Preparing To Sell A Business: How To Handle Your Contract Extensions/Renewals

October 31st, 2018

After consulting with an attorney, many times businesses begin to do legal clean up as they approach a potential sale of the business. As we have discussed, selling a business takes time, and careful planning is key.

One of the first areas that legal counsel is asked to tackle for a business considering a sale, is to review legacy contracts in place before granting any renewals/extensions and determine how to approach the renewals/extensions to best frame the business for a potential buyer down the road. Many times, vendor or service agreements have provisions for auto-renewal or extension, and it is typical for businesses to use this time as an opportunity to renegotiate terms that are more important now than before as the sale of the business is closer than it was 5-10 years ago. A business’s key contracts embody a valuable business asset. Thus, it is crucial that these agreements either remain in force as a business changes hands from the seller to the buyer, or at the very least do not deter a potential buyer due to unfavorable provisions within the contract.

Prior to negotiating these agreements, the business owner and lawyer need to work together to determine the best framework in case of a future sale. Specifically, the business owner and legal counsel should review and prepare to negotiate the following key provisions that may be included in a contract extension:

1. Early Termination: The business owner will want to negotiate for early termination rights. These rights will be important in allowing the business owner to terminate the agreement upon sale if the potential buyer does not wish to assume the contract after closing.

2. Renewal Options: Similar to termination rights, the business owner will want to negotiate and take into consideration automatic renewal options. Renewal options are often good, as the buyer may need the continued service, but these renewal rights need to be drafted in a particular way so as to get the best terms including consent.

3. Fixed Pricing: The business owner will also want to strategically review all fixed pricing provisions to ensure that they are competitive with the market, and to ensure they will not be an issue to any future buyers when conducting their contract due diligence.

4. Assignment: In general, the default rule is that a party to a contract has the right to assign the agreement to a third party. However, contracting parties often want to have the right to control who they do business with. Figuring out the best language for the particular needs of a party and having carve outs sometimes work to pacify everyone’s concerns.

5. Change of Ownership Provisions: The business owner may want to refrain from agreeing to any change of ownership/control provisions within the contract. These provisions allow the other party to terminate or have similar effects of an anti-assignment provision. Again, if the contract is a material contract to the operation of the business, the buyer will want the contract to be in full force and effect after closing.

Each agreement should be reviewed for these material contract terms to help identify and plan for any potential setbacks or hardships on potential buyers. Failure to do so could delay or endanger the closing of a future sale or even leave the buyer with less of the business than expected. Either of which is a recipe for disaster. Therefore, if you are considering selling your business in the near future, it is important to consult your attorney prior to renewing or extending any vendor and service agreements.

This article was sponsored by Vlodaver Law Offices, LLC, an experienced business solutions and transactions law firm in the Twin Cities. If you would like a free legal consultation, contact us.