Cliff Ennico: Hi, and welcome to today's program. I'm your host, Cliff Ennico, and we are going to be talking today about buying and selling the web-based business, a business that can operate on the internet. I'm going to be your host for this program. I am a solo practitioner in Fairfield, Connecticut, admitted in New York and Connecticut. I have been practicing law for 40 years. 25 of those years, I've been a solo practitioner, and I have been doing internet law probably as long as there has been a commercial internet, since the early 1990s.
I represented some of the earliest internet web startups that got started around that time, and I have had literally dozens of clients who have bought and sold their web-based businesses over the past 20 years. Without any further ado, let's begin our program. First of all, if you doubt that I am a lawyer, this slide will definitely prove that I am. Lawyers always tell you what we're not going to do before we do anything. The most important disclaimer here is the second one. We are going to be talking a lot about legal and tax information, and generally how to do these types of transactions.
But nobody listening to this program should rely upon this as a one-on-one legal or tax advice as to what you should do in a specific situation. That can only be done by retaining a lawyer's services and maybe paying a little bit of money. Okay. Let's begin. What is a web-based business? Okay, let's start with that. Basically, any business that operates on the web is a web-based business. Virtually, I would say most businesses that you encounter today are web-based businesses, but a brick-and-mortar business that just has a website and derives less than 10% to 15% of its income from web-based activities, I do not consider a web-based business.
A web-based business is a company that primarily generates its income from web-based activities, either a website or from social media or from some other venue. There are four components to a web-based business. Generally, the web-based business has one or more websites that operate on one or more domain names, and domain names are called URL. That is the dot-com address. Www.cliffennico.com, that is my domain name, from my law firm website. But these days a website, up until around the year 2000, that is all that a web-based business did, was operate from one or more websites.
But since 2000, we've had an explosion of other ways that web-based businesses can make money online. Many web-based businesses have social media accounts, they have pages on Twitter, Facebook, Instagram, all the major social media websites. Also, if they're engaged in e-commerce, they probably have accounts on one of the major e-commerce platforms, which is eBay, Amazon, Etsy. Shopify is another one, and these accounts can create special difficulties when you're looking to and sell a web-based business, and we'll talk about those later on in the program.
Last but not least, a web-based business usually has one or more payment accounts with one of the various online payment providers, PayPal, Venmo, Alipay, there's a new one called Stripe.com, like a tiger stripes.com. These accounts are not part of the website, but they're very important because they generate the revenue of the web-based business. These are the four basic components, and it's important to know them all because when you buy or sell a web-based business, all of these things have to transfer over to the buyer. I'm going to use a very homely analogy here.
As I said, I've done a lot of these deals. Many of you remember doing jigsaw puzzles. When you were a kid, if it was a rainy Saturday or a Sunday, you got a bunch of your friends, you went over to somebody's house and you put these things together on the kitchen table, and soon or later, mom wanted to start working on dinner, so you had to move the jigsaw puzzle to someplace else when it was 80%, 90% complete. Of course, when you try to move a jigsaw puzzle from one place to another, what happens? A lot of the pieces fall off. It's a homely analogy, but it's the best one I've ever around for dealing with a web-based business sale.
To some extent, all businesses are this way, but web-based businesses specifically are a collection of puzzle pieces. They're a jigsaw puzzle, and many of the puzzle pieces are connections to other websites. These are things that are not self-contained within the web domain name. These are things that operate by contract with other people. The e-commerce accounts, the payments accounts. A web-based business is a web, if you will, of contacts and connections with other websites. In moving these things from one place to another, it's very easy for some of these things to get lost.
Counsel, when you're dealing with a deal like this, you have to be very mindful of all these puzzle pieces, and the goal is to keep the number of lost pieces at a minimum. The goal is to get as much of the jigsaw puzzle to the new location while losing as few pieces as possible and making sure that the pieces that are lost are not the important ones that drive the business. That's one thing, that's just a very homely analogy for those of you who are trying to look at this from 5,000 feet up. The key question here, whenever you're doing a web-based sale, web-based businesses are not for everyone.
You have to ask, does the buyer have adequate search engine optimization, web marketing skills? Web-based businesses are not passive. You don't just load up a website and watch while the money comes in. There's very active management required. Basically, the site, the business has to be tweaked on virtually a daily basis to ensure that it maintains its search engine rankings on the various search engines, such as Google. It requires a certain knowledge base in web marketing and web advertising. I've done a number of deals where the buyer did not come from that background and figured they could learn on the job, and it has almost always ended in disaster.
If you are representing a buyer of a web-based business, somebody buying a web-based business, and you do not feel that they have adequate SEO or web marketing talents, the very first thing you need to do is to help find someone who can help keep this business alive and on life support, and in the top 10% of Google rankings, or else it will fail. It is almost a certainty. Okay. This is a lesson that I've learned. It really applies to buying and selling any business. But it really applies in a big way when you buy and sell a web-based business.
Whenever a client is buying or selling a web-based business, I don't worry so much about the seller or the buyer. As long as they communicate well, things will usually go smoothly. What I do worry about are third parties over whom the parties have no control because they are not as incentivized to do the deal as the seller and buyer, and may pose problems during the negotiations. As long as the seller and buyer communicate, things will go very smoothly between them. It's the third parties over whom nobody has any control that may pose problems down the road, especially if key assets are held in their names.
Now, a web-based business, like I said, is like a jigsaw puzzle and there are usually lots of third parties. Here are some of the typical third parties in a website sale. Domain registrars and website hosts. They are different. The domain registrar is where the URL is registered. The website host is the place where the website actually lives, where the servers are, where the website lives. It's the company that hosts those servers. Of course, hopefully, there may be more than one server, obviously, because you want to try to have redundancy. You don't want everything in one server.
Advertisers, companies that advertise. If it's a content-driven website, they probably make their revenue by advertising. Contracts with advertisers become very important. Content providers. If it's a content-rich site, a lot of the content is going to be provided by employees, independent contractors, other people. If those people have not assigned all their rights to the website owner, those third parties own the content. If you're selling a review site, for example, where most of the reviews are done by third party reviewers, there has to be assignment of rights contracts with each one of those third party providers.
Otherwise, you might sell the website and lose a key reviewer that maybe has a huge following on social media. That has happened to some of my clients. E-commerce platforms, eBay, Amazon, Etsy. Again, these are very difficult to transfer. We're going to spend a lot of time talking about these because it's where a lot of people think that by building a successful on Amazon, they can just sell it at will to somebody else, and it's not quite that simple. Affiliates. A lot of e-commerce sites have affiliate programs, and hopefully they're managed by third parties, but a lot of smaller websites do them themselves.
Those affiliates relationships and contracts have to be transferred over to the buyer. If an affiliate doesn't get their month royalty on time, even if it's just a few pennies, they raise holy hell with the website owner. Generally speaking, what makes this difficult, there typically are not written contracts with these people like we lawyers are used to. A lot of times, these are just handshake agreements or a clickwrap agree at some point that they signed. But nobody of course saves a copy of the clickwrap contracts that they signed.
Do you have a copy of the contract that you signed with Amazon when you first opened your account? Of course not. You can look up their users agreement online, but that's the best you can do. Counsel may have to create these as part of the representation, especially with third party content providers. If your website has third party content providers, I guarantee there are no written contracts in place with those people. You will have to create a template and get the client to get as many of them as possible. Again, the goal here is not 100%. The goal is to get as much of the jigsaw puzzle over to the buyer as possible while losing only a handful of non-essential puzzle pieces.
Okay. That's the big picture. Now, let's start walking through the sale process. These are some of the things you have to do before the sale. Okay? Now, some of you are representing sellers, some of you are representing buyers, so I'm going to try to have something in here for everybody. Let's talk about prepping the seller first. Let's say you're representing the seller of a web-based business. You should really think about why are they selling? There are right reasons and wrong reasons to sell a web-based business. Here are some of the right reasons. The seller's ready to retire, the kids don't want the business.
It was a hobby for the person, so he just wants to get some money and retire in Florida. That's a perfectly valid reason. The business's revenue profits are at an all-time high or have been relatively steady over time. I call this the Seinfeld approach. The TV comedy, Seinfeld, which ran during the 1990s was probably the most popular program ever in television history. Jerry Seinfeld and Larry David, the people who created that show, decided to end the show at a all-time high because they just felt that at this point, they couldn't do any better, and that by continuing the show, it was only going to be ...
The novelty had worn off and they were afraid that the viewership was going to be steadily going down over time and they didn't want to be involved in that. They figured, "Hey, we built the best TV show in history. Let's end it while it's at an all-time high." There's a lot to be said for that kind of an approach. Also too, especially because web-based businesses tend to be extremely volatile, today's high flying hit website, maybe tomorrow's has been failure. Sometimes the best thing is to get out while the getting is good. The market for the type of business is hot. That's a good reason for selling out.
Then [inaudible 00:12:52] you're receiving inquiries from buyers with money. If people are calling the client and offering to buy the website, that's probably a good sign that the website is sellable and that they should sell. But there are some wrong reasons to sell as well. Perhaps the business has been hit hard by COVID-19 and numbers are down. That's not really that true of web-based businesses. If anything, web-based businesses benefited from the COVID-19 pandemic and related government shutdowns in 2020. But there are some that may have been, especially in service businesses.
Your revenues and profits have been declining steadily over time. If your revenue and profits are declining steadily over time, you're much more likely to get a fire sale price, and that's about it. You need to sell to pay the business's debts. If the wolf is beating down your door at this point, it's not a great time to sell. A, you're going to get a fire sale price, and B, you might not be able to pay all your debts with the proceeds of the sale. Google Dance is coming. This is a big issue with web-based businesses.
Your business may have a Google ranking in the top 10% today. But every once in a while, Google changes its algorithms, and nobody really knows how they do it, and they never give warning when they do it. One day you're top 10%, the next thing your number 3,287,489 on the Google rankings, and you wonder how the heck did that happen? The answer is Google changed its algorithm and you have to work hard to get your SEO back up into the top 10% again. This is why I say the buyer of a web-based business has to be familiar or have someone on their team who is familiar with search engine optimization and web marketing.
If they do not have that experience, it is the first step on the road to disaster. Google Dances happen. When they happen, the team has to be prepared to move quickly and get these search engine rankings back up again, and they can't do it if they don't have the relevant experience. A big competitor is muscling their way in. Amazon has decided that they want to get into your line of business. Now, that is the wrong reason to sell. Then last but not least, the seller is personally burned out and will sell to anyone with a pulse. Generally speaking, the best time to sell is when the business is doing well and the seller really feels that the business has value.
Okay. Now let's shift over to the buyer's side. Here's some of the tricks to think about when prepping the buyer. Again, the key question, does the buyer have the necessary SEO and web marketing skills to keep the business going? I cannot stress this strongly enough. If not, they will be heavily reliant on the seller's employees, which is okay as long as they're going to stay on board. But a lot of employees, especially in small, closely held web companies, they get like family. Daddy sells out, all of a sudden, they don't really want to work for this total stranger who's buying into the business.
They'd rather go elsewhere, and since all the relationships are virtual, it's very easy for them to snap on and snap off. You have to spend a lot of time making sure that the key employees, especially the web marketing people, stay on board. Can the buyer do a better job growing the business than the seller can? Does he have better experience or she have better experience? Does the buyer care about the business's customers and does the buyer share the culture of the business? These are intangibles. But you're going to find that like any business, web-based businesses have certain culture.
Auto companies, for example, websites that deal with auto related issues, tend to be very masculine, macho, Y chromosome, towel-snapping kind of places. They just tend to be that way. Whereas certain other sites, like many female friendly e-commerce businesses that sell things on Etsy, that's much of a more female handy craft type of a culture. Some people think it's a little bit of a counterculture type of thing. It really helps if the buyer gets the customers and gets the culture of the business. That's true of any business sale, but it's especially true of web-based businesses.
A lot of the time you're dealing with niche markets here, and it's very important to understand that niche. The buyer's temperament and lifestyle. Beware the absentee owner sales pitch. Sooner or later, especially if you're dealing with a broker, they're going to try to say, "Oh, you can just buy the business and it runs itself. All you got to do is stay on top of the rankings every once in a while and make sure they haven't slipped too far." Never, ever buy onto that. Web-based businesses are hands on 24/7. You have to change things every ... Customers want to know what's new? What's changed today?
I understand that over a million new listings are posted on eBay every day, thousands every hour. This is the kind of thing that's going on. While you can automate a lot of it, you can't automate everything. Is the buyer comfortable with selling? Are they comfortable with marketing? There are a lot of people that want to buy these businesses that are more oriented on the tech side, which is great. They understand the technology, but you also have to know how to sell stuff too. I have a great YouTube video. For those of you who are interested, I do have a YouTube channel.
If you go to youtube.com and search for Cliff Ennico, you'll see I've got 52 videos up there. Each one's about an hour long on different aspects of running a small business or an entrepreneurial startup. These do not qualify for MCLE credits, I have to say that. This program you're listening to now does, but my YouTube stuff doesn't. The one you want to search for is one call Cliff Ennico, How to Sell. This is a video I recorded in 2015. It has over 300,000 views from people in over 85 countries around the globe. I think I did a pretty good job with this. It's absolutely free, it'll take an hour out of your life, and it'll give you a perspective on selling that I guarantee you will not find anywhere else.
Okay. Last but not least, consider the buyer's resources. A lot of buyers like to finance these transactions with SBA loans. SBA loans at the end of the day are second mortgage loans. Yes, they're taking a lien on the business assets, but they're also going to take a second mortgage on the buyer's home. Is the buyer and their spouse comfortable with that process? Also too, SBA loans must be personally guaranteed by the individual owners of the buyer. You're putting all your assets on the line to buy this web-based business. It sure as heck better succeed, or else you're not only going to be without a business, you're going to be homeless.
That's a conversation you have to have with a buyer, especially the buyer that is really relying on SBA financing to make the deal happen. How do you find the right seller or the right buyer? How do these people find each other? Well, there are published sources. But again, the best business for sale are the ones the sellers aren't thinking about selling yet. Business brokers tend to be a last resort in this world. There are brokers out there that specialize in web-based businesses. There are several. The two largest, there's a company up in Boston called FE international. I'll give you the website here.
The other is a company based in Florida called Website Closers. They're down in Florida. There are brokers, but the brokers tend to be the last resort for sellers. If you are a fan of a particular niche website, say a review site, and you rely on this for reviews of auto parts or something like that, and you're really fond of the site and you really think it's a great site, there is nothing wrong with sending an email to the owner saying, "Hey, by the way, I've always wanted to get into this business. Are you thinking of selling? If so, I might be interested." All they can do is say no.
Those are sometimes the best businesses for sale because the sellers aren't thinking about selling yet. They're not a death's door yet. Whenever a client is looking to buy a business that was referred by a broker, I always have to do a lot more diligence to figure out what's the real reason they're selling? Why is a broker getting involved here? Why is the seller willing to part with 10% or more of the purchase price to have a broker involved? These are usually dogs that have lots of fleas on them, and I'm just suspicious by nature.
Consider asking around. If you have a SCORE chapter, that's a federal government volunteer program that's run by the SBA, the Small Business Administration, these people go and give a lot of free advice to startup businesses. They might know of some small websites, especially in your area, that might be up for sale. Maybe accountants and lawyers that do a lot of work in the internet. But generally speaking, accountants and lawyers are very reluctant to refer their clients because they don't know you. The best bet is just a search online, find a business that you like and consider making them an offer, or check the listings of some of the bigger website business brokers.
But be sure to look for brokers who specialize in web-based businesses. Okay. A seller and buyer find each other, now we have to negotiate the purchase price. Okay? Here are the steps involved. What you generally do, whenever a buyer and seller hookup, the first thing that they do is they prepare a non-binding letter of intent, an LOI. In some parts of the country, these are called memoranda of understanding, MOUs. Same thing. It's a non-binding term sheet. There's no legal language in there, but it sets out all of the business terms of the deal.
What the purchase price is going to be, how the purchase price is going to be paid. Is the seller going to take back a note? If so, what are the note terms going to be? When is the closing going to take place? It saves a lot of money in legal fees later on. The more detailed and LOI you can do at the beginning of a transaction, the smoother things will go and the lower the legal fees would be. If I have to be drafting legal documents and negotiating the business deal at the same time, that's going to be a big bill. There's going to be lots of drafts flying back and forth, several versions on each day, and that can rack up a big legal fee in no time.
By getting the business details nailed down in front, you save a lot of money when the actual legal documents are done later on. Generally, the purchase price will be a multiple of average sales or pre-tax earnings. Generally, I don't like deals where the price is based on last year's revenue or profits. I like to look back three to five years, especially now. If you're looking to buy a business and you're just looking at 2020 results, a lot of those 2020 results are not going to be all that great. By looking back three to five years, you get a better sense of how the business performs in both good times and bad times, and you tend to get a more realistic figure of what the business is worth.
Look for non-recurring and extraordinary income and expenses, things that happened just once. They sold a key asset or somebody left or something like that. Back those out of the calculation. The one reason to use a business or a website broker is that they can give you very good idea of what other similar businesses have sold for, what other comparable businesses have sold for, which will make it easier to get the right purchase price the first time. One question you always need to ask a seller, what is their owner's discretionary income? How much money are they taking out of the business?
Because that's a key thing. In accounting terms, it's called free cash flow. I like to call it owner's discretionary income. Generally speaking, most buyers will want the ODI to cover the purchase price in one to three years. If a business is up for sale for $250,000, but the ODI is only $25,000, it's going to take 10 years for the ODI to cover the purchase price, and that's not going to be real attractive to a buyer. They're going to want to see that ODI covering it in one to three years. How do you find the right multiple? Well, again, if you're using a broker, they will help you find the multiple. They'll figure what comparables are out there, other comparable businesses that have sold.
Generally speaking, though, if sales and profits are growing, the multiple will be a high one. It will be somewhere between two to five times trailing revenue or trailing profits. If sales and profits are steady or declining or the business is facing some competitive or technology challenges, then the multiple's going to be much lower. It's only going to be one to two times revenue or profits. Remember, it's a business, not a baby. If you are the seller or representing the seller, prepare your client for some disappointment because you will never get an offer for what the seller really thinks the business is worth.
Okay. How do you structure the deal? Well, there's two ways of structuring any kind of a business purchase or sale. You either sell the assets of the business or you sell the stock, or if it's an LLC, the membership interests in the business. Generally speaking, selling assets is good for buyers and bad for sellers. Buyers will always insist on an asset sale. The buyer assumes only those liabilities they wish to assume, and that's it. The seller is stuck with the rest of them. That's one big thing. If you're buying a business and there's some unsavory liabilities there, the buyer can leave those with the seller and cherry pick only the good ones that they want. That's a big advantage to buying assets.
The buyer gets a step up in basis for the assets, meaning lower taxes when the buyer resells the business later on. That's another major advantage of selling assets. But for the seller, it's not all that great. Especially if the business is a seed corporation, the proceeds of the sale get taxed twice. It gets twice at the closing when the seller receives the proceeds of sale and then when the company later liquidates and distributes the proceeds to the shareholders, it gets taxed again at the shareholder's marginal tax rate. It's not very attractive to a seller.
Also, in a lot of these deals, the seller has a post-closing employment or consulting agreement with the buyer, and those are taxed at ordinary income, which is a very unfavorable tax treatment. Right now the current federal ordinary income tax rate is around 40% for high income tax payers. Whereas long term capital gains rates are only 15% or something like that. It's a major difference. If the business is an LLC or an S corporation, well, there's no double taxation there for the seller. But there will be depreciation recapture, which if the business has a lot of assets, can really eat into the sale proceeds.
Also, in an asset sale, the corporation and LLC, the seller's company, remains in business. It will have winding up costs, accounting, legal, whatever, to keep it on life support. That's selling assets. Now, selling stock is just the opposite. It's good for sellers, bad for buyers. The buyer assumes all assets and liabilities of the business, the entire balance sheet, including ones that they didn't know about, when the seller is off the hook, once the deal closes, everything becomes the buyer's headache that happens thereafter. The buyer gets only a carryover basis in the assets.
They get the same basis for tax purposes as the seller did. If the seller was the person who started the business, the basis is going to be zero, which means that when the buyer goes to resell the business later on, they're going to have to pay taxes on virtually the entire fair market value of the business assets. But there are good news aspects too to a stock sale. All the EINs and bank accounts remain the same. In an asset sale, you have to start a new company, so all the EINs, bank accounts start from scratch. If there's a strong credit history with this company, a stock sale's the better way to go because the buyer gets the benefit of that positive credit history, the FICO scores and all that.
Another benefit for the seller is that the seller's income is the difference between the purchase price and its basis in the shares, and usually in a stock sale, it's taxed at favorable long term capital rates. Okay? But the last thing is, and this is one of the most important thing, if a web-based business has a license, an account or another asset that cannot be legally transferred, it may be the only way the deal can be structured. In an asset sale, the asset would have to be transferred. If the asset is of such a nature that it cannot be transferred ...
In a brick-and-mortar world, a liquor license is the classic example. In the brick-and-mortar world, most liquor licenses in most states cannot be transferred. The buyer has to get a whole new liquor license on their own. In the web-based world, the eBay and Amazon accounts are very difficult to transfer. If an Amazon business is being sold, where Amazon account accounts for 90% or more of the business's revenue or income, you may have to consider selling the stock in that business rather than assets to avoid losing the benefit of that e-commerce account. We'll talk a bit more about that later on.
Okay. Those are the preliminary negotiations. Now, let's talk about the purchase and sale agreement, the contract of sale, and how that looks different for a web-based business than it does for a business in the brick-and-mortar world. First of all, who should draft the documents? Okay? In a business sale, the party whose attorney is drafting the documents almost always has the higher legal bill. Okay. That is Cliff Ennico's rigid and inflexible rule. In most acquisitions, the buyer's attorney drafts the documents. But if the buyer's attorney isn't familiar with business sales and drafts the documents, the documents are going to be garbage, and the seller's attorney may incur higher fees cleaning up the mess.
Whenever I'm called upon to represent a seller, one of the first questions the seller asks me is, "Cliff, now the buyer's going to draft the documents. That means your fee is going to be lower, right? Because you don't have the drafting responsibility." Well, the short answer is maybe so, maybe no, it all depends on how familiar the buyer's attorney is with these kinds of deals. If they're not, if they're real estate attorneys who've never done a business sale and the documents come in looking like garbage, I'm going to actually spend more money trying to get those documents up to standard than I would if I had drafted them from scratch.
Okay. Also, keep in mind that if the buyer drafts the documents, the documents are going to be drafted in the buyer's favor, the seller is going to have to fight an uphill battle to get any sort of concessions out of the buyer. Again, that's going to end up spending more time. Generally speaking, like I said, the attorney who's drafting the documents runs up the higher legal bills, but that's not always the case. Okay. Now, let's start walking through the purchase agreement, whether it's an asset purchase or a stock sale deal.
Okay. The first thing you have to do is you have describe the assets being sold, especially in an asset sale deal. Now, for a web-based business, this is going to include all of the seller's URLs, including all of the domain name extensions. For example, the seller may be operating at whatever.com, but the seller may also own whatever.net, whatever.org, whatever.info. All of those sellers URLs that relate to that business or that trade name should be transferred over to the buyer.
Now, if the seller has multiple businesses, which is very common, by the way, in the web world, very often the seller of a web-based business has several businesses going and he or she is only selling one of those businesses, then in that case, there has to be a specific provision in the agreement where the seller excludes all the other domain names in the sale. In other words, the seller will say, "I'm only selling the URLs relating to this business, which are A, B, C, D E. All other domain names that I may own are excluded from the sale." That has to be very carefully spelled out. The domain name registration and hosting accounts.
Like I said earlier, the domain name registrar and the web host may be two different entities. A lot of the times, they're not. A lot of more recent websites do everything on GoDaddy, which is both a web registrar and a web hosting service. But there are a lot of web-based companies out there where the host is different than the domain name registrar. If the hosting service is a mom-and-pop operation, there may be some resistance to transferring that hosting relationship over to a new buyer that doesn't have the credit history with the host that the seller does.
E-commerce accounts, eBay, Amazon. Payment accounts, PayPal, Venmo, Stripe, everything should be spelled out in section one of the agreement that describes the assets that are being sold in the asset sale. Transferring email accounts. This is a major issue for sellers when selling a web-based business. It's funny to talk about, but it isn't so funny when it arises in practice. Many website owners combine their business email with their personal email. A lot of business owners who are [email protected], that is not only the business email, that is also their personal email where they talk about all their personal stuff.
What you have to do with the seller's you have to sit them down and say, "Look, sometime between now and closing, keep in mind that when you sell the domain name, all of the email accounts that are attached to that domain name are going to go over to the buyer. You're not going to have them anymore. If you've got personal stuff tied to any of those email addresses, you got to go through each one of those accounts and purge them, move them, forward them to a personal email account, a Gmail, a Hotmail, a Yahoo account, something like that, and make sure that they are purged. Otherwise, the buyer is going to see all of those emails, including all of the emails between the two of us, between you and your client."
Be very careful. If you are communicating with your client via an email address that is tied to the domain name that is being sold, all those emails are going to be visible to the buyer after the closing, and there goes the attorney-client privilege between you and your client. The first thing that I do when a client is selling a web-based business, I insist that all communications happen with via a personal email account, a Gmail, a Hotmail, a Yahoo account, something like that. We never use the business email address for lawyer-client communications. That's an ethical point you need to be aware of.
Okay, the website content all needs to transfer over. Again, if there are third party creators or providers, have they signed assignment of rights agreements with the seller? Since virtually all creators and providers of content are independent contractors, the law says that they own the copyright to everything that they do for a web-based business client, unless that copyright is assigned to the client at some point. If you've got a review site, for example, with 50 content reviewers, and they're all independent contractors, these people all have to sign assignment of rights agreements. Another question you have to ask about assets, have any of the domain names been trademarked? Okay?
If any of the domain names have been trademarked, then in addition to all of the web transfer documents, you're going to have to do an assignment of trademark and file it with the United States Trademark Office at the closing. It's a very simple process, and you can file it electronically now at the uspto.gov site, but it's a thing you have to do. Transferring the domain name will not transfer a separately registered trademark. All the contracts with advertisers, suppliers, third party software license source, key personnel, these are all of the puzzle pieces that have to transfer over. Otherwise, the jigsaw puzzle will not make sense.
The last thing you need to do in describing the assets is we have to set a time when the revenue is going to transfer. Unlike many businesses, sales are going to be going on even while the closing is taking place. It's not like a brick-and-mortar business where the seller can shut down for 24 hours and the sale happens when the store is closed, so there's no revenue on that day. Web-based businesses, there's revenue going on even while the closing and sales are being made, even while the closing is going on. The custom is to set the time of day at which point any revenue that comes in belongs to the buyer.
Up to that moment in time, any revenue coming in belongs to the seller, any revenue that comes in after that time of day belongs to the buyer. Okay. That's section one. Now let's talk about section two, the purchase price and payment. How is this all going to be handled? Well, generally in most website transfers, there is an upfront deposit, which is 5% to 10% of the purchase price, and that's usually held either by the broker, if there is one, or otherwise by the seller's attorney. The rest of the purchase price will be either cash paid at closing or a promissory note to the seller or some combination thereof.
A very typical purchase price section will say 10% is a deposit which will be released to the seller at closing. The remaining 90% will be paid so much by cash paid at the closing and so much by a promissory note, and the balance will be paid from the proceeds of the buyer's SBA financing. Those are the four common ways in which the seller gets paid at the closing. Now, in web-based business sales, there are frequently holdbacks and earnouts. These are two very, very different things. In a holdback, the buyer holds back a portion of the purchase price for a period of time. It's usually 90 to 180 days.
If the website revenue drops significantly during that period of time, they get to keep part of the purchase price as payment for that. The seller does not get the full benefit of the purchase price at that point. An earnout is something different. An earnout is where the purchase price is paid partly in cash at the closing, but then there are going to be payments going forward based on the future revenue and profits of the business, which may exceed the amount of the purchase price that's stated in the purchase contract. Those are two different things. Those should clearly be spelled out in the purchase price section of the agreement.
The allocation of purchase price for income tax purposes. The IRS requires that when a business is sold, whether it's brick-and-mortar or web-based, the seller and the buyer have to allocate the purchase price to various asset categories for income tax purpose. If the purchase price is $200,000, the allocation section will say, well, 50% for equipment, 40% for inventory, and the balance for goodwill. That has to be done, and the seller and buyer must agree on that allocation and make sure they tell the IRS the same story when they file their tax return the following year.
Otherwise, if the seller and buyer allocate the purchase price in different ways, then everybody gets audited. That is an audit trigger for the IRS. Then finally, the purchase price section should describe any adjustments that are going to take place for prepaid expenses and prepaid income. For example, prepaid income, if any of the seller's customers have prepaid for goods or services that the buyer is going to have to provide after the closing, that amount is normally credited to the buyer. Likewise, if there were prepaid expenses, if the seller has paid for a year in advance, a subscription to a publication, for example, and the buyer's going to get part of the year's benefit of that, that is normally handled as a credit to the seller.
Should the seller take back paperwork? Generally speaking, if the seller is going to take back a note for a portion of the purchase price, it's generally a two to three year maturity period. Right now commercial interest rates are somewhere between 6% and 8% per anum. It may be slightly higher or lower when you are listening to this program. But right now that's about where they are. Be aware of SBA loans. The SBA has very strict rules about SBA loans and seller financing in SBA loans. If the buyer is using SBA financing, the seller will need to subordinate its lien to the buyer's bank. That's okay.
But the SBA is going to require them to stand by at least five to 10 years. That means they have a note, but they don't get any payments until the SBA loan is paid in full. Now, if the seller is over 60 years of age, if you are representing the seller, you have to push back on this. There's no way a seller should have to wait five or 10 years to get paid. By that point, the business may be underground. Things on the internet change very, very rapidly, and it may well be that in five or 10 years, this bill, this business is obsolete. You can't give it away. In a situation like that, a five to 10 year note doesn't work.
I'm that way when I go to the local wine store now. I'm getting up in my 60s here. I used to buy a lot of wine where you can't drink it for three or four years, and sell it for three or four years, best drinkable in five. I don't buy that wine anymore at my stage of life. I want to buy the wine that's drinkable as you leave the store. That's what I'm looking for now. It's the same when you're selling a business. The seller should insist on getting a lien on the business assets and a personal guarantee from the business's owners. Generally the buyer in a web-based business is a company that's been newly formed.
It has no credit history, it has no cash on hand. You got to get a personal guarantee from the buyer if you're taking back paper. Talking about holdbacks now, and we talked about this a little bit earlier, but it's important to talk about it again because they're so common in these deals. A holdback is where a portion of the purchase price is held back and reduces the purchase price if the revenue or profits of the business declines by more than 5% to 10% during that period of time, which is usually 90 day to 180 days. Well, what if the buyer is incompetent and just runs the business into the ground?
That creates a horror for the seller. The seller doesn't want to face a holdback in a situation where he or she had no influence over how the business performed. Generally speaking, holdback provisions need to be very carefully thought through. Consider limiting reductions in the holdback amount to circumstances that are beyond the seller's reasonable control, for example, a Google Dance, or requiring the buyer ... I've done deals like this too, where the buyer has to maintain at least the same level of spending on marketing that the seller did during the 90 to 180 day period.
He can't just cut back on marketing and watch the business decline and then get the benefit of that. "Well, gee, I'm not going to be able to pay the holdback amount because the business declined 10%. Well, I didn't do any advertising and that's why it declined." Sellers are not going to be happy with that kind of conversation. Also, if there are contingent payments, earnins ... These are called earnins or earnouts. But basically, it's a situation where the purchase price, in addition to what the seller gets at closing, the seller gets periodic payments based on any increase in revenue or profits that take place after the closing.
Basically it allows the seller to participate in the growth of the business. We sometimes call these equity kickers. They are scaled to the growth in revenue and profits after the date of closing. Generally speaking, when you're doing an earnout or an equity kicker, you usually base it as a percentage of revenue because revenue is much easier to audit you. Either the buyer sold something or he didn't. If you base the earnout on the profits of the business, well, there are a lot of ways that a buyer can monkey with that. They can basically reduce salary or they can increase it.
They can hire five new people or pay themselves a year-end bonus, which would reduce the taxable profit of the business and reduce the seller's payout. If you are going to base an earnout on profit, then there has to be an attachment to the agreement which spells out exactly how that profit is going to be calculated, that the seller can rely on for his or her payment. I wouldn't close a deal otherwise. The seller should require periodic financial statements from the buyer, make sure they have audit rights so they can look at the buyer's books every once in a while and make sure they're not screwing around.
They should also consider becoming a consultant to the buyer and get paid during the earnout period so that they can keep on top of the business. Whenever a seller is taking an earnout payment or any kind of contingent payment, I always ... I'm reminded of Mark Twain's famous quote, "Put all your eggs in one basket, but then watch that basket." That's not a deal where you can walk away, retire to Florida and wait for the checks to arrive in the mail. If you're taking an earnout, you got to stay on top of that, of what the buyer is doing during the earnout period, or else the earnout will not happen.
Okay. The next section we're going to talk about is describing the closing timetable. Never believe any SBA lender who says that they can close an SBA loan in 30 days. That is a sales pitch and is probably fraudulent. In my experience, it takes generally 90 to 180 days to close an SBA loan after the initial application is filed. If you're doing the purchase agreement, make sure you give at least that amount of time for the buyer to get financing. Consider putting in a provision that the closing date will automatically be extended if the seller is having trouble getting the financing or if it's necessary to transfer e-commerce or payment accounts.
Also too, if the buyer is using SBA financing, you need to ask the lender if you are going to be the SBA's closing agent or some other attorney is going to be doing that for the lender. Some lenders have staff attorneys that act as the closing agent. The good news is if you're the closing agent, you get an additional $2,000 legal fee. The bad news is you'll basically work a 14-hour day trying to close the SBA loan and the deal with the seller at the same time. Okay. Conditions for closing. Okay. Obviously, in any acquisition, the buyer has a due diligence period where they can due diligence on the seller.
There's usually a financing contingency. If the buyer cannot come up with the SBA loan proceeds on time, the deal falls apart. Generally speaking, there is a period which can either be pre-closing or post-closing for the transition and migration of key accounts. It's better to do it pre-closing if you can. For example, if there's an eBay account that accounts for 90% of the business's revenue, you want to make sure that account transfers to the buyer before the closing. If you do, you got to work out some language in there that says who keeps the revenue from the business if the transfer actually completes pre-closing?
That could be a condition of closing. It could also be part of a holdback too, a post-closing. You could say that we're going to close the deal today, but then no money changes hands for 90 days while the key accounts transfer over to the buyer. When the buyer is satisfied that the accounts have transferred over, the money will be released at that time. That's another very common way to handle that. Making sure you get consensus of third parties under assigned contracts. I've given you some very specific language here on what the seller needs to provide the buyer in order that they can run the website properly.
Rather than get into it, on this program, I've given you the language and the slide that I use in my standard form. You see all the technical stuff, all the web documentation. In some cases, the buyer will ask the seller to provide a list, an employee manual for the technical employees and what they do each day. They require the seller to commit to writing all the protocols that they expect the employees to follow when keeping the website up to date each day. I've done that in some of my deals. Also too, keep in mind that in some states you may have to get a tax clearance.
If the seller is an e-commerce business and has been paying sales taxes in many states, you got to get a clearance letter. Otherwise, the buyer will be responsible for any sales taxes that the seller failed to pay prior to the closing. Okay, now let's talk about e-commerce accounts. We've referred to this several times during the program, but I want to really nail this here. eBay, Amazon and Etsy accounts are very difficult to transfer. If you look at the user's agreements for all three of these platforms, they will say that they will allow accounts and user IDs to be transferred.
But if you do, you lose all of your customer feedback and reviews. The dial is reset at zero for the buyer going forward. For example, on eBay, the buyer would acquire the seller's user ID, but the feedback score, which may be in the hundreds of thousands, would reset to zero and the buyer would be starting out as if they just were selling on eBay for the very first time. That is a very unfair result for the buyer. A number of attorneys and scholars have been pushing eBay and Amazon and Etsy to change these rules, to make it easier because otherwise it becomes impossible to transfer goodwill of a business in an asset sale.
If a business is an Amazon third party seller business, well then the only remaining ... You can't transfer the goodwill of the business, the name and the reputation on Amazon, well then the only asset left over is the inventory, which isn't really worth very much. Amazon recently amended its rules to allow seller account transfers, but you got to deal with an Amazon representative and have them approve the transfer, which takes time. Gradually, I think eBay and Etsy will go over to that, but they haven't as yet. It takes a while to get these accounts transferred over properly.
Venmo, Stripe, the online payment services. Generally the more recent formed ones, like Venmo and Stripe, generally allow transfer of the account upon notice to the platform. But PayPal can be difficult. You can get their approval for a transfer, but it generally takes about 30 to 60 days to get approval. If this is going to be an issue, if a site has to transfer on short notice, then it may be better to transfer the stock of the business rather than the assets of the business. This is an example of what I said before, where if a company has an asset that's difficult to transfer, the stock sale may be the only way that you can get the business sold.
It may be possible to transfer that, but the purchaser will be tax disadvantaged and they may be assuming undisclosed liabilities of the seller. Now, there is a little trick. If the seller is a sole proprietor, they have a single member LLC or other entity that is disregarded for tax purposes, there's a little trick where you may be able to sell the stock of the business, transfer all the e-commerce accounts smoothly, and then have it treated as an asset sale for tax purposes, which benefits the buyer. If you look at the notes section of this slide, you'll see that I've given you a link to an article by a scholar who describes how you can do that. Okay?
Now, if the e-commerce accounts don't transfer by closing, well then there has to be a holdback or another penalty if the key account either doesn't transfer or it transfers and you lose all your feedback and all your positive reviews and all the goodwill benefits of the business. Generally speaking, in that situation, you set a transition and migration period, which is usually 90 to 180 days after the closing, during which the purchase price is held in escrow, either with the seller's attorney or with an escrow agent. Okay.
The representations and warranties in the purchase and sale agreement look very different for a web-based business than they do for a brick-and-mortar business. For example, there are specific representations regarding website revenue, website expenses, and visitor activity. Generally, what I do in my deals is I actually attach a schedule with screenshots of the seller's monthly Google Analytics reports for the last two years. I actually attach that to the document saying, where the seller says, "Now, I represent and warrant that everything on this schedule blop is accurate and it's screenshots of all their Google Analytics reports for the last two years."'
I've given you the language in this slide that I use in my master document. It's always a good idea, especially if the seller is operating multiple businesses, that he has not created or reserved a domain name that is confusingly similar to the domains that are being sold. Another important representation and warranty that you will not see in a brick-and-mortar deal is that the seller has complied with all applicable data privacy laws and its own privacy policies on the websites that are being sold. If the seller has significant European activity, this may mean that the seller is warranting that he or she is in compliance with all 90 provisions of the GDPR, the European Commission's Data Privacy Regulation, which is extremely comprehensive.
The seller may be reluctant to do that. But if the seller has a significant European presence, it may be unavoidable. If the seller has a lot of advertising on the site, you need a specific warranty that the seller has complied with all truth and advertising laws and especially substantiation of claims laws. If the seller is selling nutritional supplements online and is saying that these things cure cancer, that does violate quite a few FTC and FDA regulations. Make sure that any seller advertising is not so outrageous that it would violate advertising laws. You need a representation that the seller is not responsible for a material adverse change in business due to changes in a platform's terms and policies.
If a Google Dance occurs two days before the closing, the purchaser cannot use that as an excuse to totally rewrite the deal. Now, that is a risk that both parties are taking, and it sometimes happens that there's a Google Dance or a material adverse change in a platform's policies a day or two before the closing. Obviously, the seller and buyer will cooperate in that instance, but you want to make sure that the seller doesn't breach his warranty because of something that is outside of his or her control. You need a representation or warranty that says that the websites have not been the subject of a security breach or hack.
I would make this to the best of seller's knowledge. You need a specific representation and warranty as to the seller's SEO practices. I've given you the language here on this slide that I use in my master documents, because it does get rather technical. Last but not least, if as is common a data room is used, where the seller and buyers set up a data room and share all of the due diligence information while the purchase and sale agreement is being negotiated, the buyer should specifically represent and warrant in their warranty section that they have knowledge that they are charged with knowledge of any matter in the data room.
That way, if there's a dispute after the closing as to whether the seller made a promise or something like that, if the matter was covered in any document in the data room, the buyer has to eat that. That's a very important provision. Data rooms are being used more and more commonly now in all M&A transactions for due diligence. The seller's attorney needs to be sure that the buyer can't come back and claim breach of representation or warranty when the matter was clearly disclosed in a document that was in the data room and they didn't read it.
Okay. There are other common provisions in a purchase and sale agreement. The seller's non-compete agreement. Like in any M&A deal, the seller will represent and warrant and will agree that they will not engage in a similar business for two to three years. In all of my seller non-compete clauses, if I'm representing the seller, I always make sure that the non-compete disappears if the buyer defaults on any of his payment obligations. I also feel very strongly that the seller should resist non-disparagement clauses. I'm seeing these more and more now in M&A deals, especially involving web-based businesses.
These are gag order provisions. It basically says that for a period of one to two years, the seller will not disparage the buyer or the business or any third party, in any form, manner or shape whoever. Let's face it. If the business goes downhill, customers are going to complain and some customers are going to complain to the seller because they knew the seller, they were friendly with the seller, and it would be very easy for the seller to say, "Yeah, I know I sold the business. It really sucks. The guy's really doing a horrible job." That is a breach of a non-disparagement clause, and it could cost the seller to lose any holdback amount or earnout contingent payment that may have been in the deal.
The buyer now has a gun pointed at the seller's head that they can use to whittle down the purchase price because the seller was knocking the buyer on his social media, Facebook page. Okay. If the seller is operating other web-based businesses, this is frequently the case, you may need a buyer non-compete as well. An agreement where the buyer says that he, she, or it will not compete with any of the other businesses the seller is operating. That the buyer can do whatever he wants with the business that they're acquiring, but they cannot do anything that would compete with any of the seller's other activities.
Then there's the usual indemnities by the seller. The seller normally indemnifies the buyer for anything that happens pre-closing. The buyer indemnifies the seller out for anything that happens post-closing. That's the same as in any other M&A deal. There's always a survival clause. This is a private statute of limitations that apply to any action for breaches of representation, warranty, or indemnity. The seller obviously wants these as short as possible. The buyer wants them as long as possible. There needs to be a clause that describes the seller's commitment during the transition period.
Generally, the seller provides informal consulting for 30 to 60 days after closing, and then charges an hourly rate thereafter. Then last but not least, dispute resolution. I tend to favor arbitration clauses in my agreement specifically for disputes relating to web traffic. If there's an earnout in a deal, for example, and there's a dispute about exactly how much the website traffic declined during the transition period, it's best handled by commercial arbitration with an arbitrator who is familiar with how web traffic works. A jury will not know how to analyze a Google Analytics report. That just won't happen.
Okay. We have decided that we are going to acquire or sell a web-based business, we've done all the preliminary negotiations, we have negotiated the purchase and sale agreement with a set closing date. Now we're at the closing, what happens? Well, the first thing we have to think about is the so-called transition and migration period. Now, as we've said, we've been talking about this throughout the program, but I want to make very clear how this works. Unlike the sale of a brick-and-mortar business, where almost all the assets are going to transfer simultaneously at the same time at the closing, you hand over bill of sale, the other side hands over cash, the sale of a web-based business is very, very different.
It takes time for these assets to transfer over. If you're transferring a domain name, you have to change the administrative contact information with both the registrar and the hosting service. They have to point the sites in different directions. That takes time. As we've seen, if you have eBay or other e-commerce accounts, Amazon, Etsy, you may have to get the consent of the platform to transfer the site, and that's not automatically given. It's going to take some time for that to happen. There's going to be a period of time where things are just unsettled and things are in transition, and we call that the transition and migration period.
It can be as short as 10 days, it can be as long as 30 or 45 days, whatever is in the contract. It can happen either before closing or after the closing. As we discussed earlier, you can have the transition and migration period as a condition of closing, where the deal doesn't close until all the assets have migrated over to the buyer. Obviously, if you are doing that, there has to be something in the contract that says when the seller gets revenue and when the buyer gets revenue, there has to some kind of a provision that says that even though the asset has transferred over, the seller is entitled to all website revenue until the actual closing date and closing time, at which time any revenue coming in after that belongs to the buyer.
But in most transactions, the transition and migration period occurs after closing. The seller does not want to part with any of these assets without knowing that the purchaser has the money in his hot little hands or her hot little hands. In these transactions, unlike normal transactions, normal sales of businesses, it's very common in web-based business deals to use an escrow agent. Escrow.com is the most commonly used agents in website transfers, although there are some law firms that provide this service as well. For example, there's a firm in Florida called e-commerce law group, Inc. in Florida.
This is their website that provides this service, and a growing number of law firms escrow service. But you have to ask exactly, whenever you're using an escrow agent, you have to ask yourself, what exactly is the escrow agent escrowing? There are some escrow agents like law firms that will only want to escrow the purchase price. At the closing, the purchase price, the purchaser wire the purchase price to the escrow agent, and then once the escrow agent confirms receipt of the money, the seller will authorize the transfer of the assets during the transition and migration period over to the buyer.
If all the assets don't transfer over by the end of the transition and migration period, well, there's usually a provision that says that it'll extend it for five or 10 days, but at some point the buyer will probably be allowed to hold back a portion of the purchase price to represent the assets, the puzzle pieces that did not come over to the buyer during the transition and migration period. But the better escrow agents, such as escrow.com, will put both the domains and the purchase price into escrow. The seller will actually transfer the domain names into the name of the escrow agent.
The escrow agent, then at the closing, collects the purchase price. When the escrow agent has the purchase price, it then gives the buyer new user names and passwords for the domains, which will enable the buyer to immediately transfer the domain names out of escrow and into their own name. If you can do it that way, it's usually more expensive to do it that way, but it's the better way to go because it creates a scenario where all the assets are transferring over at the same time, and there's no delay in transferring them over. The escrow agents usually charge a fee. It's generally between $1,000 and $5,000, and customarily the seller and buyer split it 50/50, although you can do it really any way you like.
It's one of the closing adjustments that you do on a closing statement, and we'll talk about that in a minute. Virtually, all escrow agents though, and you need to be aware of this, if a dispute happens over whether an asset is transferred over or whether over the exact amount that the escrow agent is going to release to the seller, the escrow agent will not do anything. They will sit on their hands until they get instructions from both the seller and buyer as to what they should do. Escrow agents do not assume liability of any kind. In fact, in a standard escrow agreement, you will be indemnifying the escrow agent for any escrow omissions that they may do.
You have to be careful. When you review the escrow agent, never assume by the way that an escrow is boilerplate. Both council to the seller and buyer should be looking at this. Obviously, the seller is going to want the transition and migration period as short as possible, and that's just not because they're anxious to get their money. They also have to keep in mind that the vast majority of escrow agents do not accrue interest on the funds that they hold in escrow. If the transition and migration period is 45 days, that is money that's going to be sitting in an escrow account not earning interest until the transition and migration period is over.
That's how the escrow arrangement works in these deals. In the vast majority of them, the transition and migration period will be a period of 10 to 45 days after the closing. During that time, both the money and hopefully the domain names as well will be held by the escrow agent and will be swapped when everything has migrated over to the buyer's satisfaction. Okay. Now we get to the actual closing. What happens? Well, if the purchaser has used SBA financing, that's the first thing that has to happen. The buyer has to close with their SBA lender, and that can take some time.
I cannot tell you how many closings I've attended that start at 10:00 AM, where we don't even get around to doing our part of the deal until 2:00 in the afternoon. We're sitting around munching on sandwiches, waiting for the purchaser's attorney to get every last thing nailed down with their bank. Because let's face it, if the money's not there, then the deal's not going to close. The first thing is the buyer has to close with the SBA lender. If you are the purchaser's attorney, you should also try to be the closing agent that gets all the documents done. If not, you'll be dealing with the bank's attorney, and that may cause additional delays because they're doing everything remotely and electronically.
An SBA closing is a very complicated thing. There are upwards of 50 or 60 different documents that need to be signed at the closing to make an SBA loan happen. It is not a 10 minute process, as much as we would all like it to be. Just like I said before that you got to plan on at least 60 to 90 days to close an SBA loan. You have to plan for at least several hours at the closing for the SBA loan to be finalized and the wire transfer happens. The SBA, the purchaser closes with the SBA lender, the money has been wired, the purchaser's attorney has it in his escrow account. Now, we have to do our deal.
Now the buyer and seller have a number of things to do. The first thing they have to do is they have to finalize the closing adjustments for prepaid revenue and prepaid expenses. I said in one of my earlier slides that you should try to do this before the closing. But in reality, this is almost always gets done at the closing. The seller and the buyer go off into a room and they basically go, "Okay, now there's this one account we got yesterday. I've already done this and such, but there's still X, Y, and Z to be done. Can you take that part? Okay. Now, how are we going to divide that income between the two of us?"
It's done on a case-by-case client-by-client basis, and it may take a while. You should try to encourage your clients to get it done before the closing. But in reality, it's almost always going to have to happen at the closing. That's the first thing that gets done. Then while that's going on, the two attorneys are agreeing on a closing statement with the final numbers of what's going to be transferred at closing. The original purchase price, plus any credits to the seller, less any credits to the buyer that have been agreed to, payments to third parties, the one half of the escrow fee that the buyer has to pay, for example, would have to be added to the purchase price.
Otherwise, the seller would take a hit there. All these numbers need to balance out. If there's lease involved, that there's brick-and-mortar involved, you have to worry about allocating apportioning the rent for the current month, utilities and other things. Usually that doesn't happen in a web-based business transfer, but sometimes there's brick-and-mortar that's transferring as well. You have all the issues that you would have in a normal non web-based deal on top of all the stuff that we've been talking about on this program. Then when all the final numbers have been agreed to, the closing statement is finalized.
Then if there is an escrow agent, the purchaser will wire the funds to the escrow agent, and the domain and the seller will begin the process of transferring all of the domain names and other assets to the escrow agent under the escrow agreement. Let's talk about the closing statement in a little bit more detail. This is the document that basically it looks like an income statement or a P&L. But basically, it describes the flow of funds that closing, and it should track the asset purchase and sale agreement, and what was in there about how this was going to happen.
How much is the purchaser putting up out of their own funds? How much are they taking from the proceeds of the SBA loan? Is there an upfront deposit that has to be released from the seller's attorney's account at the closing? Oh, by the way, if you're representing the sale, be sure to bring your trust account checkbook to the closing. Because if you are holding a deposit, the parties are both going to want that money released at the closing, and one of the biggest mistakes you can make is to not have your checkbook handy. That's a little tip from me.
Because I've represented a bunch of sellers and there was a situation years where I totally forgot that I was holding a $5,000 deposit and I forgot to bring my checkbook to the closing, and we had to interrupt the closing for me to drive home and get the bloody thing so that we could write that $5,000 check to the escrow agent. That was an embarrassment. Don't get yourself into that position, at all ways. Any adjustments for prepaid income or expenses should be taken care of before the closing date.
But that rarely happens. What usually will happen is that as soon as the SBA loan is closed, because the purchaser won't be free before then, the purchaser and the seller should get together in a side room and hammer out the pennies of exactly who's going to keep what income from such customers for any work in progress that is going on at the closing. Then also, the closing statement has to list payments to any third parties. The escrow fees. Escrow agents will not do anything unless they're paid upfront at the closing. The seller can take his 50% out of the purchase price, but the buyer is probably going to add that to her wire transfer because otherwise, the sellers is not going to pay the purchaser's portion of the escrow agent fee and vice versa.
Any attorney's fees, I always like to be paid at the closing. I make sure that that comes out of ... If I'm representing the seller, that's going to come out of the closing proceeds. Otherwise, I want the purchasers check at the closing. Also, if there is a broker involved, they will probably have someone physically present at the closing to collect their commission check. If not, that needs to be overnighted from the closing. Brokers can be very, very hissy if their commission is not paid within 24 hours of a closing. Okay. Now the deal has closed, let's talk about some post-closing things that the parties have to think about.
In most web transfers, the seller commits to work with the buyer for a training and consulting period. It's usually 30 days, but it can be less or more depending on what the parties agree to. Sometimes the seller gets paid for their time. Sometimes they do not. More commonly, they will give the buyer two weeks or so without a fee. But if it's six months after the deal closed and the buyer is still asking questions, the seller will probably be right in insisting on being paid for that. The details of the post-closing transition and migration period need to be nailed down. Never walk away from a closing figuring that the transition will occur smoothly.
If you're representing the seller, there has to be a daily communication between the seller and the escrow agent regarding how things are transferring over. At some point, the seller needs to call the buyer and say, "Okay, I think we've transferred everything. Take a look at the escrow agent's records. If anything's missing, let me know. Otherwise, please release the damn money," and that's got to happen. There has to be ongoing communication between the seller and buyer as things transfer over, especially e-commerce and payment accounts where a seller and buyer may have to coordinate with the platform on conference calls to ensure that those accounts transfer over.
The seller should monitor the buyer's compliance, especially if there are earnouts involved. A seller who agrees to an earnout should never walk away from the closing assuming that that will go smoothly. The seller should insist on at least quarterly or if not monthly financial statements. They should be examining the Google Analytics on at least a monthly basis so that if there is a Google Dance and the algorithm change and driven the site's performance down, the seller and buyer can coordinate right away and figure out how that's going to impact the earnout.
Earn outs are the biggest cause of litigation in these transactions. Whenever there's an earnout transaction, like Mark Twain said, put all your eggs in one basket, but then watch that basket very, very carefully. Okay. Then last but not least, the buyer, for their part, should be monitoring the seller's compliance with non-compete, non-solicitation and especially non-disparagement agreements. The sellers going around dissing the business on his social media, that is something the buyer needs to call them on the carpet on very, very quickly. Okay. That's basically it.
Here's some of the key points we've learned today. The success of a web-based business often hinges on the SEO and web marketing skills of the people owning it. If you are representing a buyer who is not familiar with SEO or web marketing practices, then the seller or the seller's employees are going to have to stay on for a significant period after the closing to make sure that the site maintains its level of performance and its rankings with the various search engines. Transferring a web-based business is like moving a jigsaw puzzle.
Some pieces are going to fall off no matter what you do. Hopefully they will not be major ones and the buyer will still be willing to move forward with the transaction, even though they're not getting the complete puzzle picture. Both parties and their counsel need to focus on third parties, such as advertisers and content providers whose continued involvement with the business is essential to its future success. Sales of web-based businesses are almost always structured as asset sales, unless there are key assets such as eBay and Amazon accounts, Venmo or PayPal accounts that cannot be legally transferred to a new entity without some delay and some involvement by the third party platform.
E-commerce accounts are frequently not transferable. Counsel has to build holdbacks and earnouts into the purchase price in case an account gets sticky and cannot be transferred by the closing date, or maybe that sometimes doesn't get transferred at all. There has to be a plan B if a buyer is relying on an Amazon account that cannot be transferred quickly or at all. There has to be a plan B and some way of adjusting the purchase price so that both parties will walk away. Maybe they won't walk away happy, but they'll be able to walk away and move on with their lives.
Consider using an escrow service at the closing to ensure that all the assets transfer smoothly and quickly to the buyer before the purchase price is released. Finally, most importantly, both sides in a web-based acquisition, same as in a brick-and-mortar acquisition, should have a good lawyer and a good accountant who are familiar with web-based businesses. Do not try to do this yourself, folks. If you're buying or selling a web-based business or indeed any business, even if it's only for a small amount of money, these deals get complicated in a hurry and you need professionals who are internet savvy, who can help you deal with the issues. Otherwise, your costs will go out of control.
You don't want to get into a situation where the legal and accounting bills are greater than the purchase price, and that can easily happen in these deals. Thank you for your time. I appreciate your time and effort today. I've given you some contact information for me. If you want to reach out to me personally, that's fine. I do a lot of this kind of work and more than most people I think. I'd love to hear from you. Otherwise, enjoy the rest of your day. Thank you for listening.
