Buying / Selling an Arizona Business FAQs & Checklist

Buying an Arizona business is usually the largest check a buyer will ever write, and the legal structure of the deal determines whether that check buys a clean business or somebody else's problems. This article answers 30 questions Arizona buyers ask about entity purchases versus asset purchases, due diligence, successor liability for the seller's unpaid Arizona transaction privilege taxes and unemployment taxes, the documents a properly papered deal requires, escrows, earnest money, seller financing and the mistakes that cost buyers the most money. It is written by Arizona business attorneys Richard Keyt and his son, attorney and former CPA Richard C. Keyt. Richard, the father, has prepared purchase and sale documents for Arizona business transactions since 1979.

In theory, buying a business is simple. The buyer signs a contract, pays the money, takes possession and starts running the business. In practice, the buyer who skips due diligence or signs whatever paperwork the broker hands over frequently discovers after closing that the equipment is leased rather than owned, the landlord will not consent to the assignment of the lease, the seller opened a competing shop two miles away, the state is looking to the buyer for the seller's unpaid sales tax, or the "$40,000 a month in revenue" existed only in a spreadsheet the seller created for prospective buyers.

When you spend real money to buy a business, your purchase documents should give your investment the legal protection it deserves. Here is what Arizona buyers need to know.

Questions Answered in This Article

1. What Are the Two Common Methods of Buying a Business?
2. What Is an Entity Purchase?
3. What Is an Asset Purchase?
4. Should I Buy the Entity or the Assets?
5. Is There a Tax Benefit to an Asset Purchase?
6. What Is IRS Form 8594 and Why Does It Matter?
7. Which Method Do Sellers Usually Prefer?
8. How Do the Parties Decide Which Method to Use?
9. How Can the Buyer Minimize Post-Closing Problems?
10. What Is Adequate Due Diligence?
11. Am I Liable for the Seller's Unpaid Arizona Sales Tax?
12. Will I Inherit the Seller's Arizona Unemployment Insurance Account?
13. What Happens to the Seller's Employees?
14. Do the Seller's Licenses and Permits Transfer to Me?
15. What About Real Estate Due Diligence?
16. What About the Website, Phone Number, Social Media and Online Reviews?
17. Can a Buyer Cancel a Purchase if There Is a Problem?
18. Can a Buyer Close if Problems Are Not Resolved?
19. What Legal Documents Are Used in a Business Purchase?
20. Can You Explain the Common Purchase Documents?
21. Can an Arizona Business Broker Prepare the Contracts?
22. Is Earnest Money Required to Have a Binding Contract?
23. What Is an Escrow?
24. Is an Escrow Necessary?
25. What if the Seller Is Financing Part of the Purchase Price?
26. How Long Does an Arizona Business Purchase Take?
27. What Are the Biggest Mistakes Arizona Business Buyers Make?
28. Additional Legal Issues Every Arizona Buyer Should Address
29. KEYTLaw's Business Purchase & Sale Document Preparation Service
30. How to Hire KEYTLaw to Prepare Your Documents

1. What Are the Two Common Methods of Buying a Business?

Almost every purchase and sale of a business is structured as either a purchase of the company that owns the business (an "entity purchase") or a purchase of the assets used in the business (an "asset purchase"). Everything else about the transaction — price, financing, employees, leases, taxes and risk — flows from that single structural choice, which is why it should be the first thing the buyer and the buyer's attorney discuss.

2. What Is an Entity Purchase?

An entity purchase occurs when the buyer purchases the ownership interests of the people or entities that own the company that owns the business. Most businesses today are owned and operated by a corporation, a 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 closes, the buyer steps into the shoes of the prior owners of the entity that owns and operates the business. The public may never know there is a new owner. Title to all of the assets of the business stays in the name of the entity, no assets are transferred, and every contract, lease, license, debt and lawsuit of the entity remains exactly where it was — inside the entity the buyer now owns.

3. What Is an Asset Purchase?

An asset purchase occurs when the buyer purchases all or some of the assets used in a business. The buyer does not acquire any ownership interest in the company that owns the business. The owners of the selling company remain the same, and the selling company continues to exist after closing, typically holding the sale proceeds and whatever liabilities the buyer did not agree to assume.

In an asset purchase, the buyer normally takes title to the assets in the name of a newly formed limited liability company so the buyer does not own the business personally and does not inherit the seller's entity.

4. Should I Buy the Entity or the Assets?

Most businesses are purchased using the asset purchase method. The primary reason prudent buyers insist on an asset purchase is that they do not want to acquire liabilities they never agreed to assume. The general rule for an asset purchase is that the buyer is liable only for the liabilities of the seller that the buyer specifically assumes in the purchase agreement.

A buyer who buys all of the stock or membership interests of an entity that owns a business indirectly bears the burden of all liabilities of that entity, known and unknown. The entity is not affected by the sale of its owners' interests, which means the company remains liable for all of its contracts, employee claims, lease obligations, tax obligations, tort liabilities such as negligence and product liability claims, and every other obligation it has — including the ones nobody disclosed and the ones nobody has discovered yet.

When you buy assets, negotiate with the seller over exactly which liabilities of the company, if any, you will assume and pay after closing. A well-drafted asset purchase agreement expressly lists the liabilities the buyer is assuming and expressly states that the buyer is not liable for any liability of the seller that is not listed.

Caution: An asset purchase is not a magic shield. Arizona and federal law impose successor liability on asset buyers in several situations, including unpaid transaction privilege taxes (see question 11), unpaid unemployment contributions (see question 12), certain environmental obligations, and de facto merger or "mere continuation" claims where the buyer is essentially the old business with a new name. Buying assets reduces risk. It does not eliminate it.

5. Is There a Tax Benefit to an Asset Purchase?

Usually, yes. An asset purchase generally gives the buyer a stepped-up tax basis in the purchased assets equal to what the buyer paid, which can produce substantially larger depreciation and amortization deductions after closing. When you buy an entity, the tax basis of the entity's assets is generally unaffected, and the buyer inherits assets that may already be fully or partially depreciated with little or no remaining write-off.

In general, the buyer and the seller may allocate the purchase price among the purchased assets, and an allocation negotiated between unrelated parties will ordinarily be respected by the IRS. Because different asset classes are written off over very different periods — equipment over a few years, goodwill over fifteen years, land not at all — the allocation is worth real money and should be negotiated in the purchase agreement rather than argued about after closing.

6. What Is IRS Form 8594 and Why Does It Matter?

When a business is sold in an asset sale, both the buyer and the seller must each file IRS Form 8594, Asset Acquisition Statement, with the tax return for the year of the sale. Form 8594 reports how the purchase price was allocated among seven classes of assets. See About IRS Form 8594.

Here is the trap: the buyer and the seller each file their own form, and if the two forms do not match, both parties have painted a target on their tax returns. The buyer wants more of the price allocated to fast write-off assets such as equipment; the seller wants more allocated to assets that produce capital gain. Settle the allocation in the purchase agreement, attach it as an exhibit, and require both parties to report consistently with it. This single provision prevents an expensive fight nine months after everyone has shaken hands and moved on.

7. Which Method Do Sellers Usually Prefer?

Sellers usually prefer to sell their ownership interest in the entity rather than the entity's assets because they can generally report the entire gain as capital gain. In an asset sale, the tax basis of the assets sold may have been fully or partially depreciated and subject to depreciation recapture, which forces the seller to report large amounts of ordinary income taxed at higher rates.

If the seller is a C corporation, the shareholders may suffer double taxation in an asset sale: the corporation reports and pays tax on the gain, then distributes the after-tax proceeds to the shareholders, who report the distribution and pay a second tax on the same money.

8. How Do the Parties Decide Which Method to Use?

The interests of buyer and seller on this issue are exactly opposite. Sellers generally want an entity purchase. Buyers generally want an asset purchase. The structure is negotiable, it is agreed on by the parties, and it is usually settled before the purchase agreement is drafted because it changes almost every other provision in the deal.

When a seller insists on an entity sale, one common compromise is a purchase price adjustment: the buyer accepts the entity structure in exchange for a lower price, a larger holdback in escrow, a longer survival period for the seller's representations and warranties, and personal indemnity from the owners. The buyer is taking on more risk, so the buyer should be paid for it.

9. How Can the Buyer Minimize Post-Closing Problems?

The three most important things a buyer can do to minimize post-closing problems are: (i) perform adequate due diligence before becoming legally 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 the selling entity will still have enough assets to satisfy any breach of the purchase agreement long after it has distributed the sale proceeds to its owners.

That third item is the one buyers skip and later regret. A representation and warranty from an LLC that will be an empty shell thirty days after closing is not protection. It is a sentence in a document.

10. What Is Adequate Due Diligence?

Adequate due diligence depends on the facts and circumstances of each purchase. Buyers should consult their advisors, including their accountant and attorney, to determine what constitutes adequate due diligence for their transaction. There is no substitute for pre-closing due diligence. A prospective buyer must investigate every important aspect of the business, because what the buyer does not know will come back to haunt the buyer after closing, when the buyer has no leverage left.

At a minimum, due diligence should include the following.

A. Confirm that every entity involved exists and is in good standing.

It is very common for people to operate a business under a name that differs from the actual legal name of the entity, or to keep operating as an entity after the state has administratively dissolved it. Confirm the exact legal name of every entity involved and make sure every document uses the correct name. Demand a certificate from the appropriate governmental authority showing the entity exists and is in good standing in its state of formation.

To confirm whether an Arizona corporation or limited liability company exists and is in good standing, order a Certificate of Good Standing from the Arizona Corporation Commission. You can run a free preliminary search on the ACC's entity search page. If the entity was formed outside Arizona, obtain a Certificate of Good Standing or its equivalent from the state of formation. If an out-of-state entity is registered to do business in Arizona, you can also obtain a Certificate of Good Standing from the ACC.

B. Obtain written evidence that the person signing for the seller has authority to sign.

Whenever you deal with an entity, remember that the entity may escape liability if it can prove the person who signed the agreement lacked authority to bind it. The buyer's obligations should be contingent on receiving written evidence that the signer was authorized and that the entity's governing authority approved the transaction. Proper written evidence of authority consists of:

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

(ii) for a limited liability company: a copy of the company's operating agreement showing either that the signer can bind the company without member approval or, if member approval is required, resolutions adopted by the members approving the transaction and authorizing the manager or member to sign.

C. Perform judgment, lien and bankruptcy searches on the sellers and all entities involved.

Under Arizona law, a purchaser of an asset that is subject to outstanding judgments and liens takes the asset subject to those judgments and liens. Most buyers understand that if you buy land encumbered by a deed of trust, you take the land subject to the lien and must satisfy it or risk losing the land. The same principle applies to tangible and intangible assets. If I buy all of the inventory of ABC, Inc., and that inventory is subject to a security interest held by XYZ Incorporated, I must satisfy the lien or XYZ may seize the inventory I just paid for and sell it to pay ABC's debt.

At a minimum, check for judgments, liens and bankruptcies with each of the following:

(i) Judgments: Check the superior court in the county where the party resides and in every county where the party does business for lawsuits involving the party. Investigate each case to determine whether a judgment was entered. Copy and carefully review anything you find. See the Maricopa County Superior Court online case history.

(ii) Recorded judgments and liens: Check the documents recorded with the County Recorder in the county where the party resides and in every county where the party does business. See the Maricopa County Recorder document search.

(iii) Liens on personal property, tangible and intangible: Check the Uniform Commercial Code financing statements on file with the Arizona Secretary of State. Arizona law allows creditors to protect their lien claims by filing a UCC-1 financing statement that gives notice to the world of the lien. See the Arizona Secretary of State UCC lien search.

(iv) Bankruptcies: Check the U.S. Bankruptcy Court for the District of Arizona through PACER to determine whether any party is currently in bankruptcy or has filed in the past. If a party is in bankruptcy, consult an Arizona bankruptcy attorney immediately about what you must do to protect your position.

If a party resides outside Arizona, perform the same investigations in the state and county where that party resides.

D. Verify every representation the seller makes.

Example: If the seller states that its use of the leased premises complies with zoning law, confirm with the city, county or other governmental agency that the zoning permits your intended use. If the seller represents that the business generated a certain gross revenue in each of the last three years, demand copies of the seller's federal income tax returns and financial statements for those years. Tax returns are excellent evidence of the historical income and expenses of a business.

Caution: Beware the seller who tells you the numbers on the filed tax returns are wrong because income was underreported and deductions were overstated. That seller is confessing tax fraud. If the seller will lie to the IRS and risk criminal prosecution to pay less tax, what are the odds the seller is telling you the truth about the business you are about to buy?

E. Obtain and approve copies of every material contract.

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. Review every contract and confirm you are willing to perform every obligation in it. If the buyer is assuming the World Wide Widget supply contract, the buyer must read it, because the buyer will have to live with it after closing.

F. Obtain and approve every real estate lease.

If the buyer will assume a lease, obtain the lease and every amendment and confirm that all provisions are acceptable, because the buyer will be legally obligated to satisfy every term and condition of the lease as modified. Pay particular attention to the remaining term, renewal options, rent escalations, common area maintenance charges, personal guaranty requirements, and restoration obligations at the end of the term.

G. Obtain the landlord's consent.

Most commercial leases give the landlord the right to declare a default if the tenant transfers any interest in the lease without the landlord's consent. A buyer who closes without the landlord's consent risks eviction, or at best a substantial rent increase as the price of consent. When a landlord has approval rights, an assignment of the lease obviously requires consent — but so does an entity purchase if the lease provides that a change in ownership of the tenant is deemed a transfer. Read the lease. Then get the consent in writing before closing.

H. Verify the condition of every material asset being purchased.

This one is a no-brainer. If you are buying a car, you have a mechanic inspect it. The same concept applies whether you are buying an office building, a franchise, a restaurant or a widget manufacturer. Have knowledgeable people inspect the assets you are buying, and confirm the seller actually owns them rather than leases them.

I. Inventory the inventory.

If you are buying inventory, and especially if part of the purchase price depends on inventory on hand at closing, inspect the inventory before closing and take an actual physical count as of the closing date to verify the number of units and their condition. Obsolete inventory sitting in a back room is not worth what the seller's spreadsheet says it is worth.

J. Confirm the tax situation.

Obtain the seller's federal and Arizona tax returns, transaction privilege tax filings, payroll tax filings and property tax statements. Unpaid taxes are the liabilities most likely to follow the buyer despite an asset purchase structure. See questions 11 and 12.

K. Interview the people who know the truth.

With the seller's permission, talk to key employees, major customers and major suppliers. Ask whether the relationships are with the business or with the departing owner personally. A business whose revenue walks out the door with the seller is not worth what a business with durable customer relationships is worth.

L. Confirm insurance and claims history.

Obtain loss runs from the seller's insurance carriers for the last five years. A clean set of loss runs tells you one story about how the business has been operated. A stack of claims tells you a very different one.

This list is not exhaustive. It is the minimum. Every business purchase has its own due diligence requirements that may go well beyond the items above.

11. Am I Liable for the Seller's Unpaid Arizona Sales Tax?

You can be, and this is one of the most commonly overlooked risks in an Arizona business purchase. Under A.R.S. § 42-1110, a purchaser of a business or stock of goods must withhold from the purchase money an amount sufficient to cover the transaction privilege taxes, interest and penalties owed by the seller until the seller produces either a receipt from the Arizona Department of Revenue showing the taxes have been paid, or a certificate stating that no amount is due. A buyer who fails to withhold is personally liable for the former owner's unpaid taxes, interest and penalties.

The protection is straightforward and it is free. Require the seller, as an express condition to closing, to submit a Tax Clearance Application to the Arizona Department of Revenue and deliver a Letter of Good Standing to the buyer at or before closing. The Department must respond to the seller's request within fifteen days. If a later audit turns up a deficiency that arose before the sale, that deficiency is the seller's problem, not the buyer's — provided the buyer obtained the certificate.

Practice tip: Build both belt and suspenders into the purchase agreement. Make delivery of the Letter of Good Standing a condition to closing, and hold back a portion of the purchase price in escrow until the letter is delivered. Sellers who are current on their taxes will not object. Sellers who object have just told you something important.

12. Will I Inherit the Seller's Arizona Unemployment Insurance Account?

If you acquire an entire Arizona business, or substantially all of its assets, and continue operating it, yes. Under A.R.S. § 23-733, the predecessor employer's experience rating account transfers to the successor employer as of the date of acquisition for purposes of determining the unemployment tax rate. The experience rating account includes the record of wages and taxes previously paid, and unemployment benefits awarded based on wages the former owner paid may be charged against the buyer's account. The successor is also liable for the predecessor's unpaid contributions, interest and penalties, and that liability becomes a lien against the acquired assets.

There is a valuable protection built into the statute that most buyers never use. On written request, the Arizona Department of Economic Security must furnish the successor with a written statement of the amount of contributions, interest and penalties due and unpaid by the predecessor as of the date of acquisition, and the successor's liability cannot exceed the amount disclosed in that statement. Send the request. Get the statement. Cap your exposure.

A buyer who acquires only a distinct and severable portion of a business is not automatically assigned the predecessor's rate and experience rating account. To apply for a transfer of that portion of the account and its corresponding tax rate, the buyer must file an Application & Agreement for Severable Portion Experience Rating Transfer (Form UC-247) with DES within 180 days after the acquisition. The former owner must agree and provide payroll information for the portions acquired and retained.

Caution: If the seller's experience rating is poor, the buyer inherits a higher unemployment tax rate that can cost thousands of dollars a year. The purchase agreement should contain a mechanism to compensate the buyer for additional expense arising from the transferred account, and the buyer's accountant should quantify the cost before the buyer signs.

13. What Happens to the Seller's Employees?

In an entity purchase, nothing changes. The employees keep working for the same employer, because the employer is the entity the buyer just bought, and every accrued obligation to those employees — unpaid wages, accrued paid time off, commission obligations, employment agreements, employment claims — stays inside the entity.

In an asset purchase, the seller's employment relationships do not automatically transfer. The seller terminates its employees and the buyer hires the ones it wants as new employees of the buyer's entity. That means the buyer must:

• Decide which employees to hire and on what terms, and make the buyer's obligation to close contingent on key employees agreeing to stay.
• Complete a new Form I-9 for each new hire and set up new payroll, withholding and workers' compensation coverage.
• Determine whether the buyer will honor accrued vacation or paid time off, and if so, obtain a purchase price credit from the seller for that liability.
• Confirm the seller pays all final wages when due under Arizona law and confirm the seller — not the buyer — is responsible for all pre-closing wage, overtime and benefit claims.
• Review existing employment agreements, noncompete agreements and confidentiality agreements. A noncompete between the seller and a key employee usually does not automatically run to the buyer unless it is assignable and actually assigned.

Do not overlook the departing owner. If the business depends on the owner's relationships, technical knowledge or license, the buyer should require a consulting or employment agreement obligating the owner to stay through a transition period, and should make signing that agreement a condition to closing.

14. Do the Seller's Licenses and Permits Transfer to Me?

Usually not, and buyers who assume otherwise sometimes cannot legally open the doors on the Monday after closing. As a general matter:

• Arizona transaction privilege tax license: Does not transfer. The buyer must obtain its own TPT license from the Arizona Department of Revenue if the business engages in a taxable activity, and may also need city licenses.
• Contractor's license: An Arizona Registrar of Contractors license belongs to the licensee. A buyer generally must qualify for and obtain its own license, which requires a qualifying party with the required experience and, frequently, a bond and an examination.
• Liquor license: A transfer of an Arizona liquor license requires approval from the Arizona Department of Liquor Licenses and Control and typically the local governing body. This takes time. Make it a condition to closing.
• Professional licenses: Licenses issued to individual professionals do not transfer with a business at all.
• Health, fire, sign, occupancy and specialty permits: Many must be reissued in the buyer's name and may trigger a fresh inspection, which sometimes reveals code violations the buyer will have to cure.
• Franchise agreements: A franchisor almost always has approval rights over a transfer, imposes a transfer fee, and may require the buyer to sign the franchisor's current agreement rather than assume the seller's older, more favorable one.

Identify every license and permit the business needs during due diligence, determine how long each takes to obtain or transfer, and make the buyer's obligation to close contingent on obtaining them.

15. What About Real Estate Due Diligence?

Buyers who acquire or lease real estate in connection with a business purchase, or who buy an entity that owns or leases real estate, have additional due diligence obligations that are real estate specific and largely outside the scope of this article. Real estate due diligence includes, but is not limited to: (i) obtaining an environmental assessment showing the land is free of environmental problems, (ii) reviewing and approving the state of title and the liens, encumbrances and other matters affecting title, (iii) obtaining and approving a survey, (iv) verifying that zoning and the recorded conditions, covenants and restrictions permit the buyer's intended use, and (v) obtaining acceptable tenant estoppel certificates from every tenant occupying the land.

Environmental exposure deserves special mention. Federal environmental liability can attach to a current owner of contaminated property regardless of who caused the contamination, and it is not eliminated by structuring the deal as an asset purchase. If the business ever involved fuel, solvents, dry cleaning chemicals, paint, plating or vehicle maintenance, get a Phase I environmental site assessment.

16. What About the Website, Phone Number, Social Media and Online Reviews?

For many businesses the most valuable asset is not the equipment. It is the phone number customers have called for twenty years, the domain name, the Google Business Profile with 400 five-star reviews, and the social media accounts. These assets are easy to overlook in a purchase agreement and painful to lose.

The purchase agreement should expressly identify and require transfer of:

• The domain name or names, with the seller obligated to complete the registrar transfer at closing, plus website files, hosting accounts and the content management system login.
• Business telephone and fax numbers, and any obligation of the seller to cooperate with the carrier to port them.
• The Google Business Profile, together with the seller's obligation to transfer primary ownership rather than simply add the buyer as a manager.
• Social media accounts on every platform, including passwords and the email addresses the accounts are tied to.
• Customer lists, customer databases, CRM data and email marketing lists.
• Trademarks, service marks, logos, trade names, trade dress and any registrations or applications, transferred by a written assignment.
• Trade secrets, formulas, recipes, processes and proprietary software, protected by confidentiality obligations that survive closing.
• Business email accounts and, if applicable, the seller's business listings on review and marketplace platforms.

Also require the seller to change or surrender any Arizona trade name registrations so the seller cannot continue to use the business name after closing, and confirm during due diligence that the seller actually owns the intellectual property. It is remarkably common to learn that the logo belongs to a freelance designer who was never asked to assign it and the website belongs to a marketing agency that will not release it until an unpaid invoice is satisfied.

17. Can a Buyer Cancel a Purchase if There Is a Problem?

The short answer is yes, no, or maybe. It depends entirely on the language of the purchase agreement. If the agreement contains no review period and no language giving the buyer a right to cancel when a problem surfaces, the buyer may be legally bound to close and pay. A buyer who discovers a problem before closing and does not clearly have a right to cancel should consult a business attorney immediately.

I once had a client who signed a one-sentence contract that said "I will buy your widget for $50,000." She later decided she did not want the widget. She could not unilaterally terminate the contract, because it contained no conditions and no outs. The result would have been very different if the contract had said "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 she had applied for financing and not obtained it. In that case the condition precedent to her obligation to buy would not have been satisfied and she could have walked away.

A prudent buyer signs a purchase agreement that gives the buyer a free look period to investigate and perform due diligence, during which the buyer may cancel for any reason or no reason and receive a full refund of the earnest money. That is the best kind of provision, because the buyer never has to justify the decision.

A prudent buyer also builds express conditions into the agreement, so the buyer can cancel and get the earnest money back if specified events do not occur. If the buyer is assuming a lease, the agreement should state that the buyer's obligation to close is contingent on obtaining the landlord's unconditional consent to the assignment. If the buyer needs financing, a liquor license, a Letter of Good Standing from the Department of Revenue, or a key employee's signature on an employment agreement, each of those should be an express condition to closing.

Before signing, make sure the purchase agreement gives you an adequate due diligence period, express conditions to closing, and the right to cancel and recover all earnest money if problems are found or conditions are not satisfied.

18. Can a Buyer Close if Problems Are Not Resolved?

A party is always free to waive unsatisfied conditions and unresolved problems and close. The real question is whether doing so is prudent. If the buyer finds a material problem before closing and has the right not to close, the buyer normally should refuse to close until the problem is resolved to the buyer's satisfaction. The buyer's leverage is at its absolute maximum before the seller gets paid, and it drops to nearly zero the moment the money changes hands.

If a buyer decides to close despite unresolved problems, the buyer should modify the purchase documents to reduce post-closing exposure. For example, if a condition to closing is that an asset be free of a $5,000 lien owed to ABC Creditor, Inc., and the lien is still of record at closing, the buyer can be protected by holding $5,000 of the closing proceeds in escrow until the lien is released, with the escrowed funds paid to the creditor if the lien is not released by a specified date.

19. What Legal Documents Are Used in a Business Purchase?

Arizona business purchases typically involve the following documents:

• Purchase Agreement
• Escrow Agreement
• Bill of Sale
• Assignment and Assumption Agreement
• Amendment to Articles of Organization or Articles of Incorporation
• Covenant Not to Compete
• Consulting or Employment Agreement
• Consent of Landlord to Assignment of Lease
• Landlord Estoppel Certificate
• Assignment of Lease
• Resolutions Authorizing the Transaction
• Assignment of Intellectual Property
• Promissory Note
• Security Agreement
• UCC-1 Financing Statement
• Deed and Deed of Trust
• Personal Guaranty

The primary document evidencing an agreement to buy or sell a business, whether an entity purchase or an asset purchase, is the purchase contract. It may be titled Asset Purchase Agreement, Purchase Agreement, Purchase & Sale Agreement, Stock Purchase Agreement, Membership Interest Purchase Agreement or something similar. It is the most important document in the transaction because it contains all of the deal points and every term and condition applicable to the sale.

When we prepare documents for a business purchase, we attach every ancillary document as an exhibit to the purchase agreement so that when the parties sign the purchase agreement they have already agreed on the exact form and content of every other document. This practice eliminates a whole category of disputes that otherwise erupt three days before closing.

The list above is typical but not exhaustive. Every transaction has its own documentation needs.

20. Can You Explain the Common Purchase Documents?

Purchase Agreement: The most important document. It sets the purchase price and all other terms and conditions, and it contains the seller's representations and warranties about every important aspect of the business. It should also state how long those representations survive closing and what remedies the buyer has if they turn out to be false.

Escrow Agreement: If an escrow is used, the buyer, seller and an independent escrow agent should sign an escrow agreement. The escrow lets a neutral party hold what each side deposits until closing and then deliver each item to the right party. The escrow agent holds the buyer's money until every closing condition is satisfied, then delivers the money to the seller and the Bill of Sale and other transfer documents to the buyer.

Bill of Sale: Signed by the seller and delivered at closing. It evidences the seller's assignment and transfer to the buyer of the assets listed in it.

Assignment and Assumption Agreement: Transfers the seller's rights under specified contracts to the buyer and documents exactly which obligations the buyer is assuming. In an asset purchase, this document and the Bill of Sale together define the line between what the buyer took and what the seller kept.

Deed: If the purchase includes real property, title is transferred by a deed signed by the owner of the land, notarized, and recorded with the County Recorder of the county where the land is located.

Promissory Note: If the entire purchase price is not paid at closing, the unpaid balance should be evidenced by a promissory note signed by the buyer setting forth the terms of future payments.

Security Agreement and Deed of Trust: An unpaid balance evidenced by a promissory note may or may not be secured by a lien on property. A prudent seller who is not paid in full will insist on a lien on property of the buyer and of any guarantors. Whether property is encumbered is entirely a matter of negotiation. Security agreements create liens on personal property. Deeds of trust, and mortgages, which are used infrequently in Arizona, create liens on real property.

UCC-1 Financing Statement: Used only when the transaction involves a lien on personal property. A seller who takes back a promissory note secured by personal property located in Arizona should always file a UCC-1 financing statement with the Arizona Secretary of State to perfect the lien and give notice to the world. If the debtor is an individual who resides outside Arizona or an entity formed outside Arizona, the seller should also file where the debtor resides or was formed.

Guaranty: When the buyer is an entity, a prudent seller who is not paid in full at closing, or who is concerned about post-closing covenants, should obtain a guaranty from the owners of the buyer.

Caution: Under Arizona law, if only one spouse signs a guaranty, the creditor can satisfy a judgment on that guaranty only from the separate property of the signing spouse and cannot reach the couple's community property. Because most married Arizonans hold nearly everything as community property, a one-spouse guaranty is often worth very little. Whenever a creditor seeks a guaranty from a married person, the creditor should obtain both spouses' signatures.

Assignment of Lease: Used when the buyer acquires the seller's interest as tenant under a lease. It assigns the seller's rights in the lease to the buyer.

Consent of Landlord to Assignment of Lease: If a lease is being assigned, or if the buyer will occupy premises subject to a lease and the landlord has approval rights, the buyer must obtain the landlord's signature on this document before closing.

Covenant Not to Compete: A prudent buyer obtains a written agreement from the seller, and from the key owners of an entity seller, that they will not compete with the business being purchased. Without one, the seller and its owners and affiliates are generally free to open a competing business across the street. A buyer may also allocate part of the purchase price to the covenant and amortize it in accordance with IRS rules.

Caution: Arizona courts will not enforce a covenant not to compete that is unreasonably broad in duration, geographic scope or scope of restricted activity, and Arizona courts will generally not rewrite an overbroad covenant to make it enforceable. A covenant not to compete intended to be enforceable in Arizona should be drafted by an Arizona attorney who knows the case law. An unenforceable noncompete is worse than none, because the buyer paid for protection it does not have.

Consulting or Employment Agreement: Use a consulting agreement for independent contractors, or an employment agreement for employees, when the buyer wants to obligate key personnel affiliated with the seller to help the buyer during a transition period after closing.

21. Can an Arizona Business Broker Prepare the Contracts?

If an Arizona business broker is involved, the broker may offer to prepare the purchase agreement and related documents. Set aside the question of whether a broker who drafts contracts is practicing law without a license, and ask a more practical question: who does the broker represent? If the broker represents the seller, the broker's documents may well favor the seller.

Even a broker who prepares genuinely neutral documents may not protect the buyer adequately. The broker's overriding objective is usually to get the deal closed so the commission gets paid. Many broker-prepared purchase agreements are deliberately drafted not to rock the boat or raise issues that might cause either party to hesitate — which is precisely the opposite of what a buyer needs from a purchase agreement.

Of course, as Arizona business lawyers we are biased. But we recommend without exception that every buyer of an Arizona business consult an experienced business attorney before becoming legally obligated to purchase. The legal fees are almost always trivial compared to the purchase price. Unless the investment is nominal, buying a business is not the time to be penny wise and pound foolish and rely on a broker's form documents to protect the biggest check you may ever write.

22. Is Earnest Money Required to Have a Binding Contract?

No. Contrary to popular belief, Arizona law does not require a buyer of an Arizona business to pay earnest money to create a legally binding agreement. Whether to pay earnest money, and how much, is entirely a matter of negotiation. The buyer should try to eliminate earnest money altogether or, failing that, negotiate the smallest amount possible, deposit it with an independent escrow agent rather than with the seller or the broker, and make it fully refundable during the due diligence period.

23. What Is an Escrow?

An escrow is a device created by an agreement among three or more parties to accomplish specific purposes. Escrows are commonly used in business purchases to ensure that both the buyer and the seller satisfy all conditions to closing before the purchase actually closes. Escrows protect both sides.

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 an escrow agent that is in the business of acting as an escrow agent to be licensed by the Arizona Department of Insurance and Financial Institutions.

In a business purchase escrow, the following should occur:

• The buyer deposits the purchase money with the escrow agent, signs all documents required of the buyer, and delivers those documents to the escrow agent.
• The seller signs all documents required of the seller, such as the Bill of Sale and Assignment of Lease, and delivers them to the escrow agent.
• The escrow agent holds the buyer's funds and both parties' documents until the transaction closes or dies.
• If the transaction dies, the escrow agent returns the money and documents to the parties designated in the escrow agreement or the purchase documents. Absent 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.
• If one party defaults, the escrow agent's duties are governed by the escrow agreement and the purchase documents.
• If the buyer and seller disagree about a proposed action by the escrow agent, a prudent escrow agent will refuse to act until both parties agree or a court authorizes the action.
• If all closing conditions are satisfied, the escrow agent pays the purchase proceeds to the seller and delivers to each party the documents that party is entitled to receive.

Escrow agreements should be in writing and signed by the buyer, the seller and the escrow agent. Commercial escrow companies charge a fee for their services, and the fee is ordinarily split between the parties.

24. Is an Escrow Necessary?

An escrow is not legally required, but it is usually in the best interests of both parties to use one with a licensed, independent escrow agent. An escrow is also the natural place to park a holdback — money set aside at closing to cover unreleased liens, unpaid taxes, inventory adjustments or breaches of the seller's representations discovered after closing. A holdback is often the single most effective protection a buyer can negotiate, because it converts an unsecured claim against a seller who may disappear into cash the buyer already controls.

25. What if the Seller Is Financing Part of the Purchase Price?

Seller financing is common in small business sales, and it cuts in the buyer's favor in one very important way: a seller willing to carry paper is a seller who believes the business will generate enough cash to pay the note. A seller who insists on all cash at closing may know something you do not.

If the seller is financing part of the price, the buyer should address the following in the purchase documents:

• Right of offset. The buyer should have the express right to offset against the note any damages the buyer suffers from the seller's breach of the purchase agreement. Without this, the buyer keeps making payments while suing the seller.
• Scope of the guaranty. If the seller demands a personal guaranty from the buyer's owners, negotiate a cap, a burn-down as the note is paid, or a release once specified milestones are met.
• Collateral. Understand exactly what the seller's lien covers and what happens to the collateral if the buyer defaults.
• Subordination. If the buyer also has a bank loan or an SBA loan, the lender will typically require the seller's note to be subordinated. Confirm the seller will sign the subordination agreement before you sign the purchase agreement.
• Earn-outs. If part of the price is contingent on post-closing performance, define the performance metric in mathematical detail, specify who calculates it, give the seller audit rights, and address what happens if the buyer changes how the business is operated.

26. How Long Does an Arizona Business Purchase Take?

A straightforward small business asset purchase typically takes 45 to 90 days from signed letter of intent to closing. Larger or more complicated transactions take longer. The usual sequence is:

• Weeks 1 to 2: Letter of intent or term sheet, confidentiality agreement, and engagement of the buyer's attorney and accountant.
• Weeks 2 to 6: Purchase agreement negotiated and signed, earnest money deposited, due diligence period begins.
• Weeks 3 to 8: Due diligence, lien and judgment searches, tax clearance request to the Department of Revenue, landlord consent, license and permit applications, financing approval.
• Weeks 8 to 12: Conditions satisfied or waived, closing documents finalized, funds deposited into escrow, closing.

The items that most often delay closing are landlord consent, liquor and contractor license approvals, SBA loan underwriting, and the tax clearance letter. Start all four the day the purchase agreement is signed.

27. What Are the Biggest Mistakes Arizona Business Buyers Make?

After decades of preparing business purchase documents, we see the same expensive mistakes over and over:

• Signing first and calling a lawyer second. Once you sign a binding purchase agreement without conditions, your attorney's job changes from protecting you to explaining what you agreed to.
• Buying the entity to save time. An entity purchase is faster and simpler. It also hands the buyer every unknown liability the entity has ever incurred.
• Accepting revenue claims without tax returns. Cash-basis "off the books" revenue that is not on a tax return is not revenue you can finance, verify or count on.
• Skipping the lien and judgment searches. A UCC search costs almost nothing. Discovering a perfected security interest in your equipment after closing costs everything.
• Ignoring the landlord until closing week. If the location matters, the lease matters more than almost anything else in the deal.
• Failing to obtain a tax clearance letter. See question 11. This one is free and buyers still skip it.
• Taking a noncompete from the entity but not from the owner. The individual who built the customer relationships is the one who can take them away.
• Not getting personal guaranties from the seller's owners. An indemnity from an entity that will distribute all of the sale proceeds and dissolve is worth exactly nothing.
• No holdback. Money in escrow is the only remedy that does not require a lawsuit.
• No transition plan. The seller who has run the business for twenty years knows things that are not written down anywhere. Buy the seller's time along with the seller's business.

28. Additional Legal Issues Every Arizona Buyer Should Address

Before signing a purchase agreement, remember that everything in it is negotiable. The purchase agreement should be weighted in favor of the buyer, because the buyer is the one paying the money and the buyer should get the full benefit of the bargain. Here is a partial list of additional issues a buyer should resolve in the agreement:

• Use the asset purchase method. In general, buyers should use their best efforts to negotiate an asset purchase to reduce the risk of inheriting unknown obligations and to obtain a higher tax basis in the purchased assets. Discuss the choice with your advisors, because there are exceptions to the general rule.
• If you must do an entity purchase, get a tough agreement. It should (i) list every obligation of the company the buyer is willing to let the company pay after closing, and (ii) obligate the seller to indemnify and hold the buyer harmless for every other obligation of the company paid or incurred after closing.
• Provide a method to resolve post-closing problems. Anticipate what can go wrong and write the solution into the agreement. If you may need help from a key employee, condition closing on that person signing an acceptable contract. If you are worried about the seller's debts, hold part of the price in escrow after closing to pay them.
• Get personal guaranties. If the seller is an entity, the entity may have no assets when a problem surfaces. A prudent buyer insists that the owners of the selling entity personally guarantee the seller's obligations.
• Negotiate survival periods and indemnity caps carefully. Representations that expire ninety days after closing protect nobody. Tax and title representations should survive far longer than operational ones.
• Address dispute resolution. Decide in advance whether disputes go to arbitration or court, where they will be heard, and whether the prevailing party recovers attorneys' fees.
• Form your buying entity before closing. Buy the business in the name of a new Arizona LLC rather than in your own name, so the business's liabilities are not automatically your personal liabilities.

This article is not intended to give legal advice. Every prospective purchase has its own facts and circumstances that may involve some or all of the issues raised here plus others not mentioned. We 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.

29. KEYTLaw's Business Purchase & Sale Document Preparation Service

If you are buying or selling an Arizona business or the assets of a business, hire Arizona business attorneys Richard Keyt, who has practiced business and contract law in Arizona since 1979, and his son, attorney and former CPA Richard C. Keyt, to prepare all of the legal documents needed to document the transaction. For a low guaranteed fixed fee, we will prepare the following documents, customized to favor the buyer if we represent the buyer, or the seller if we represent the seller:

• Purchase Agreement
• Escrow Agreement
• Bill of Sale
• Assignment and Assumption Agreement
• Amendment to Articles of Organization
• Covenant Not to Compete
• Consulting or Employment Agreement
• Consent of Landlord to Assignment of Lease
• Landlord Estoppel Certificate
• Assignment of Lease
• Resolutions Authorizing the Transaction
• Promissory Note
• Security Agreement
• UCC-1 Financing Statement
• Deed of Trust
• Personal Guaranty

Every document is custom prepared for the specific transaction. We do not use fill-in-the-blank forms.

The fixed fee includes unlimited consultations and telephone calls at no additional charge through delivery of the first draft of all documents. It also includes up to one additional hour at no charge after delivery for conferences, negotiations with the other side and changes to the documents.

30. How to Hire KEYTLaw to Prepare Your Documents

Arizona LLC and business attorneys Richard Keyt and his son, attorney and former CPA Richard C. Keyt, have formed 10,000+ Arizona LLCs and have spent decades preparing the documents that protect people who buy and sell Arizona businesses. Rick and Ricky will answer your questions about buying or selling a business or its assets at no charge.

Call Arizona business attorney Richard Keyt at 480-664-7478 or attorney and former CPA Richard C. Keyt at 480-664-7472 and take the first step toward protecting your investment. You can also email Richard Keyt at rk@keytlaw.com.

To hire KEYTLaw to represent you and prepare your documents to buy or sell a business or its assets, complete and submit our online Business Purchase / Sale Questionnaire. Our fixed fee is:

• $2,497 if the purchase price is less than $1,000,000
• $4,997 if the purchase price is more than $999,999 and less than $2,000,000
• $6,997 if the purchase price is $2,000,000 or more and less than $4,000,000
• If the purchase price is $4,000,000 or more, call Richard Keyt at 480-664-7478 for a quote.

If you need to form an Arizona LLC to acquire the business, see the fees and contents of our 3 LLC Formation Packages.

To hire us to form an LLC submit our online questionnaire at keytlaw.com/llcq, call 480-664-7478 or email rk@keytlaw.com.