The Significance of Disclosure in a Business Transaction

Full disclosure by buyer and seller is a vital component in any successful business sale/purchase transaction.  In a small business transaction, buyer and seller disclosure statements are customarily exchanged and reviewed before or during the due diligence process. Hopefully there are no significant surprises at that point and the transaction proceeds smoothly.

When the buyer is an individual, the buyer’s disclosure statement generally focuses on the buyer’s personal, professional, and financial background and reorganization plans.  However, the seller’s disclosure statement is broader and is often organized into these categories:

1. Business Conditions
2. Regulations
3. Other Considerations
4. General

Business Conditions encompass internal aspects of the business.  Any financially adverse conditions such as prior bankruptcy, undeclared income or expense, client or vendor concentration, future promises to current employees or independent contractors, current or anticipated conflicts with landlord(s), deferred maintenance issues, unpermitted work performed on premises, equipment in need of repair, anticipated increases in worker’s compensation insurance due to recent claims, and existence of hazardous materials must be disclosed and addressed should they exist.

Regulations focuses on required licenses and permits, zoning, tax compliance, and local, county, state or federal law violations or investigations of any kind.

Other Considerations may include union or employment agreements, employee stock ownership plans, underfunded pension liabilities, accrued back wages, vacation pay or sick leave, equipment leases, pending or threatened litigation, unresolved insurance claims, unpaid local, state or federal tax, etc.

The General category raises one all-encompassing question: is the seller aware of any other facts or conditions not disclosed in the three prior categories that may adversely affect the operation of the business, a buyer’s decision to purchase it, or the price that a buyer might pay for it?

Should any of the aforementioned conditions exist, it is critical that they be acknowledged and explained to the buyer before they buy. A significant business weakness or risk revealed early in the discovery phase is usually a manageable hurdle or a point to negotiate around. That same information revealed during due diligence becomes a catalyst for buyers to reexamine other data, lower their price, or walk away. In our experience, appropriately exposing warts early in the M&A process builds trust and credibility with buyers, which is an advantage in negotiations, and helps ensure that sellers avoid disputes and keep all of their proceeds after the sale.

Ultimately, the best advice is: Disclose, Disclose, Disclose.