Key considerations when selling your business

June 2021 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

financierworldwide.com

The decision to sell your business is a landmark event, whether you are an entrepreneur, the owner of a family business or a business owned with partners. The skills used to build and operate a successful business, however, are different than those necessary to achieve a successful sale.

When considering a sale, what steps should you take to ensure that it is a success? One key consideration is to position the business to achieve its maximum value. However, this should not be the only consideration. Sometimes, obtaining the maximum gross sale price does not result in a successful sale. And, even if your goal is restricted to achieving the highest gross sale price, simply having impressive revenues and operating results is not the only, and sometimes not even the most important, gateway to this goal.

So, what are the key considerations to achieve a successful sale?

Leading the list, is to remain focused on operating your business and building on its existing success (unless you are selling a distressed business, and the considerations involved in those types of sales are different and not the focus of this article). Owners should operate their business without regard for the possibility of sale. Potential buyers look at trend lines for operations. Any drop off will discourage offers or adversely affect valuation and the terms of the transaction. And, of course, a sale can never be assumed.

It is important to have a team in place with the expertise to ensure a successful sale. This team needs to include both members from the business as well as outside professionals. The business team should include the chief executive, the chief financial officer or others familiar with the business financials, and members of the business possessing knowledge and expertise about the business’ operations and assets, including its intellectual property (IP) and IT systems, as well as human resources and benefit plans. Although key personnel should be included, the internal team should be limited in number to allow the remaining officers and employees to focus on operating the business.

Outside professionals who are critical to the sale process include investment bankers, experienced legal counsel and accounting and tax professionals who know the market and your industry, and are experienced in structuring and negotiating transactions, and drafting transaction documentation. Experienced professionals come at a cost, but the value of their contributions generally exceed their fees, both by ensuring that you get the best price (and get to keep it), and by ensuring that the process goes forward to closing on terms that satisfy the needs of both the seller and the buyer.

Entering the sales process with an experienced buyer without your own experienced team of professionals is like going into a gun fight armed only with a knife. The legal and accounting professionals best suited to assist in a sale may be different from the legal and accounting advisers you employed when starting and operating your business. It is important to understand that the sale process requires a specialised skill set that may be different than that of your existing advisers.

Ideally, your transaction team should develop and implement a plan before the sale process begins. This plan should include reviewing your business’: (i) corporate and financial structure, including capitalisation and outstanding debt obligations; (ii) corporate books, records and agreements; (iii) intellectual property and systems, including cyber security considerations; (iv) employee plans, including employee incentive plans and agreements, and employment agreements and agreements with independent contractors; (v) real estate, including notices and consents, the terms of existing leases and environmental issues; and (vi) regulatory issues, to the extent relevant to your business and industry, and as may be relevant to a change in ownership, including new registrations and licensing. In addition, your review should include any legal proceedings or threats affecting the business.

The next step following your review is to consider what changes or additional documentation may be required, whether to maximise value, eliminate due diligence concerns, address tax issues or otherwise better position the business, not only for sale but to improve its business operations. For example, it may be useful to prepare a shareholders or operating agreement, or amend your existing agreements, to reflect the management and ownership groups’ respective management authority, and allocations of profits and losses, particularly as may relate to a sale.

This is also a good time to identify potential bottlenecks and issues relating to consent rights, rights of first refusal, the absence of drag along provisions to require minority interests to consent to sale transactions, and severance and other change of control related provisions. These provisions may exist in the terms of specific classes of stock or other equity interests or in the terms of shareholder agreements, voting agreements, investor rights agreements or operating or partnership agreements, including any joint venture or strategic alliance agreements with other businesses.

Small businesses sometimes intermingle personal and business assets and liabilities. These should be uncoupled prior to sale, as well as any assets or business segments that will not be included in the sale.

The business’ financial obligations should also be reviewed to ensure that loans and other debt obligations can be retired without penalty, and to determine what amendments to the obligations would be required if the debt were to remain outstanding after a change of control.

Financial books and records are of particular importance. The gold standard is audited financial statements which provide assurances to third parties that the financial position and results of the business have been accurately reported. However, many small and medium sized business do not have, or need for their current operations, audited financial statements.

The books and records should, at minimum, be prepared and maintained in a manner to permit an audit in compliance with generally accepted accounting principles and support a quality of earnings evaluation. Many buyers base their valuation of a business on its adjusted earnings (removing

extraordinary, non-recurring items) before interest, taxes, depreciation and amortisation (EBITDA). Tax returns should be filed in a timely manner and all taxes owed by the business should be paid, including applicable sales and use taxes, as well as payroll taxes. If the business is part of a group of companies, and only one of the businesses will be sold, including where there are joint ventures or strategic alliances with other business, tax sharing agreements and indemnification obligations should be reviewed.

IP is an important part of many businesses, including those businesses not ordinarily thought of as technology businesses. All businesses have proprietary information and trade secrets, what often constitutes the ‘secret sauce’ that makes the business valuable and unique for a buyer. Trademarks and service marks, as well as copyrights and patents, are often critical assets. Businesses should protect these rights by appropriate confidentiality and non-disclosure agreements with employees and third-party vendors, as well as registering valuable patents, trademarks, service marks and copyrights with the Patent Trademark Office (PTO) and other government offices. Similarly, it is important that the business has appropriate licence and assignment agreements for its IP and puts procedures in place to ensure that its IP does not infringe the rights of third parties.

Websites and emails are used by almost all businesses, as well as computer systems which store critical information, including information about vendors, customers and employees. Cyber security programmes and procedures provide protection against data breaches and should be a part of every business operation. The implementation of such programmes and procedures can be critical, both for operational purposes and as part of preparing the business for sale.

Employee plans include medical, dental, life and disability policies. Employee plans also include a company’s policies regarding vacation, paid time off and reimbursement for expenses. Many companies have 401(k) and similar savings plans, some with equity in the company as an investment option. Businesses also often use equity incentive plans that provide for stock options, restricted stock, stock grants or equity equivalent awards, such as stock appreciation rights, to align the interests of employees with the company by basing compensation on the business’ performance or value of its equity. Such plans must be properly documented and, if required, funded, to comply with legal requirements. Provisions of equity-based incentive plans can be important to a prospective buyer, particularly if they are deemed deferred compensation, or would accelerate their benefits in the event of a change of control.

Employment agreements and agreements with independent contractors should include, for key employees and contractors, non-solicitation and non-compete provisions, as well as confidentiality provisions. For employment agreements which are for a term of employment, as opposed to employment at will, provisions relating to termination can be important, particularly if an employee is entitled to a bonus or severance payment in the event of a change of control.

Real estate is often an important part of a business. Sometimes owners will seek to separate the real estate from the business sold. Environmental issues, particularly for certain types of businesses engaged in manufacturing, can be an issue in terms of storage and disposal of hazardous waste, or remediation requirements. Leases of real property should be reviewed for consent and notice requirements, and estoppels may be necessary for the buyer’s acquisition financing.

Regulatory issues most often relate to businesses which require licensing or registration with a governmental authority. This may include financial service, and healthcare- related businesses. In such cases, a sale may require notice, consent or re-licensure.

Legal proceedings can occur for any business, and range from administrative proceedings relating to employment issues, to lawsuits about the business and its operations. In assessing a business, a buyer will want to know how an adverse outcome might affect the business.

Robert C. Brighton, Jr. is a shareholder at Becker & Poliakoff. He can be contacted on +1 (954) 985 4178 or by email: rbrighton@beckerlawyers.com.

Robert C. Brighton, Jr.

Becker & Poliakoff