made by the seller and confirm that the representations are true. 

Example.   If the seller states that its use of the leased premises complies with applicable zoning law, confirm with the city, county or other appropriate governmental agency that the zoning is adequate for the buyer's intended use of the premises.  If the seller represents that the business has generated certain gross revenue in each of the last three years, demand copies of the seller's federal income tax returns and financial statements for the periods in question.  Tax returns are excellent evidence of the historical income and expenses of a business.  Caution:  Beware of a seller who claims that the information on a filed tax return (under reported income and over stated deductions) is incorrect.  This seller is admitting tax fraud, and if the seller will lie to the IRS and risk criminal charges to pay less tax, what are the chances the seller is telling you the truth?

5. Obtain copies of all pertinent contracts and documents and approve the contents of each one.  The purchase agreement should state that true and complete copies of all contracts to be assumed by the buyer (in an asset purchase) or for which the purchased entity will remain liable after closing (in an entity purchase) are attached as exhibits to the purchase agreement.  Carefully review all the contracts and make sure that you are willing to satisfy all obligations of all the contracts.

Example.  If the buyer is assuming the World Wide Widget contract, the buyer must review the contract because the buyer will have to satisfy all obligations under the contract after closing.

6. Obtain a copy of all real estate leases and approve the contents of each one.  If the buyer will assume a lease, the buyer must obtain a copy of the lease and all amendments and make sure that all provisions are acceptable because the buyer will become legally obligated to satisfy all terms and conditions of the lease, as modified.

7. Obtain the consent of all landlords if the buyer is to occupy premises leased by the seller or by the entity.  Most commercial leases contain provisions that give the landlord the right to declare the lease in default if the tenant transfers all or any interest in the lease without the landlord's consent.  A buyer who purchases a business without obtaining the consent of the landlord risks being evicted after closing or at best, a substantial increase in the rent in return for obtaining the landlord's consent to the transfer.  When a landlord has a right to approve a transfer of the tenant's interest in the lease, an assignment of the lease from a seller to a buyer obviously requires the landlord's consent, but the same is also true in an entity purchase situation where there is only a change of ownership if the lease has language that states that a change in ownership of the entity is deemed to be a transfer of an interest in the lease.

8. Verify the condition and other pertinent facts concerning all material assets being purchased.  This one is a no brainer.  If you are buying a car, you should have its condition inspected by a knowledgeable mechanic.  This concept applies if you are buying an office building, a franchise, a business that sells widgets or any other business.  The buyer should have knowledgeable people inspect the assets being purchased.

9. Inventory the inventory.  If you are buying inventory (especially if part of the purchase price is based on inventory on hand at closing), inspect the inventory before closing and do an actual inventory as of the closing date to verify the number of units being purchased and their condition.

11. Determine if the buyer will be liable for the seller's Arizona unemployment insurance account.  Arizona law provides that a buyer of an entire business that continues the seller's operation will be assigned the tax rate and experience rating account of the seller.  The experience rating account includes the record of wages and taxes previously paid.  Any unemployment benefits awarded based on wages paid by the former business owner may be charged to the buyer's account.  The buyer may also be liable for the former owner's unpaid unemployment taxes.  Caution:  The purchase agreement should contain a mechanism to compensate the buyer if the buyer will incur additional expense after closing arising from becoming liable for the seller's unemployment insurance account.

A buyer that acquires a portion of a business and continues to operate it is not automatically assigned the tax rate and experience rating account of the former owner.  To apply for a portion of the account and its corresponding tax rate, the buyer must file an "Application & Agreement for Severable Portion Experience Rating Transfer" (UC-247) within 180 days of acquiring the business.  The former owner must agree and provide payroll information for the portions of the business acquired and retained.  The buyer's account may then be charged for a portion of the unemployment benefits paid to the former owner's employees.

The above list of due diligence items is not meant to be all inclusive.  It is a list of the minimum due diligence tasks that should be performed by all buyers.  Each particular business purchase will have its own due diligence requirements that may require additional due diligence beyond the tasks referred to above.

What About Real Estate Due Diligence?

Buyers that buy or lease real estate in connection with the purchase of a business or purchase of an entity that owns or leases real estate have additional due diligence requirements that are real estate related and outside the scope of this article.  Real estate due diligence, includes, but is not limited to:  (i) obtaining an environmental assessment that shows the land is free of environmental problems, (ii) reviewing and approving the state of the title and liens, encumbrances and other items that affect title, (iii) obtaining and approving surveys, (iv) verifying zoning and that the intended use of the land is not prohibited by applicable zoning and conditions, covenants and restrictions that encumber the land, and (v) obtaining acceptable tenant estoppel certificates from all tenants, if any, that occupy the land.

Can a Buyer Cancel a Purchase if there is a  Problem?

The short answer is yes, no and maybe?  The answer to the question depends on the language of the purchase agreement.  If the purchase agreement does not contain a review period or any language that gives the buyer the right to cancel if a problem arises, the buyer may be legally bound to close.  Buyers who discover a problem before closing and who do not clearly have the right to cancel a purchase agreement should consult a business attorney immediately to determine their rights.

I had a client once that signed a simple contract that said "I will by your widget for $50,000."  My client later decided she did not want to buy the widget.  Unfortunately, the client could not unilaterally terminate the contract because it did not contain any conditions or "outs."  The result would have been different if the contract said, for example, "I will buy your widget for $50,000 if I obtain financing satisfactory to me in my sole discretion within ten days of this agreement" and I applied for and was not able to obtain satisfactory financing.  In this case, the condition precedent to my obligation to buy is not satisfied so I can terminate the purchase agreement.

A prudent buyer will sign a purchase agreement that gives the buyer a free look period of time to investigate and perform due diligence during which time the buyer may cancel the purchase agreement for any reason and receive a refund of all earnest money.  This is the best type of provision because the buyer can cancel without any reason.

A prudent buyer will also provide in the purchase agreement that the buyer has the option to cancel the purchase agreement and receive a refund of all earnest money if any important events do not occur.  For example, if the buyer is to assume a real estate lease, the purchase agreement should expressly state that the buyer's obligation to close is contingent on obtaining the landlord's consent to the assignment of the lease without any conditions that are unacceptable to the buyer.  This type of express condition gives the buyer an option to cancel if it is not satisfied.

Before the buyer signs a purchase agreement, the buyer must make sure that its allows for an appropriate due diligence period, express conditions to closing and that the buyer can cancel to purchase agreement and receive a refund of all earnest money if any problems are discovered or conditions are not satisfied.

Can a Buyer Close if Problems are Not Resolved?

A party is free to waive unsatisfied conditions and unresolved problems and close.  The real issue is whether it is prudent to do so.  If the buyer finds a material problem before closing and has a right under the purchase agreement to not close, normally the buyer should refuse to close unless and until the problem is resolved to the buyer's satisfaction.  The same is true of material conditions in a purchase agreement that are not satisfied before closing.  The buyer has the most leverage with the seller to resolve problems and unsatisfied conditions before closing and the seller gets paid.  Buyers should normally not close a purchase transaction when a problem is found before closing or a condition to close is not satisfied unless the buyer is willing to take the risk that the problem or condition will not be resolved after closing.

If a buyer elects to close despite unresolved problems and unsatisfied conditions, the buyer should try to modify the purchase documents to in a way that will reduce potential problems after closing.  For example, if a condition to closing is that a certain asset be free and clear of a $5,000 lien owed to ABC Creditor, Inc., and the lien remains of record at closing, the buyer could be protected if $5,000 of the closing proceeds is held in escrow until the lien is released or paid to the creditor if the lien is not released by a specified date.

What Legal Documents are Used in a Business Purchase?

Arizona business purchases typically include the following legal documents:

1. Purchase Agreement
2. Escrow Agreement
3. Bill of Sale
4. Promissory Note
5. Security Agreement and/or Deed of Trust
6. UCC-1 Financing Statement
7. Guaranty
8. Assignment of Lease
9. Consent of Landlord to Assignment of Lease
10. Covenant not to Compete
11. Consulting Agreement

The primary document that evidences an agreement to buy or sell a business (entity purchase or asset purchase) is the purchase contract.  It may be called "Asset Purchase Agreement," "Purchase Agreement," Purchase & Sale Agreement," "Stock Purchase Agreement" or something similar.  This is the most important agreement because it sets forth the "deal points," i.e., all the terms and conditions applicable to the sale.

When I prepare documents for a business purchase, my purchase agreement includes all ancillary documents as an exhibit to the purchase agreement so that at the time the parties sign the purchase agreement they agree on the exact form and contents of all the ancillary documents.  This practice prevents disputes between the parties before closing as to the provisions that should be in the ancillary documents.

The above list is typical of business purchases, but is not all inclusive.  Each particular purchase transaction has its own special documentation needs that may require all or a portion of the above-referenced documents or additional documents.

Can You Explain the Common Purchase Documents?

1. Purchase Agreement:  This is the most important document because it sets the purchase price and the other terms and conditions of the purchase.  It should state all material terms and conditions and include representations and warranties of the seller with respect to all important matters relating to the transaction.

2. Escrow Agreement:  If an escrow is used for the purchase, the parties should have an Escrow Agreement among the parties and an independent escrow agent.  The purpose of the escrow is allow a neutral party to hold items submitted by each party until closing and then deliver the items to the appropriate party.  For example, the escrow agent should hold the buyer's down payment money until all closing conditions are satisfied then at closing deliver the money to the seller and deliver the Bill of Sale and other asset assignment documents to the buyer.  If a purchase does not involve an escrow, this document is not necessary.

3. Bill of Sale:  This is a document signed by the seller and delivered at closing that evidences the seller's assignment and transfer of the assets listed in the Bill of Sale to the buyer. 

4. Deed:  If the purchase involves the acquisition of real property, title is transferred by a deed signed by the owner of the land (and notarized) and recorded with the County Recorder of the County in which the land is located.

5. Promissory Note:  If the entire purchase price is not paid at closing, the balance owed should be evidenced by a Promissory Note signed by the buyer that sets forth the terms of future payments.

6. Security Agreement and/or Deed of Trust:  An unpaid balance owed at closing that is evidenced by a Promissory Note may or may note be secured by a lien on property.  A prudent seller that does not get paid in full will insist on a lien on property of the buyer and property of guarantors (if the buyer is an entity and the Promissory Note is guaranteed by any third parties) to secure payment of the debt.  Whether any property will be encumbered to secure payment of a debt is entirely a matter of negotiation between the parties.  Security Agreements are documents that create liens on personal property.  Deeds of Trusts (and Mortgages - used infrequently in Arizona) create liens on real property. 

7. UCC-1 Financing Statement:  This important document is used only if the transaction involves a lien on personal property.  A prudent seller of an Arizona business or assets located in Arizona and who that takes a Promissory Note to evidence an unpaid balance owed at closing that is secured by a lien on personal property should always file a UCC-1 Financing Statement with the Arizona Secretary of State to perfect the lien and give notice to the world that the seller has a lien on the assets listed in the UCC-1.  If the debtor does not reside in Arizona or is formed in a state other than Arizona, the seller should also file a similar document in the state in which the debtor resides and in the state in which the debtor is formed (if the debtor is an entity).  See our Arizona Uniform Commercial Code links.

8. Guaranty:  When the buyer is an entity, a prudent seller that does not get paid in full at closing or is concerned about the buyer satisfying post-closing covenants should obtain a guaranty from owners of the buyer that they will satisfy the buyer's obligations if the buyer defaults.

Caution:  Arizona law provides that if only one spouse signs a guaranty, the creditor can satisfy a judgment arising from the guaranty only from the separate property of the spouse that signed the guaranty, but cannot reach the married couple's community property.  For this reason, whenever a creditor seeks a guaranty from a married person, the creditor should obtain the signature of both spouses on the guaranty unless the creditor is willing to satisfy a judgment only from the signer's separate property (if there is any separate property).

9. Assignment of Lease:  This document is used only if the purchase of assets also involves the buyer's acquisition of the seller's interest as a tenant in a lease.  It is the document that evidences and assigns to the buyer the seller's rights in and to the lease.

10. Consent of Landlord to Assignment of Lease:  If a lease is being assigned or if the buyer intends to use or occupy the property subject to the lease and if the lessor of the lease has a right to approve all assignments of the lease, the buyer must obtain the lessor's signature on this document.

11. Covenant Not to Compete:  A prudent buyer of a business will obtain the written agreement of the seller and key owners of a seller that is an entity by which they promise that they will not compete with the business being purchased.  Without an agreement not to compete, a seller and the seller's owners and affiliates are usually free to open a competing business across the street from the buyer's new business.  A buyer may also allocate a portion of the purchase price to the Covenant Not to Compete and amortize it over the life of the covenant or in accordance with IRS guidelines. 

Caution:  Arizona courts will not enforce Covenants Not to Compete if they are too broad in duration, scope or area.  A Covenant Not to Compete intended to be enforceable under Arizona law should be prepared by an Arizona attorney familiar with applicable Arizona law.

12. Consulting Agreement:  A Consulting Agreement (for independent contractors) or Employment Agreement (for employees) should be used if the buyer wants to obligate one or more key personnel affiliated with the seller to assist the buyer during a transition period after closing.

Can an Arizona Business Broker Prepare the Contracts?

If an Arizona business broker is involved, the broker may prepare the purchase agreement and related documents.  Disregarding the issue of whether the broker who prepares the documents is practicing law without a license, the parties should ask themselves "who does the broker represent when preparing the documents?"  If the broker represents the seller, the broker may prepare the documents to favor the seller. 

Even if the broker prepares "neutral" documents, the documents may not sufficiently protect the buyer.  Usually the broker's most important objective is for the deal to close so the broker can get the commission.  Many broker prepared purchase agreements and ancillary documents are drafted to not "rock the boat" or create issues that might cause the buyer or seller to refuse to sign the purchase agreement.

Of course being an Arizona business lawyer I am prejudiced, but I recommend without exception that every buyer of an Arizona business consult with an experienced business attorney before becoming obligated to purchase.  The relatively small legal fees paid to an Arizona lawyer will probably be insignificant when compared to the buyer's large investment to purchase the business.  Unless the investment is nominal, buying a business is not the time to be "pennywise and pound foolish" and rely on a business broker or standard form documents to protect the buyer's investment.

Is Earnest Money Required to Have a Binding Contract?

No.  Contrary to popular belief, Arizona law does not require that the buyer of an Arizona business pay any earnest money to create a legally binding agreement.  Whether to pay earnest money and the amount thereof is entirely a matter of negotiations between the parties.  The buyer should try to eliminate earnest money entirely or if that is not possible, negotiate the smallest amount possible. 

What is an Escrow?

An escrow is a device created by an agreement between three or more parties to accomplish specific purposes.  Escrows are commonly used in connection with business purchases to make sure that the buyer and the seller each satisfy all conditions to closing before the purchase actually closes.  Escrows are used to protect the interests of buyer and seller. 

The parties to a business purchase escrow are the buyer, the seller and an escrow agent.  The escrow agent should be an independent third party.  Arizona law requires that an escrow agent that is in the business of acting as an escrow agent must be licensed as an escrow agent by the Arizona State Banking Department.

In a business purchase escrow, the following events should occur:

1. The buyer pays the purchase money (or delivers a check payable to the proper party) to the escrow agent and signs all necessary documents required of the buyer and delivers the documents to the escrow agent.
2. The seller signs all documents required of the seller (such as the Bill of Sale and Assignment of Lease) and delivers the documents to the escrow agent.
3. The escrow agent holds the buyer's funds, the buyer's documents and the seller's document in the escrow until the transaction closes or dies.
4. If the transaction dies, the escrow agent returns the money and documents to the parties designated in the escrow agreement and/or in the purchase documents.  Unless there is an agreement to the contrary, if the transaction does not close and the buyer is not in default, all money deposited into escrow is returned to the buyer.
5. If one party defaults, the escrow agent's duties are as set forth in the escrow agreement and/or the purchase documents. 
6. If the buyer and seller disagree with any proposed action by the escrow agent, a prudent escrow agent will refuse to act until both parties agree to the proposed action or a court authorizes the action.
7. If all conditions to closing are satisfied, the escrow agent pays the purchase proceeds to the seller, delivers to the seller the purchase documents deliverable to the seller, and delivers to the buyer the purchase documents deliverable to the buyer.

Escrow agreements should be in writing and signed by the buyer, the seller and the escrow agent.  I recommend that the escrow agent always be an independent third party that is licensed to act as an escrow agent by the Arizona State Banking Department.  Commercial escrow companies charge a fee for their services.

Is an Escrow Necessary?

An escrow is not required, but it is usually in the best interests of both parties to use an escrow with a licensed escrow agent.

Arizona Business Buyer's Additional Legal Issues

Before a buyer signs a purchase agreement, the buyer should keep in mind that every thing in the agreement is negotiable.  The purchase agreement should be one-sided in favor of the buyer because the buyer is paying the money to purchase the business and should get the full benefit of the bargain.

The following is a partial list of additional legal issues that a buyer should seek to resolve in the purchase agreement:

1. Use an asset purchase method.  In general, buyers should use their best efforts to negotiate an asset purchase to reduce the risk of paying unknown and/or unwanted obligations of the seller and to obtain a higher tax basis in the purchased assets.  Buyers should discuss whether to use an asset purchase or an entity purchase acquisition method with their advisors because there are exceptions to the general rule that the asset purchase method is the preferred method.

2. For entity purchases.  A buyer that agrees to an entity purchase (rather than an asset purchase) needs an especially tough purchase agreement that: (i) describes all obligations of the company that the buyer is willing to allow the company to pay after closing, and (ii) obligates the seller to indemnify and hold the buyer harmless for all obligations of the company paid or incurred by the company after closing that were not expressly agreed to be paid in the purchase agreement.

3. Provide a method to resolve post-closing problems.  Anticipate potential post-closing problems and include provisions in the purchase agreement to resolve the problems if they arise.  For example, if a buyer thinks it may need assistance from a key person employed by seller or from the seller, add a condition to buyer's obligation to close that the buyer enter into an acceptable contract at closing with the key person.  If the buyer is concerned about becoming obligated to paying debts of the seller that are to remain payable by the seller, put some of the down payment money in an escrow to be held for a period of time after closing and used to pay the debts if necessary.

4. Consider a personal guaranty.  The seller will be obligated to satisfy all of its obligations under the purchase documents.  Caution:  If the seller is an entity, keep in mind that if any problems arise after closing, the seller may not have sufficient assets to satisfy the buyer's damages for breach of contract.  A prudent buyer dealing with an entity will insist that the owners of the entity seller personally guaranty the obligations of the seller.

This article is not intended to give legal advice.  Each particular prospective purchase has its own unique facts and circumstances that may involve some or all of the issues raised herein and other legal considerations not mentioned above.  I recommend that every buyer and every seller of a business be represented by an experienced business attorney licensed in the jurisdiction where the sale occurs.

KEYTLaw's Business Purchase & Sale Document Preparation Service

If you are buying or selling an Arizona business, you should hire Arizona business law attorney Richard Keyt (practicing since 1980) to prepare all the legal documents necessary to document the transaction.  For a low guaranteed fixed fee, we will prepare all the following documents customized to favor the buyer (if we represent the buyer) or the seller (if we represent the seller):

1. Purchase Agreement
2. Escrow Agreement
3. Bill of Sale
4. Promissory Note
5. Security Agreement
6. Deed of Trust
7. UCC-1 Financing Statement
8. Guaranty
9. Assignment of Lease
10. Consent of Landlord to Assignment of Lease
11. Covenant not to Compete
12. Consulting Agreement

Each document is custom prepared by Richard Keyt specifically for the buyer's transaction. 

We prepare the above-referenced 12 documents for a fixed fee of $2,000 ($167/document).  The fixed fee includes unlimited consultations and telephone calls at no additional charge up to the delivery of the first draft of all the documents.  The fixed fee also includes up to two hours (at no charge) of additional time after delivery of the documents for conferences, negotiations with the other side and changes to the documents.

Call Rick Keyt today at 602-906-4953 or email at rickkeyt@keytlaw.com and take the first step to protecting your valuable investment.

This article was first published on September 1, 2003.

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For a complete description or KEYTLaw's low price fixed legal fee to buy or sell a business and the tasks we will perform if you hire us to document your purchase or sale, see the KEYTLaw Business Purchase & Sale Document Preparation Service. 

To hire KEYTLaw to document your sale or purchase of a business, call Rick at 602-906-4953.  A short ten minute phone call is the first step to documenting your transaction.

This page was last modified on July 22, 2007.

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