Most small and lower mid-market business sales are structured as asset sales rather than the sale of shares of stock. In an asset sale, the assets of the selling legal entity will be conveyed to a legal entity owned by the buyer. When an asset sale occurs, contracts and claims of the seller’s legal entity are not assumed by the buyer. Consequently it may seem like a buyer shouldn’t care about any outstanding legal and insurance claims, but buyers will view outstanding claims as a red flag and a risk factor.
Buyers will want to understand:
Why there were claims.
Whether there are problematic systems, people, or issues that make the business more susceptible to claims.
The likelihood of future claims.
The history of claims.
The financial impact of past claims.
In some industries insurance and third party claims are a routine part of doing business. However, to the extent possible, a business owner should try to resolve and close any claims prior to selling a business. In an industry where legal and insurance claims are not routine, a company that has a history of such claims will tend to be less marketable. Regardless of whether claims are a normal part of business or not, a history of claims should be documented in a way that identifies the nature of claims, the dollar amount, the outcome, and what proactive measures are in place to help reduce and manage claims in the future.