We sat down with Jake Parsley to hear about business transactions from a legal perspective. We discussed the role of attorneys, the key legal documents owners should have, and the differences between asset sales and stock sales.
Will: I know you’ve carved out a niche within business transactions, whether that’s helping a business sell or negotiate a real estate acquisition. What did the journey to main street look like for you?
Jake: I’m a farm kid, I grew up in the southwestern corner of Minnesota, right on the South Dakota border. The farm I grew up on was 12 miles outside of town. We had cattle, corn and soybeans. It was definitely a rural upbringing.
I came to Minneapolis for college, and got a liberal arts degree. I found my way into law school without really a clear plan at all and definitely without a sophisticated business background.
I graduated law school in 2010, which was a terrible time to enter the workforce because of the state of the economy. In the spirit of paying off my student loans, I ended up working in the business department of a midsize law firm - about 15 attorneys.
Pretty early on, I realized that I really liked working with small business owners. They’re just practical people. They want to get things done. In some ways, they reminded me of people that I grew up around. We’re not talking about the realm of MBA grads and huge bureaucracies. We’re talking about people looking to do the best for their businesses and their families.
Now, originally, when I was working at the midsize firm, I was playing the role of outside counsel. I wasn’t focused on transactions, which meant that I was taking questions on employment issues and various contracts. Over time, I realized I found myself drawn to the world of transactions. Of all these areas, it was the most practical.
It’s the rare opportunity to do something in the world of law, where everybody walks away happy from the closing table.
Will: I’d love to hear how you find these clients and build the relationships. Are they coming to you with a specific need? Or, are you forming a relationship with them a few years prior to a sale or ownership transfer?
Jake: It’s a little bit of both. That being said, I’m the world’s worst marketer. My website is under construction going on two or three years now.
Every client I’ve worked with has come from a referral source. Some of them are referred prior to needing a lot of work done. Others will come directly to me when they’re in the midst of a transaction. That’s most often the case. So, whether it’s a CPA or a commercial lender that’s working with an owner, they’ll typically suggest that the owner review the legal documents with a lawyer and send them my way.
In the main street market, which I’d loosely define as less than $5M of enterprise value, people aren’t using lawyers very often. For some of my clients, I’m the first lawyer they’re using for business.
Will: I imagine a business sale is a time of firsts for a lot of things. It’s often the first time an owner has sold or a buyer has bought. How do you recommend owners think about who they bring to the table from a legal perspective?
Jake: I would say that two things are very important.
One is that they shop around. People don’t like doing this. I think it’s part of the small business owner mindset. They know they want to sell their business, and they just want to get it done as fast as possible. So, they talk to someone who sounds like they know what they’re doing and the owner plows ahead with that person.
Second is that it’s really important that the client be the one that decides the appropriate level of risk in a deal. Lawyers should be there to manage that level of risk. At the end of the day, our job in the transaction is to make sure that the level of risk is commensurate with what the client wants.
In order for a lawyer to manage that risk well, he or she needs to be able to communicate well. They shouldn’t be someone who puts together a ton of documents and “just gets a deal done.” They should be focused on tailoring the risk of a given deal to what the client wants.
The good news is that you should be able to get a free consultation pretty easily. From that consultation, you should know if it’s someone you understand and who will be within budget. Some will even do flat fee work.
Will: When a business owner is shopping for an attorney, what are the questions they should be asking?
Jake: It’s going to be different for every client. That being said, what you want to know going into that consultation is what the biggest risks are in a given deal.
Once you know that, you want to make sure that the lawyer is in a position to address those risks.
There is some benefit to having someone specialized in the transaction space. Almost every lawyer that advertises as a corporate lawyer will do a dela if you bring it to them. However, the advantage of someone specialized in transactions is that they will know what needs need to be addressed and how to do it in a practical way.
As an owner, some of the questions I’d ask: “What’s your experience in business transactions?”, “What type of transactions have you done?”, “What are some examples that are most similar to my needs?”.
They won’t be able to get too specific, as there are significant issues of protecting client privilege and confidentiality. But, at the same time, you want to get beyond just discussing hourly rates. You want to find a lawyer who can be creative and can think outside the box.
If I can criticize my profession a little bit, which is one of my favorite pastimes, my thought is that a lot of lawyers, especially in the transactional space, approach every deal as if it were a law school exam. When you’re in law school, the whole point of a law school exam is to figure out every single possible thing that could go wrong and address it.
So, lawyers approach a business transaction and want to address every single thing that could go wrong. They want to correct every single typo. They want to make sure everything is perfectly formatted in the transfer documents. The irony is that 9 times out of 10, or really great bit higher than that, all of those documents go into a file cabinet and never see the light of day again.
Now, if something goes wrong, frankly, it probably doesn’t matter what the formatting is. The contents matter. But, a lot of the stuff lawyers spend time on doesn’t.
If you want a perfect document, then that’s great. Just be prepared to pay for it.
What the typical small business acquirer or seller doesn’t understand is that all the time spent on making these documents perfect is not necessarily going to have a good return on investment for them.
Everybody overestimates how much they’re going to walk away from the table with at the end of a transaction. So if money’s tight, the last thing an owner should be doing is spending several thousand extra on legal fees when they’re not going to accomplish something you care about.
Will: It sounds like when an owner is looking for an attorney, what they really want is a partner to help them think through what risks matter and what risks don’t. Based on that, their lawyer should help allocate their budget towards that list of priorities, if you will.
Jake: Yeah, I think that that’s exactly right.
What I always tell people is that if you’ve got a lawyer, and you think that they’re raising concerns that either you don’t understand or don’t think are that important, ask for specific real world examples.
A common section of every purchase agreement is the indemnification section. It’s a section of the agreement that addresses issues of liability that arise after the closing. It gets a lot of confusion and haggling over.
Sometimes that section can be really significant and important. Other times it’s not that important.
If the lawyers are going back and forth on a transaction, and you’re not sure why or you’re not sure that it’s worth it, pull your lawyer aside and ask what the discussions are about and ask for an example in the real world about how this could impact you after the closing.
That way you can make an informed decision about whether or not it makes sense to be spending time negotiating these more arcane sections of a purchase agreement.
Will: Speaking of the transaction process, I’ve heard a number of owners get into the diligence phase of a transaction and realize that they’re missing employment agreements or something that’s considered table stakes. What are the key documents owners should have prior to going to market?
Jake: Well, in the main street space, you see everything. I’ve seen owners with great documents and record keeping. Others barely have anything.
Ironically, when it comes time to sell, it may or may not matter. Some buyers don’t care about whether the corporate record book is in order or whether or not the employee contracts are perfect. Other times they care a lot and it becomes really important.
So it’s a little bit hard to say exactly what owners should have prior to going to mark.
In an ideal world, a seller should have employment agreements in place with appropriate non-compete, non-solicitation and confidentiality language. It’s particularly important for those key personnel that are going to be important to the business post closing. These are the employees who are going to stick around after the owner exits.
Corporate record books can be quite important, depending on who the buyer is. Some buyers may want to see every annual meeting’s minutes going back to the beginning of time. They may want to see share certificates.
But, there have been plenty of times where I’ve seen a buyer that finds the right deal. We get to this due diligence phase, and the corporate record book is a mess. But at the end of the day, the buyer doesn’t care because the deal is still right.
If you take a step back, as a buyer, you have to realize that there are plenty of small business owners out there. They spend time playing whack-a-mole and dealing with fires that pop up during the day. The last thing they’re going to do is try to oil and non-squeaky wheel.
The other area that can be an issue is contracts. That can cover everything that your business does, whether its contracts with a vendor, with recurring clients, with a landlord. With contracts, it’s important that not only have an agreement in place but also that you are able to assign that contract.
It can be quite tricky getting agreements formalized after years of working with a client or vendor on a handshake basis. They may be a bit suspicious if you approach them asking them to sign a long legal contract. However, there are different ways to approach it.
You can blame your lawyer. Say that your lawyer assessed your business and claims that there is a bunch of legal risk. You can explain that you’re not trying to change the way you do business, but you want to get this lawyer off your back.
Another person to blame is your banker. You can say your banker wanted to see a little extra security for an outstanding line of credit.
There are a lot of potential villains out there that you can use to blame.
Will: Sure - these are really helpful tactics for getting your business ready to sell.
Jake: One other reason contracts come up is during the course of an asset sale. Buyers want to make sure that they’re buying a business that has been operating well and that they can take forward. They don’t want to worry about anything that will take the business backward.
A risk that the vendor’s pricing structure is suddenly going to change is concerning to a buyer.
A risk that a key recurring customer may churn without notice is concerning to a buyer.
Will: You mentioned the importance of having non-solicit or non-compete language in employee contracts. Outside of protecting themselves from losing employees to competitors, how can buyers incentivize employees to stay on?
Jake: There are different ways of looking at it. When I first started doing deals in the still slow and sluggish economy of 2012-2013, employees were pretty happy if they were allowed to keep their jobs.
When a business announces that they’ve been acquired, normally employees find out at an all-hands after the deal is done. What’s the first concern they have? It’s whether or not they still have a job. The second concern is how much their job is going to change?
With the economy that we’re currently in, simply having a job may not be enough.
So broadly, there are two different ways of doing it. There’s the carrot and the stick. The non-competes and non-solicits are generally more of a stick. You’re saying, “I’ll give you some benefit upfront in exchange for you promising not to compete against me or solicit other employees.” Now, that stick varies based on the state. Minnesota honors non-competes. In other states, the stick is completely unenforceable.
I’m personally a fan of the incentive approach, where everyone is working together for the success of a business. If a buyer has a key employee who helped build the value of a business, then they can be rewarded at the sale of business. It doesn’t have to be through equity. There are a number of different ways. This is where it’s helpful to have a lawyer who can think outside the box.
Will: Earlier you alluded to the importance of contracts within an asset sale. I’d love to hear you spell out the difference between asset sales and stock sales. I know it can be confusing for owners and buyers, alike.
Jake: In a perfect world, when lawyers are not worried about transaction costs, we always like asset sales.
Asset sales allow us to limit our liability. We’re only buying the assets that we want, and we’re able to avoid any liabilities we don’t want. We’re technically a brand new legal business. We’re picking and choosing what we want from the seller and leaving everything else behind.
With the stock sale, you are becoming the seller. You are stepping into the shoes of that entity completely. This means that any existing contracts, any existing debts that aren’t allocated for at closing - they become your problem.
Now as the seller, the upside of the stock sale is tax base. Administratively, a stock sale is a lot easier than an asset sale, too.
In an asset sale, you’re assigning contracts that exist or you’re entering into new contracts with everyone, whether that’s with employees or vendors or customers. You need to do an I-9 onboarding with each employee. You need to open new bank accounts. Asset sales are a lot of paperwork.
For a business where there’s less concern about liabilities or it’s very clear what the extent of those liabilities are, then maybe it’s not worth worrying about the downside of the stock sale. Instead, maybe it’s worth considering the upside of a stock sale, which is minimizing transaction costs and time.
Will: Would you say one type of transaction is more common than the other on Main Street?
Jake: I think asset sales are quite a bit more common. Buyers tend to want to minimize their liability.
Will: And does entity type play a role in which type of sale you can do? for instance, if you are a sole proprietor, can you do a stock sale?
Jake: It does.
If you are a sole proprietor, you cannot do a stock sale, as you don’t have any stock.
Technically, an LLC can’t do a stock sale either, because an LLC doesn’t have stock, but an LLC can sell its membership interests.
This all depends on state law as well. Each state has different terminology and definitions of corporate entities.
Not to get too much in the weeds, but there’s even something called an 338(h)(10) election. Businesses can elect to treat the transaction as an asset sale for tax purposes, although it’s legally treated as stock sale.
Will: How often are decisions like this made prior to going to market versus being a product of a specific buyer’s requests or negotiations?
Jake: In the world of business transactions, anything can be negotiated.
For instance, a stock sale may be the most tax advantageous for a seller. But, if the seller gets a high enough asset price from a buyer, maybe it comes out in the wash.
I think that it’s good to know what your options are. But, I don’t necessarily think that it makes a ton of sense to spend a lot of time and a lot of resources, investigating different options before you even go to market.
You just don’t know what that buyer is going to be looking for, and what they might be set on.
Will: One thing that we’ve spoken about before on this podcast is the role of business brokers. How many of your transactions are brokered? What do you advise owners you work with?
Jake: I’d say maybe 50% of the deals that I work on are brokered deals.
There’s a wide spectrum of brokers out there, but there are plenty who are very good and provide a lot of value.
I think it’s very similar to selecting legal counsel: shop around and talk to as many brokers as possible.
To the extent that you’re looking for just someone to find a buyer, there are a lot of different ways you can do that. It probably doesn’t make sense for a broker to take 10% of your gross proceeds to throw something up on a website.
But, there are a lot of intangibles that come with business sales. If you can find a broker that’s going to help you cover as many of those intangibles as possible, that’s great.
You should be able to get a sense of the broker’s style and capabilities from shopping around.
For a lot of the business owners that I work with, this is the single biggest transaction of their live. I think it makes sense to be intentional about the entire transaction and to shop around for everything, including brokerage services.
Will: I know we met through the Searchfunder community, which has a lot of really good information on due diligence, financing, and so on. In the spirit of being intentional and knowing your options, are there any other communities you’d recommend to owners?
Jake: You know, Searchfunder is great, and that is one that I’ve recommended to a lot of people. There are a lot of people on Searchfunder who give a common sense approach, who have been there before and have exited or bought businesses. That type of experience is really valuable.
I don’t really know any communities that are similar to Searchfunder that are super useful.
But, I think that any community where you can trade stories and tips with other business owners can be really valuable. For many, that can even be the local business association or chamber of commerce.
At the same time, those communities are also a really good way to get referrals to good advisors that have the type of experience that you might need when it comes time to buy or sell a business.
Will: That’s a great point. Well, thanks so much for joining us today Jake. This has been really awesome. Do you have any final plug for Parsley Law?
Jake: Well, it’s just me. It’s a small shop. As we were discussing before the podcast, my pipeline gets filled up pretty quickly and I’m only working on a couple of deals at a time.
But please feel free to find me on LinkedIn. I’m generally happy to talk with anyone in the transaction space. It’s something I really think is interesting. I love doing it.