As the yoga world has expanded, I have seen an increase in purchases and sales of yoga and wellness studios.
Some owners want to sell their studios because they are moving, their interests have changed, or running a yoga studio proves to be a much harder and stressful business than they imagined. Also, as the number of yoga studios has increased, so have competitive pressures and conflicts between yoga studios.
On the other hand, others are interested in purchasing existing studios. They fall in love with the practice or the lifestyle, or want to dedicate themselves to service through yoga.
Their are many advantages to buying a pre-existing studio. The new owners can step into a lease, and acquire pre-existing relationships with a student and teacher community. The yoga supplies and office equipment have been purchased, the studio has been built out and software systems such as Mind Body have been set up. Many owners view buying an up and running business as being easier than building a business from scratch. Of course, it is not all unicorns and rainbows, and there are many potential problems that may arise from buying an existing business.
What are the legal and business issues that both buyers and sellers should consider? Be mindful that the interests of a buyer and a seller are very different. The seller wants to receive the highest price and the avoidance of future liabilities coming from the studio. The buyer wants to pay the lowest price and for the seller to protect the buyer from future liability. This article will present both sides of the discussion.
1. Asset or Stock Sale?
The first issue is whether the sale will be an asset sale or a stock sale. If the transaction is an asset sale, then the seller is selling a specific list of assets of the business. The liabilities are not sold with the business, and the seller remains responsible for the liabilities. In some cases, the seller may retain a few specific assets or transfer certain liabilities if the buyer agrees. If the seller owns the business through a legal entity such as a corporation or a limited liability company (“LLC”), the seller will keep ownership of the entity. It will not be transferred to the buyer.
If the transaction is a stock sale, the legal entity that owns the studio is sold to the buyer. If a corporation owns the studio, all of the shares of corporate stock will be sold to the buyer. If a LLC owns the studio, all of the membership interests in the LLC will be transferred to the buyer. It is possible for the seller to retain shares of stock or membership interests such that the seller becomes a minority owner after the transaction, but this structure would be rare in the yoga world.
In a stock sale, the buyer takes the entire business. This means that the buyer purchases all of the assets and liabilities of the business. The seller would not be responsible for the liabilities of the business after the sale closes.
This decision can involve complicated tax, accounting and legal issues. I recommend that you consult with your accountant or lawyer in making this decision.
2. What Are The Assets and Liabilities?
Under either structure, it is important that the seller is able to accurately account for all of the assets and liabilities of the business.
A list of all assets being sold must be prepared so that they can be legally transferred to the buyer. Assets include the yoga props and equipment, office furniture, studio art, boutique merchandise, other tangible assets, accounts receivable, customer and student lists, website and domain names, social media accounts, cash, and intangible assets such as intellectual property and goodwill.
All of the liabilities must be understood so that they will be either conveyed to the buyer or retained by the seller. Liabilities include such items as the lease, promissory notes, account indebtedness, contingent liabilities, tax liabilities, employee or independent contractor liabilities, and contractual obligations and liabilities. Any contingent liabilities such as lawsuits or tax audits must also be identified.
This shows that it is important that all yoga studios keep accurate accounting records. It will help you keep your taxes straight and will be important if you ever decide to sell your studio.
3. The Letter of Intent
I recommend that the buyer and seller prepare a letter of intent. This is a simple letter agreement which sets forth the important points about the proposed sale of the business. It is written in plain English, and does not contain legal language. It is designed to help both parties identify, discuss and resolve all of the issues.
Here are the points that the letter of intent should cover:
a. Is the sale an asset sale or a stock sale?
b. If it is an asset sale, what are the assets of the business? Are any assets being excluded from the sale?
c. If it is a stock sale, what type of legal entity does the seller own? Is it a corporation or a LLC? What State is it organized in, and how many stockholders or members does it have? How many shares or membership interests are issued and outstanding? How many shareholders or members does it have? Is it in good standing in the State where it was organized? Has it filed all of its federal and state tax returns?
d. What are the liabilities of the business? Is the seller retaining any liabilities (under either structure)?
e. What is the purchase price of the business?
Valuation of small businesses is very difficult because there are few comparable sales that can be used as guidance. It is “fuzzy math.” Generally, the calculation is based on net cash flow. This could be 100% of net cash flow or a multiple of net cash flow. Net cash flow is usually averaged over a several year period.
There is also a component of goodwill in valuing a small business. This is an intangible asset (as distinct from a tangible or physical asset), but it does have value in a sale. Goodwill could be the brand name of the studio, the reputation of the owners, the value of the yoga community, the length of time that the studio has been in business and similar factors.
Another method is an asset-based valuation. This is a straightforward method in which the value of the business is determined by the total value of the company’s tangible and intangible assets.
The amount of the lease payments should also be considered because it is a significant liability that the buyer is assuming.
I have done transactions in which the price was based on the fair market value of the studio’s physical assets plus a small amount for the goodwill. The seller was primarily interested in transferring responsibility of the lease to the buyer.
f. How Is the Purchase Price Paid?
There a few options: all cash, cash and a promissory note, and cash and an earn-out.
Sometimes the buyer cannot afford to write a check for the full purchase price of the business. Sometimes the buyer pays a portion of the price in cash and the balance in a promissory note. The note should be secured by the assets of the business.
Cash with an earn-out means that the buyer makes an upfront cash payment and then pays the seller the balance of the purchase price by giving the seller a percent of free cash flow or a royalty payment each year. That way the buyer pays the purchase price over time.
g. Post-Closing Duties of Seller
Is the seller willing to help the buyer with the business after closing the sale? Is the seller willing to help transfer the business in an efficient and elegant way? This could mean participating in an announcement to the student community and working with the teachers to help them feel comfortable with a change in ownership. It may also mean that the seller is willing to be available for a certain period of time to teach the buyer about running the business. The duties of the seller, if any, should be described.
h. Consents
What consents are need to sell the business? The consent of the landlord to assign the lease will almost certainly be required. There may be a need to amend business permits to reflect the change in ownership. These permits are usually issued by the city or county where the business is located. If there are other stockholders and members who are owners in the business, their consent would be required.
i. Due Diligence
The buyer should have the right to examine all of the books and records of the business. This helps the buyer understand the profitability of the business, and all of the assets and liabilities that it may be assuming, and will have effect the purchase price.
j. Non-Disclosure Agreement
A non-disclosure agreement (“NDA”) is usually signed before the seller gives the buyer the books and records of the business for due diligence purposes.
k. Public Announcements
When will public announcements be made about the sale? Who will make the announcement? What will it say? Will the seller participate in the announcement?
Parties should discuss how to manage the yoga teachers and studio staff. The sale of the business may be quite stressful to the teachers and staff, so it may be a good idea to hold a meeting to answer questions.
l. Expenses
Who will pay the closing expenses? Usually each party pays for its own expenses, including lawyers and accountants. Sometimes legal fees are split between the parties because it may be unfair for one party to pay all of the legal fees.
m. Closing Day
When and where will the closing occur? What documents need to be signed and exchanged?
n. The Purchase Agreement and Other Documents
The parties should agree to work together in good faith to negotiate and sign a purchase agreement, and any other documents that may be needed for the sale to close. Other documents may include a bill of sale, a domain purchase agreement, an assignment of intellectual property, and a promissory note (if part of the deal).
4. The Lease
The lease is one of the most important issues in the sale of a yoga studio. It is one of the biggest expenses of running the business, and the consent of the landlord is needed to assign the lease.
Landlords often take this as an opportunity to raise the rent or impose other conditions before they will give their consent to transferring the lease to the buyer.
Be aware that the seller may remain obligated on the lease even though it has been transferred to the buyer. This means that, if the buyer defaults in payment of the lease, then the seller becomes liable.
It is a good idea for the buyer to ask the seller to get an estoppel letter from the landlord. This letter states that the seller is not in default under the lease and that the lease is in full force and effect. This will prevent the landlord from making the buyer pay for problems that the seller caused under the lease.
The return of the seller’s security deposit should also be discussed.
It is common for the buyer to ask the landlord to build out or modify the space. If this is the case, a letter agreement should be signed between the landlord and the buyer. It is important that a deadline be included in the letter. I know of situations where the landlord has delayed opening the studio because they were in no hurry to get the construction work done. I have also seen disputes over who pays for the buildout when unforeseen problems arise.
5. Allocation of Purchase Price
When selling business assets, the federal tax rate on gains can vary from 15% (long-term capital gain) to 35% (ordinary income rates). Seller and buyer should reach an agreement on the allocation of the total purchase price to the assets acquired. Guidance from an accountant is necessary to properly allocate the purchase price.
6. The Purchase Agreement
The purchase agreement is the primary document that governs the sale of the business. If it is an asset transaction, it is called an asset purchase agreement. If it is a stock transaction, it is called a stock purchase agreement.
The purchase agreement should be prepared by a lawyer. There are too many legal and business issues involved in the sale of a business to handle without a lawyer.
Here is an overview of the main sections contained within a standard asset purchase agreement:
a. Description of assets to be purchased.
This includes tangible and intangible assets. Tangible assets are physical assets such as bolsters and mats. Intangible assets are intellectual property and good will. If the studio is selling teacher training manuals or trademarks, then an intellectual property assignment needs to be used.
If social media accounts and domain names are to be sold, these should be described and legal mechanisms to transfer these assets should be included within the agreement.
b. The purchase price.
As discussed above, how is the purchase price to be paid?
c. Excluded liabilities.
These are liabilities that are kept by the seller. These may include general liabilities (i.e., any liability of seller either known or unknown), debts, taxes, violations of law, contractual liabilities, employee liabilities and litigation.
The employee liabilities are important. These include any liabilities relating to present and past employees of the business. These could include employee benefits, liabilities arising under employment agreements, or any liabilities associated with mischaracterizing the employees of the business as independent contractors. These may include: (i) liability for workers’ compensation; or (ii) liability for benefits earned by any employees prior to the closing date; or (iii) any federal, state or local back taxes, penalties and interest.
What happens if a studio is audited after the sale takes place but the audit period covers the period before the sale? Because the IRS and many state taxing authorities are auditing yoga studios over mischaracterizing their teachers as independent contractors (rather than as employees), this may be an important liability that should be discussed.The buyer may end up having to manage an audit and pay the tax bill if the buyer loses the audit, even though the misclassification occurred during the time that the seller owned the studio.
The seller should reimburse the buyer for these liabilities. What if the seller does not have any money, has moved away or cannot be found?
d. Allocation of purchase price.
As discussed above, buyer and seller should agree upon the allocation of the purchase price with the guidance of their accountants.
e. Right of the buyer to conduct due diligence into the books and records of the business.
f. The date and time of closing.
g. Conduct of business in normal course.
Before the closing date, the seller should operate the business in the normal course. This means that the seller should not do anything out of the ordinary with respect to the business.
h. Lease
The issues concerning the lease as discussed above must be addressed. It is usually a condition to closing that the landlord consent to assignment of the lease. This means that, if the landlord does not consent to assignment of the lease to the buyer, then the buyer does not have to go forward and buy the studio.
i. Representations and Warranties.
The seller must make several representations about the condition of the business. If these representations turn out to be wrong, it must reimburse (or indemnify) the buyer if the buyer suffers a loss.
These representations usually cover: title to the assets, operation of the business in compliance with laws, the condition of the physical assets, and that the sale of the business will not violate any contract to which the seller may be bound.
j. Closing Procedures
The agreement contains a section about closing procedures. These are delivery of the purchase price against a bill of sale of the assets, the assignment of the lease, the consent of the landlord, delivery of any promissory notes, and other similar matters.
k. Indemnity
The agreement should contain a section under which the seller will indemnify the buyer if any of its representations are wrong. Indemnity means that, if the buyer suffers any damages, losses or expenses as a result of the seller’s wrongful representations or other actions of the seller, then the seller has to reimburse the buyer for its losses. The indemnity may also include covering the buyer for any tax liabilities for misclassification of workers during the period that the seller owned the business.
Lawyers often engage in complex discussions around indemnity. The seller wants it to be as narrow as possible. The seller seeks to make it expire in a short period of time, to put a ceiling on the amount of damages that the seller may need to pay and limit the scope of the section. The buyer, on the other hand, wants to do the opposite!
L.Confidentiality
The agreement will provide that its provisions are confidential and that neither side can disclose the terms of the transaction.
M.Bill of Sale
The agreement will include a bill of sale. The purpose of the bill of sale is to legally transfer title to the assets from the seller to the buyer.
N. Stock Purchase Agreements.
A stock purchase agreement is similar to an asset purchase agreement, except there are many representations and warranties made by the corporate entity that is being purchased.
Comprehensive lists of assets and liabilities are also made because the buyer will be assuming everything. There are also provisions that govern the transfer of the stock or membership interests, as the case may be.
7. Post Closing Covenants
The parties may agree to post closing covenants. These could include such things as working together on allocation of the purchase price, the seller’s support of the business during a transition period, a covenant not to compete, and payment of the buyer’s promissory note over time.
8. The Closing
Most closings for the purchase and sale of yoga studios are fairly simple. The parties will have already signed the purchase agreement so all of procedures for the closing will have been discussed and finalized.
At the closing, all of the related agreements will have been prepared. These may include the bill of sale, the promissory note, intellectual property assignment agreements, agreements to transfer domains and websites, assignment of the lease, landlord’s consent and any other agreements.
The purchase price is paid, all documents are signed and exchanged, hands are shaken, and the deal is done!
Conclusion
I hope I have given you some insights into some of the issues that are involved in the purchase and sale of a yoga studio. This is just a brief summary of the many issues that may be involved and there are many nuances to all of these issues. There perspective of the buyer and the seller on most of these issues is very different. As you can see, there is much to consider with respect to the purchase and sale of a yoga studio. It will be important to get the guidance of accountants and lawyers to handle business sales in a competent, fair and professional way.
Light on Law Newsletter
Please sign up for my Light on Law newsletter so you can keep on top of current legal issues in the yoga and wellness world. Please click here:
http://tinyurl.com/clakwyn
Resources
I have prepared sample asset purchase agreements and stock purchase agreements, together with additional resources. If you are interested in purchasing these agreements, please click here:
https://garykissiah.com/legal-agreements/
For more information about me and my other activities, please visit my website:
https://garykissiah.com/#top