Sellers of a Business: Know Thyself.

So, you have decided to sell your business. Often this process starts with an inward reflection. You may have identified a good reason to sell, but many questions remain. Sellers at this early point often look to hire a broker or financial advisor to help get answers to their major questions. Don’t stop the introspection here. Continue to think hard about what your business looks like from the inside and what additional advisor can help you get the best return. Retaining legal counsel early in the process – preferably before a letter of intent or term sheet is signed – can help you scrutinize major aspects of your business and secure a deal in your desired price range.

Experienced counsel can guide you through an effective presale internal diligence process to spot issues before a potential buyer does and deliver maximum return on what you have built. Any sophisticated buyer will do the same. Identifying issues early on can help reduce negotiating points, avoid unwanted holdbacks, and get to a closing with reduced tension. Here are some of the major areas where presale seller-side legal diligence can help identify and fix problems to avoid unintended consequences such as a buyer demanding a lower price, or worse, walking away. 

It All Starts at the Top – Address Ownership Issues

You may want to sell, but are you the only owner? Are you sure all your co-owners or other equity holders are on board? Any hint of problems or dissent at the ownership level can cause significant disruption to business operations during a sales process.

For instance, do some want to stay on as advisors or employees when a new buyer takes over? Do some have a preferred buyer in mind? Is there a sentimental or emotional issue at play that will require some level of insight or control into the business post-closing, such as retention of a board seat? Are there any company loans, bonuses, or other monies owed to or by an owner? Does everyone understand exactly how the sale proceeds will be divided under the governing documents of your company? These questions are just some of the issues that can cause a deal to fall apart if not fully vetted before a buyer starts negotiating.

A good strategy is to have experienced counsel on hand to help address these issues behind closed doors. A united front and a clear list of conditions for a buyer’s consideration as the parties negotiate the term sheet will set the stage for an honest and direct negotiation process. Big asks like post-closing employee or consulting agreements, retention of favored employees, or exclusion of certain assets from the deal will need to be factored into the asking price. Dealing with these disparate interests among your ownership group at an early stage can avoid an embarrassing fracture in front of the buyer.

Other ownership-level issues sometimes overlooked are corporate records and registration. Counsel can clean up any required corporate resolutions, assemble board minutes, and ensure all prior equity transfers are properly documented so a buyer cannot question who rightfully owns the business and can authorize the sale. Counsel can also assist in ensuring your business is registered in all jurisdictions where it operates, and in reviewing any license or permitting issues.

Handshakes Backed by Hard Copy – Review Your Key Relationships

For many companies, their strategic relationships with suppliers, vendors, customers, distributors, or service providers are critical to profitability. Before allowing those relationships to come under a buyer’s scrutiny, think about whether all your relationships are properly documented, and if so, whether you need to renegotiate or update terms. It is possible, for instance, that a years-long master services agreement has grown obsolete and needs updating to reflect a changed business environment. Make sure you’ve documented any favorable terms, such as volume or bulk discounts from key suppliers, because a buyer cannot count on a handshake deal to last. Another important consideration is whether any of these agreements prevent assignment to a new buyer without written consent. Many leases, for instance, contain strict prohibitions on assignment without landlord’s express written consent, which can be triggered either in an asset sale or equity deal where a substantial portion of the ownership equity is changing hands.

Secure the Secret Sauce – Protect Your Intellectual Property

For many startups and technology businesses, intellectual property is the crown jewel of the company. Any problems uncovered by a buyer in this area will likely affect the closing process. Depending on the nature of your business, an expert can help you navigate a variety of legal issues, with some examples including registering (or renewing) your major trademarks or copyrights, ensuring you have legal right or title to use your website domains or licensed software, analyzing your patent portfolio’s strength to withstand a challenge, and evaluating security measures (cyber and physical) in place to protect customer lists or other trade secrets. A robust review of the legal protections in place over your IP can instill confidence in a buyer and ensure that the purchaser can utilize these assets to their fullest post-closing potential. Strong protections here can lead to higher returns.

Prepare Your People – Employee Considerations

The sale process can make many employees feel uneasy about their future at the company and could lead to departures or early retirements. One possible mitigation plan is having top managers or other crucial talent sign confidentiality and invention assignment agreements. Keep in mind that non-compete clauses may only be enforceable under limited circumstances, or perhaps not at all in your jurisdiction, so it is important to confer with legal counsel to understand whether you can or should include these clauses or whether your existing agreements offer effective protections. If you want certain individuals to stay on through a transition period, perhaps you need to think about incentive bonuses or an earn-out at closing.

Conclusion

Due diligence is not just a buyer’s purview. A small upfront investment on the seller side can shield buyers from latent problems lurking beneath the surface and avoid an unintended consequence of a less-than-optimal deal for the sale of your business. A good attorney will help you deal with these issues and command top dollar for your business.