In the sale of a small business, contingencies are conditions that must be met before the transaction can close. The seller of a business usually has chosen to go to market to sell the business and are focused on finding a buyer who can afford their desired purchase price. A buyer has other concerns, like wanting some assurance of what they are buying, and generally have more of an interest to give themselves the ability to cancel a deal as they learn more about the business. This article will focus on how sellers should not just be focused on whether or not a buyer can obtain financing. Contingencies can be just as important—sometimes even more so—for the seller.
Construction businesses are frequently sold to buyers who do not currently hold the required license from the California Contractors State License Board (CSLB). Many contractors selling their business are just interested in finding a buyer with money. It is common in the industry for the seller to stay on with the new buyer to “lend” their license to the new buyer. However, with this type of relationship, the selling party should no longer just be focused on finding a buyer with money. A diligent seller will recognize the possible liabilities and complications that come with such a post-sale relationship and will negotiate and contract with the potential buyer for favorable contingencies to allow a seller to stop a sale of their business to an unqualified buyer.
First: Contingencies Typically Favor the Buyer,
Buyers often include contingencies related to due diligence, financing, obtaining necessary licenses, or landlord approval. These allow the buyer to assess the business’s financials, contracts, operations, and overall viability before becoming fully committed. Contingencies can also be crafted to protect the Seller.
Sellers, especially in closely held businesses, often remain involved post-closing for a period of time. This may include:
- Transitional services, such as training the buyer or maintaining key relationships;
- Licensing compliance, such as acting as a qualifier for regulated businesses; or
- Financial incentives tied to future business performance, such as an earn-out.
An earn-out is a provision in the purchase agreement that ties a portion of the sale price to the business achieving specific financial or operational goals after closing. If the buyer fails to operate the business competently, the seller may never receive the full value of the deal. This gives the seller a vested interest in ensuring the buyer is qualified to take over.
Example: Contractor Sales and the RMO/RME Requirement
This issue is especially acute in industries subject to licensure or regulatory compliance. For example, a construction business is regulated by the CSLB. Under Business and Professions Code § 7068, a corporation or LLC must designate a Responsible Managing Officer (RMO) or Responsible Managing Employee (RME) who is licensed and oversees the construction activities.
An RME must be a bona fide employee who works at least 32 hours per week or 80% of the business’s operating hours, whichever is less. RMOs, in contrast, are licensed officers who may or may not be full-time employees but must still exercise direct supervision and control as required by BPC §§ 7068 and 7068.1.
Why it matters: If a seller, or an individual associated with a selling-entity, agrees to remain as the RMO or RME post-closing, their personal contractor license is on the line. Misconduct or violations by the buyer could lead to license suspension or revocation under BPC § 7090 and BPC § 7110. This makes it critical that the buyer operates the business properly and in compliance with the law. Many busine sses “borrow” or “rent” an individual’s license and the most that the licensed person does is let the business use their name. Frequently, the parties fail to adequately negotiate or reach definitive terms regarding the licensed person’s future involvement post-sale, e.g. terms/compensation for employment, etc.
A Common But Vague Seller Contingency: “Qualified Buyer”
In recognition of these risks, sellers sometimes include a contingency allowing them to approve the buyer’s “qualification to operate the business.” While this seems like a prudent safeguard, the language is often vague and subject to interpretation. What does “qualified” mean?
- Does it mean the buyer has the necessary state licenses?
- Does it mean they have a certain level of experience in the industry?
- Does it mean financial wherewithal?
- What does the Buyer expect of the Seller-Licensee?
Without clear definitions, this contingency can become a point of dispute. Buyers may claim they meet the standard, while sellers may argue otherwise. A prudent seller will realize that the buyer who is unlicensed at the time of their purchase of the business is going to be heavily dependent on the licensee. Put another way, can the seller trust the buyer to obtain any necessary license to replace the seller-license in the future?
Practice Tip: Define what “qualified” means in the context of the business being sold. For example, “Buyer shall be deemed qualified if they possess a valid California contractor’s license, are approved by the CSLB as RMO/RME, have at least 5 years of operational experience in a similar construction business, and obtain bonding within 15 days of the execution of this Agreement.”
When the Seller Remains Financially Exposed
Another common reason for seller contingencies is when the seller remains financially liable under a commercial lease. If a landlord requires the seller to remain a guarantor or lessee—often due to the buyer’s lack of operating history—the seller is exposed to financial risk even after transferring the business.
In these situations, sellers are entirely justified in wanting to confirm the buyer’s business acumen, creditworthiness, and operational plan. A poorly run business may default on the lease, pulling the seller into a lawsuit or collections action long after the sale.
Conclusion
Contingencies can protect both parties and help ensure a successful transition, but they frequently are not used to the extent advisable. A successful sale of a business is frequently not just about whether a buyer can obtain financing. Sellers have to be concerned with all aspects of the transaction, including post-closing obligations—whether legal, financial, or operational. Sellers must take care to negotiate contingencies that reflect their risks. Buyers should be prepared to demonstrate their qualifications and build trust.
Thoughtful, specific drafting can help avoid disputes. By clearly defining terms like “qualified buyer,” outlining expectations, and linking contingencies to measurable standards, experienced business attorneys ensure that the sale results in a good fit between a committed buyer and a seller who is ready to exit the business they built with peace of mind.