When the owners of a corporation, the stockholders, want to sell the business they usually want to sell the stock. While the sale of the stock will accomplish the sale of the business, the business can be also be sold by having the corporation sell its assets or by having it merge with another company. Choosing the method that will be best for a specific business sale depends on, among other things:

• whether the buyer and the sellers want a simple transaction.
• taxes.
• whether the entire business will be sold, or whether only part will be sold.
• how many stockholders there are and how many are required to approve the sale.

A sale of a corporation’s stock is straightforward. The corporation’s stockholders trade their stock certificates for money or for property. The corporation keeps all of its assets and liabilities. The only things that change are the names and identity of the stockholders. For a corporation whose stock is not publicly traded, the transaction is generally simple and usually involves only paperwork, including a stock purchase agreement, a bill of sale, the surrender of the existing stock certificates, the transfer of the stock on the corporation’s records, and the issuance of new stock certificates.

Under Colorado law, a merger is generally treated like a sale of stock. In the merger the buyer, called an “acquirer,” assumes all of the corporation’s assets and liabilities by operation of law and without the need for any other agreement or transaction.

When someone buys a corporation’s assets, the corporation sells its property, like its contracts, furniture, fixtures, and equipment, for money or in exchange for other property. The corporation gets the money and the buyer gets the assets. The buyer generally does not take or assume any of the corporation’s liabilities. Sales of assets are usually trickier than sales of stock. The sale of assets that involve third parties, like customer and vendor contracts or leases of property, involve the “assignment” of the asset to the buyer. Contracts with third parties usually require the corporation to obtain the third party’s consent before the corporation can assign the contract to the buyer.

If the corporation’s employees are going to work for the buyer after an asset sale, the corporation technically must fire the employees so that the buyer can hire them. The firing and hiring process can raise employee benefit issues, such as whether the employee is entitled to receive accrued vacation pay and whether their health and retirement benefits are changed.

Some sales of a corporation’s assets give rise to government agency filing or permit requirements. A sale of real estate requires that a formal deed be filed to transfer the property. Finally, if the corporation has used its assets to secure the payment of a line of credit or another debt, the corporation will be required to fully pay the line of credit or debt before the bank will release the liens on the assets that the corporation wants to sell. Buyers often prefer asset purchases to stock purchases for tax reasons. In most cases, the depreciated book value of the corporation’s assets is lower than their fair market value. In this situation, a buyer will want an asset deal so that the buyer’s tax basis in the assets will equal the purchase price and will allow for the greatest depreciation expense. The seller, on the other hand, usually wants to sell the corporation’s stock in order to avoid tax on the difference between the sales price of the assets and their depreciated book value. If the corporation is a C corporation, the seller also wants to avoid paying tax on the distribution of the sales proceeds from the corporation to the shareholder.

Under the tax laws, a merger may be treated as either an asset sale or stock sale, depending on the entity’s structure. Always consult a tax specialist for assistance when dealing with a merger.

Portion of Business Being Acquired

An asset sale is appropriate when the buyer is purchasing less than the corporation’s entire business. After the buyer takes the specified assets, the remaining assets may be used to continue as a going concern or may be disposed of by sale, liquidation, or distribution in kind.

Corporate Approval Requirements

Under Colorado law, mergers generally require the approval of only a majority of the shareholders of the parties to the merger. An asset sale ordinarily requires the approval of a majority of the selling corporation’s shareholders. A sale of stock, however, requires the approval of all of the corporation’s shareholders if the buyer wants to own 100 percent of the business. Unless there is a contractual agreement to the contrary between the stockholders, any individual shareholder can refuse to sell his or her stock.

In some cases, a buyer can use a merger to buy a corporation with a reluctant stockholder. The typical transaction is called a “reverse triangular merger.” To start, the buyer forms a new, wholly-owned subsidiary. The new subsidiary then merges into the corporation with the reluctant stockholder, since this requires only a majority vote. After the merger, the buyer owns 100 percent of the corporation’s stock, and the reluctant stockholder owns stock in the parent of the new and merged corporation. The reluctant shareholder can choose to exercise “dissenter’s rights,” but if the transaction is generally fair to the selling shareholders the cost and relative benefit of exercising these rights often dissuades shareholders from troubling themselves.

The limited liability company permits flexibility for special allocations and distributions of cash and other assets to the owners in a manner similar to that of a limited partnership.

Do you need a formal operating agreement to form a LLC?

While a formal document, called the Articles of Organization, must be filed with the Colorado Secretary of State to form a limited liability company, the internal operations of the limited liability company are generally governed by an operating agreement. An operating agreement can be a verbal agreement or a written agreement, but just like a partnership agreement, a written agreement is always advisable. An operating agreement can also specify how new owners will be admitted to the company. For example, although an existing member can transfer his or her interest in the profits of the company to a new person, the new person is generally not admitted to the company as a full member unless the remaining members vote to admit the new person. If the new person is not admitted to the company as a member, the new person has no right to participate in the management of the business and affairs of the limited liability company.

How do you form and maintain a LLC?

A limited liability company is formed by filing Articles of Organization with the Secretary of State. If the Articles of Organization are filed in a paper format, the filing fee is $50.00. If the Articles of Organization are filed electronically, the filing fee is currently $0.99.

A limited liability company must file an annual report with the Colorado Secretary of State in order to remain in good standing and to retain its authority to engage in business in the state. The annual report consists of the name and street address of the company’s registered agent, the address of the company’s principal office, and the name and address of the individual completing the report. The report is due on or before the last day of the month during which the company filed its Articles of Organization (the anniversary month) each year, and the filing fee for a report submitted on paper is $25.00. A limited liability company may file its annual report electronically beginning two months prior to its anniversary month, and the fee for electronic filing is currently only $0.99.

What are the rights and responsibilities of an LLC’s owners?

The owners of a limited liability company are called members. Members have certain voting rights that are provided by the Colorado statutes, and these generally include the right to vote on the managers of the company, the right to approve transfers of ownership interests by the other members, and the right to vote whether to continue the company’s existence upon the withdrawal of a member. A member of a limited liability company may resign at any time by giving written notice to the other members, unless resignation is prohibited in the Operating Agreement. If the member violates the Operating Agreement by resigning, the limited liability company may recover damages from the resigning member for breach of the Operating Agreement, and may offset the damages against amounts otherwise distributable to the member.

Who is responsible for running an LLC?

A limited liability company is managed by one or more managers. A manager can be a natural person or another entity. The manager can be an owner or can be a non-member. The owners elect the managers each year. The managers have complete authority to act for the limited liability company unless their authority is limited in the Articles of Organization or in the operating agreement. A limited liability company may also appoint officers and other agents that have the authority given to them by the owners. Therefore, a limited liability company may have both a “manager” and a “president.”

How do members contribute to an LLC? Are members liable for company debts?

The members of a limited liability company may contribute cash, property, services rendered, or a promissory note or other binding obligation to contribute cash or property or to perform services. The members and managers of a limited liability company are not personally liable for the debts or obligations of the company. However, a member of a limited liability company is personally liable to the company to perform any enforceable promise to contribute cash or property or to perform services for the limited liability company, unless the obligation to make such contributions is waived by consent of all of the members or unless the Operating Agreement provides otherwise. If the members waive the obligation to make additional contributions, the member’s obligation may be enforced by a creditor who has extended credit to the limited liability company in reliance on the member’s obligation to make the contribution. A member is also liable to restore distributions made to that member while the limited liability company’s liabilities exceeded its assets, and this liability extends for six years after a prohibited distribution is made.

How is an LLC taxed?

A limited liability company may elect to be taxed as a partnership or as a corporation.

How is an LLC dissolved?

A limited liability company may be dissolved as a result of the passage of a stated amount of time or the happening of a stated event specified in the Articles of Organization or in the Operating Agreement. The owners of the company may agree to dissolve the company at any time. The business of a limited liability company may be continued under the provisions for continuation of business stated in the Operating Agreement.

An “earn-out” provision is a method of measuring part of the purchase price for a business based on its financial performance after the closing date. Earn-out provisions are common where the seller continues to be involved in the business after closing, and they provide an efficient way for the seller and the buyer to share post-closing operating risk by aligning the seller and the buyer’s post-closing incentive for the business to continue to succeed.

Earn-out provisions also give the seller an incentive to provide the buyer with all available information, both good and bad, about upcoming events. Earn-out provisions also encourage the seller to help with the transition of the business to the buyer, especially the transition of customer relationships. Finally, earn-out provisions discourage the seller from “puffing up” the business’ past financial performance, since the earn-out will usually be tied to the performance measures that the seller provides.

Since earn-out provisions are usually are based on projected revenue or profits, the seller and the buyer, and especially their attorneys, should be careful to clearly define the revenue and expense accounts that will be counted toward the earn-out benchmarks. Not only will the revenue and expense accounts require attention, but the timing of when revenue is earned and when expenses are deducted must also be addressed. These definitions and procedures can become even more difficult if the buyer intends to operate the business that it is buying as a part of a larger enterprise.

Since an earn-out will mean that a buyer will pay more for a business if it performs well, a seller may blame the buyer for running the business poorly if the earn-out targets are not met. A seller may also say that the buyer didn’t invest enough time or money in the business for the business to meet its potential. To avoid this problem, the earn-out agreement should address whether the buyer is obligated to operate and support the business in a manner consistent with its history or at a certain level.

What are “Caps” and “Baskets”?

“Caps” and “baskets” describe concepts that are used to simplify the administration of the liability and indemnification sections in a purchase agreement after the sale has closed and the buyer is operating the business. “Baskets” are designed to have the parties avoid petty squabbles over minor disputes after the closing. A “basket” agreement will usually say, for example, that a buyer cannot sue the seller for damages for a breach of any term, warranty, or representation in the sales agreement until the total damages exceeds a minimum threshold such as 1 percent of the purchase price.

A “cap” limits the amount that the buyer can seek to recover from the seller for a breach of the terms, warranties, or representations of the sales agreement, such as 10 to 25 percent of the purchase price. A cap helps the seller limit the uncertainty about whether they will have to refund the purchase price. A cap also encourages the buyer to perform thorough due diligence because the buyer will not be entitled to a full refund if the business fails to meet expectations, unless the seller committed fraud.

Who is Giving the Indemnification?

If the seller is a corporation that will distribute the sales price from selling its business assets to its stockholders, the corporation may have few assets left after the sale for the buyer to go after if the business assets fail to perform as expected. If the buyer’s only indemnification rights are against the selling corporation, the buyer may be chasing a bankrupt entity.

If the buyer is purchasing stock from numerous individual stockholders and the purchase agreement provides that the individual stockholders will be severally liable instead of jointly liable for indemnification obligations, the buyer may find itself chasing many individuals who have already spent the money they received from the sale.

When an individual stockholder is wealthy enough to reassure the buyer of its ability to indemnify the buyer, the purchase agreement may provide that the buyer can sue the wealthy stockholder individually for all breaches of representations and warranties. In this case, the wealthy stockholder may enter into a side agreement with the other stockholders whereby they each agree to remain liable to reimburse the wealthy stockholder for their individual share of any indemnification obligation.

Under Colorado law, a merger is generally treated like a sale of stock. In the merger the buyer, called an “acquirer,” assumes all of the corporation’s assets and liabilities by operation of law and without the need for any other agreement or transaction. Under Colorado law, mergers generally take one of the following forms, and the form chosen will always depend on the business, tax, and practical reasons for the merger:

• Forward Merger: The Seller merges into the Acquirer, with the Acquirer surviving the merger.
• Forward Triangular Merger: The Seller merges into a wholly-owned subsidiary of the Acquirer, with the subsidiary of the Acquirer surviving the merger.
• Reverse Triangular Merger: A subsidiary formed by the Acquirer for the sole purpose of effecting the merger merges into the Seller, with the Seller surviving as a wholly-owned subsidiary of the Acquirer.

Documentation And Filing Requirements

To make a merger effective under Colorado law, the acquirer must file a Statement of Merger with the Colorado Secretary of State. The statutes that govern the filing of the Statement of Merger set forth certain information that must be set forth in the Statement, and the statute restricts the other information that may be included in the Statement of Merger. Each of the entities that are parties to the merger must comply with the statutes organizing documents and agreements under which it was formed and operates. For example, if a party to the merger is a corporation the corporation’s board of directors will adopt a plan of merger that will be approved by the corporation’s stockholders. The approval and adoption of the plan of merger may be accomplished after notice to the directors and stockholders of the meetings and of the votes to be held, all as provided in the statutes and organizing documents and agreements that govern the operation of the corporation.

Dissenters’ Rights in Mergers

If a corporation’s stockholders vote against a plan of merger and comply with the procedures set forth in the Colorado law, they may receive either: (1) cash equal to the fair value of their shares immediately before the effective date of the merger; and (2) interest accruing from the effective date of the merger, all in lieu of the consideration set forth in the plan of merger. If the stockholder believes that the fair value of the shares determined by the corporation is too low, the stockholder may demand that the corporation pay the stockholder the amount that the stockholder estimates to be the fair value of the shares. The corporation must then either file a lawsuit to have a court determine the fair value of the shares or pay the amount demanded by the stockholder.

Legal Effects of Mergers

After a merger, all of the assets and liabilities of the merged corporations become vested in the surviving corporation by operation of law. This transfer of assets and liabilities is not an assignment, and therefore does not require the consent by third parties.

Short Form Parent-Subsidiary Mergers

If one corporation owns at least 90 percent of each class of the stock of another corporation, a simplified form of merger allows the owner, the parent, to merge with the corporation whose stock it owns, the subsidiary. No votes of the subsidiary’s stockholders is required. No action is required of the subsidiary’s board of directors. The parent simply mails a written summary of the plan of merger to all stockholders at least ten days before the effective date of the merger. If the parent is the surviving corporation and the plan of merger does not change the parent’s articles of incorporation, the parent’s stockholders will not change and their stockholdings will not change, and if the parent will not issue more than twenty percent of its outstanding shares in connection with the merger, no vote of the parent’s shareholders is required.

When a company sells its assets, the seller typically enters into an asset purchase and sales agreement with a buyer. The typical asset purchase agreement contains representations, warranties, covenants, and indemnifications. Like most legal documents, there is no “one-size-fits-all” form asset purchase agreement.

At a minimum, the written asset purchase agreement should identify the specific assets that are being sold, the amount and form of consideration to be paid, and the time when the assets and the consideration are to be exchanged. The asset purchase agreement should also address how the seller and the buyer intend to pay the liabilities, debts, and obligations associated with the assets being transferred.

Successor Liability in Asset Sales

In general, when a person or company buys the assets of a business, the purchaser is not liable for the pre-existing debts and liabilities of the seller. However, the buyer may be liable for the seller’s debts if any of the following circumstances exist: (1) the buyer expressly or impliedly assumes the seller’s liabilities; (2) the buyer merges or consolidates with the seller; (3) the buyer is a “mere continuation” of the seller; (4) the buyer engages in fraud; (5) the buyer or the seller fail to warn the seller’s creditors; or (6) the seller or the buyer distribute products out of state. There are also specific statutes in tax, bankruptcy, or environmental laws that impose liability for the seller’s debts on the buyer unless specific steps are taken.

Express or Implied Assumption of Seller’s Liabilities

If the asset purchase agreement states that the buyer will assume or will be responsible for the seller’s debts, this is called an express assumption of liabilities.

If the agreement is ambiguous or is silent about the seller’s debts, or if there is no written asset purchase agreement, a court will look at the parties’ conduct to measure whether the buyer “impliedly” agreed to assume the seller’s debts. The court’s conclusion will depend on the buyer’s intent. No Colorado case has directly addressed this issue, but the courts in other states have relied on the following facts to determine the buyer’s intent: (1) discounted purchase price; (2) lack of consideration; (3) assumption of most of the seller’s debts by the buyer; and (4) the buyer’s payment of the insurance premiums for liabilities from the seller’s products that were made before the date of sale.

It is important for a buyer to clearly state in the asset purchase agreement that the seller will continue to be responsible for all of its liabilities, whether accrued, prospective, actual, or potential, unless the buyer specifically agrees to treat a specific debt differently. The agreement should list the seller’s debts and liabilities as precisely as possible and, for those liabilities that are undetermined (or undeterminable) at the time of sale, the agreement should provide clear guidance for allocating responsibility between the buyer and the seller.

Merger and Consolidation

An buyer may be held liable for a seller’s debts if a court concludes that the sale is a merger or consolidation between the parties. A court may conclude that a sale is a merger or consolidation even if the buyer and the seller believe that a sale really did take place. In order to avoid having a court treat a sale as a merger or as a consolidation, the buyer should deal with the seller in an arm’s length relationship, especially after the seller has transferred the assets to the buyer.

A buyer wishing to protect itself from being deemed to have merged or consolidated with the seller may wish to ask the seller to wait for a specified period of time after the sale before dissolving its business entity. The buyer should also avoid making insurance payments on or otherwise assuming existing contractual obligations with respect to the assets.

Buyer as “Mere Continuation” of Seller

The gravamen of the “mere continuation” theory imposing liability on the buyer for the seller’s debts is the continuation of the entity rather than continuation of the business operation. To avoid bearing the burden of the seller’s debts, the buyer should ensure that it and the seller maintain independent and separate corporate identities and existence before, during, and after the sale.

Fraud

A buyer will be liable for a seller’s debts if a court determines that the parties fraudulently arranged the sale so that the seller could escape its debts. To avoid even a hint that a sale was fraudulently arranged, the consideration given for the assets should bear a reasonable relationship to their fair market value.

Failure to Warn

In some situations, a buyer has a duty to warn consumers of the seller’s products about defects in the products that come to the attention of the buyer after the sale. In the case where the seller was a manufacturer, the buyer should include in the asset purchase agreement some appropriate representations, warranties, and indemnifications by the seller with regard to the quality of the products that the seller manufactured.

Distribution of Products Outside Colorado

In some states simply continuing the seller’s business, even though the buyer purchased only assets from the seller, is enough for the buyer to be held liable for the seller’s debts. In some states the buyer is liable for the seller’s debts if the buyer purchased the manufacturing assets of a “product line” and continues to produce the line. If the seller’s business involves manufacturing products, the buyer pay special attention to the states where the seller distributes the products.

Dissenters’ Rights in Asset Sales

Under Colorado law, shareholders who believe that they will not receive “fair value” for their shareholder interest in a sale of all or substantially all of a corporation’s assets may exercise dissenters’ rights. The substantive and procedural requirements for exercising these dissenters’ rights are essentially the same as those for minority shareholders exercising dissenters’ rights in a merger transaction.