Planning and preparing the sale of a business, favors more robust sale processes and reduces the likelihood that potential buyers will be distracted by questions and issues that could easily have been foreseen.
Here is a list of some of the actions that potential sellers should consider before embarking on a sales process:
For many shareholders of privately held and family owned businesses, effective planning can reduce or defer the amount of tax to be paid by the selling shareholders. In some cases, these actions must be completed well in advance of a sale process in order to achieve the desired effect. An experienced estate planning attorney or other advisor with expertise in this area can provide guidance. The benefits of this planning will in all likelihood far outweigh the cost.
A target company’s financial information will of course be a critical part of the diligence process. If a company which does not have bank financing or other shareholder reporting obligations requiring audited financials has not previously obtained an audit, it might be appropriate to at least consider obtaining one. Public company buyers and buyers who rely on debt financing to finance the purchase price may require that a seller have audited financial statements. Also, to the extent that family or other personal arrangements with shareholders or other affiliates run through the financial statements of the company, pro forma adjustments will need to be made to remove these items from the historical numbers in order to normalizeearnings for purposes of arriving at a purchase price that accurately reflects the post-closing operation of the business. While in many cases there are tax or other reasons for these affiliate arrangements, to the extent that arrangements which are not essential to the business can be eliminated, that will help to simplify the financial diligence process when prospective buyers look at a business from the perspective of how it would be operated on a post-closing basis. Also, if a company has unprofitable contracts or above-market expenses, they may be best dealt with in advance of a sale process so as not to be a drag on earnings.
3.Incentives for Management that Align Interests
Recognizing that buyers will vary in the extent of their desire for post-closing involvement from existing management, it is worthwhile to consider whether adopting any particular management incentive arrangements (or making any adjustments to existing incentives) could help to better align the interests of management with those of the selling shareholders, both in the period leading up to a sale and also during a postclosing transition period. For example, providing for a change of control bonus arrangement that vests and becomes payable at some point following the closing of a sale transaction (e.g., six months after a closing), assuming continued employment through the payment date, should help to ensure a smoother transition of ownership. Other incentives can be designed to fit the particular circumstances of the relationship with management and likely buyers.
4.Protect IP Rights
While this issue is more relevant in some industries than others, review and confirm that employees, consultants and/or other developers who might in the future claim rights in proprietary IP and software of the target business have assigned these rights to the company. Consider having all new hires and applicable existing employees sign non-disclosure and assignment of invention agreements in forms that are sufficient to provide enforceable rights in favor of the company and a buyer. A seasoned buyer will, at a minimum, want to be indemnified by the sellers for any post-closing problems that might arise regarding its ownership of IP rights.
5.Change of Control/Assignment Provisions
While they cannot be avoided in many circumstances, where a future sale or liquidity event transaction is anticipated, when possible, try to resist including “change of control” provisions (i.e., provisions in an agreement which give the other party the right to terminate the agreement upon a change in ownership–and which therefore require the consent of the counterparty to do a deal) in contracts and agreements. If a consent provision cannot be avoided, it may be possible to draft the language so that it is more flexible.
While thee are differences driven by the transaction structure (i.e., stock vs. asset sale) that will impact how these provisions are interpreted, any change of control or assignment provision that requires a third party’s consent can complicate a sale process and give a counterparty with a consent right leverage, including to ask for payment of a fee or changes to deal terms in exchange for its consent. Similarly, be aware of how change of control language in loan documents can impact a sale if debt will not be paid out at closing.
6.Corporate Records and Housekeeping
Minute books and other corporate records should be kept current. Minutes of board meetings which demonstrate that a board has met regularly and properly discharged its fiduciary duties and oversight functions should help to ensure that the separate existence of the entity is respected, and therefore help to protect shareholders in the case of a lawsuit or claim or other action by a creditor against the company. Poorly maintained or deficient corporate records can, at the very least, give a buyer a negative impression about a target company and cause it and its advisors to be more cautious in their due diligence in other areas. Minutes should not be transcripts of board meetings, but they should be sufficient to show that the board engaged in a thoughtful and deliberative discourse with respect to matters it considered.
If some arrangements that are important to a business have traditionally been done on a “handshake” basis or through an oral understanding (without a written contract), consider putting these understandings in writing so that they can be better understood by and assigned to a buyer. Memorializing these arrangements prior to a sale process can also identify any misunderstandings regarding terms prior to involvement from a buyer.
Also, make sure that any key corporate documents, such as stock ledger records and shareholder agreements, are up to date and signed by all relevant parties, including minority shareholders. Depending upon the composition of a company’s shareholder group, it is a good idea for the principal shareholders to understand how any “drag-along” or other shareholder agreements work well in advance of embarking on a sale process, particularly where there might be different goals and objectives within the shareholder group in structuring a sale.
7.Director Indemnification Agreements
Consider entering into director indemnification agreements between the company and directors with survival periods that extend for the applicable statute of limitations. If a sale transaction is structured as a stock sale or a merger, indemnification 3 agreements will give directors additional comfort that the surviving company will have an obligation to indemnify them for any claims that might be brought against a former director after a deal closes.