Three years ago, you launched your new business. Since that day, you have increased revenues year over year, hired more than a dozen employees, outgrown your first office space, and built strong relationships with suppliers and customers. Now you are considering selling your business. Maybe you are ready to move on to a new opportunity, maybe you feel as though you cannot grow the business any further on your own, or perhaps you are planning a “someday” long-term exit strategy. Although you may be prepared to sell the business, is the business ready for sale?
The following provides important advice on key issues related to selling a business —with the goal of preparing your business in advance so that you can get the best value and make the transaction process as smooth as possible.
1. Financial Records Must Be Accurate, Easily Reviewable and Adhere to Sound Accounting Practices to Minimize Risk.
Having a history of accurate, comparable, and easily reviewable financials is one of the most important factors in getting a deal done quickly for a good price. Conversely, building a history of solid financials when the business has not practiced sound accounting practices is time consuming and costly. Potential buyers will want at least three years of comparable financials that accurately reflect the business operations so they can confidently value the business.
Most small businesses will not have audited financials, but every business owner should work with an accountant to produce consistently applied financial accounting standards that create accurate and easily reviewable financial records for potential buyers when the business is ready to sell. A selling company with consistent and transparent financials will have a much stronger foundation from which to negotiate a fair price than a company with financials that represent inconsistent and questionable accounting practices, which creates risk for the buyer.
2. Company Records Must Be Current and Accurate to Reduce or Eliminate Future Liability.
Keeping the company’s records current and accurate as the business grows is important for all businesses. However, sometimes business owners forget, delay or are not aware that certain company records need to be updated or filed. Before the sale of a business, all company records should be reviewed and updated, including the incorporation documents and organizational documents (such as the bylaws or operating agreement). All government and regulatory filings should be current, and the company should be kept in good standing. Additionally, all company policies and guidelines should be written and all company actions approved and ratified to the date of sale.
All buyers will require a selling company to warrant that its company records are true and correct and that the company is in good standing at the time of the sale. The sellers will usually face perpetual liability for breaching fundamental warranties related to the business organization. Further, all buyers will require documentation that actions taken by the company were properly approved and ratified through the sale, so that the buyer does not face liability from third parties after closing.
One other often overlooked aspect of pre-sale diligence is conducting a lien search on the company, and possibly its owners, depending on how the company sale is structured. Business owners should routinely monitor any liens on the company’s assets and any liens or pledges against any equity holder’s interest in the company, which may affect the ability to sell the company’s assets or all of the company’s equity in a stock sale. No seller should hear for the first time that there are liens against the company’s assets from the buyer during due diligence.
3. Intellectual Property Assets Should Be Properly Organized, Easy to Access, Registered in the Company’s Name and Actively Monitored.
Whether a business has created a new technology that differentiates it from its competitors or simply has a customer-friendly website and social media presence that draws traffic, nearly every business relies on some form of intellectual property as a foundation for its growth and success. Every business should have exclusive rights or licenses to all intellectual property that it relies on to operate. Often times a company’s intellectual property was designed before the business was formally created, or in its very early start-up stage, and website registrations, trademarks, and social media accounts may be registered in the names of the company founders or employees. Frequently, as the business grows, intellectual property transfers or assignments to the company are overlooked, only arising when the company is ready to sell and is accounting for the assets it owns.
Buyers will want exclusive rights to all of the business’s intellectual property, particularly if the intellectual property is a significant portion of the enterprise value. A seller does not want to delay or lose a deal trying to track down the registered owners of the intellectual property, transfer intellectual property rights to the company, or worse, have to negotiate with a former owner or employee for the rights to intellectual property that were not assigned to the company before the employee left.
In addition to ensuring that the business owns all of its intellectual property, business owners should actively monitor the company’s intellectual property throughout the life of the business. Buyers will require sellers to warrant that the intellectual property for sale does not infringe on anyone else’s rights and that no third party is infringing on the company’s intellectual property rights. Buyers may also require the seller to indemnify the buyer for any issues with intellectual property ownership that may arise after the transaction. Sellers can mitigate any potential liability, loss of sale value, or reimbursement of the purchase price by conducting routine due diligence and protecting their intellectual property rights and usage.
4. Employee Records Must Accurately Reflect Current Rights, Responsibilities, Compensation, Benefits, Equity Ownership and Other Applicable Employment Details.
Another common mistake small businesses or startups make is overlooking the importance of maintaining relevant employee records. Many small business owners, in the flurry of early-stage growth, hire employees and offer raises, equity, and other benefits to key personnel on an ad-hoc basis or without proper forms of documentation. Although companies usually create some form of these employment documents over time, many employees have inconsistent, or non-existent, records of their hiring, job responsibilities, equity ownership, and benefits. Employee records should be routinely reviewed, particularly before the sale of a business, when a buyer will have to decide whether to retain, terminate or buy out the current employees.
Buyers will review all employment records to understand each employee’s rights, salary, bonuses, equity, accelerated payments due upon change of control of the company, potential liabilities under employment and tax laws, such as ERISA, and any other employment matters that may affect the purchase price of the company or liabilities post-sale. The buyer will also want to know if the current employees are under non-competition and confidentiality agreements which may affect the value of the purchased assets, such as intellectual property, after the sale if the employee is not offered a continuing role with the new owner and is not restricted from using the intellectual property.
Employment issues can be incredibly messy and frustrating for parties negotiating a deal because they have ramifications that touch on labor laws, tax law, and securities laws, among others, and unlike dealing with the transfer of tangible assets, navigating employees through the sale of a company can be a very personal and emotional process. Proper recordkeeping describing employee rights and obligations may not make the change of ownership conversation with employees easier, but it can clearly identify the extent to which each party faces ongoing liabilities if there are issues getting all employees on board with the transaction.
5. Finding the Right Buyer Can Be Critical to Achieving a Smooth Transaction.
When business owners are ready to sell, they may seek out multiple potential buyers and choose the best fit, or a potential buyer may come to the business owner with an unsolicited deal pitch. Regardless of how the potential buyer and business owner connect, it is important for the business owner to be comfortable with the buyer’s vision for the transaction and the future of the business. A business owner should not feel pressured into a deal too quickly or without fully understanding the terms of the transaction. The seller should feel comfortable with the buyer’s stated objectives and plan for the business after the transaction.
Although the business owner may not be able to control what the buyer does with the business after it is sold, the seller should take the time to find a buyer that shares the same philosophy and business plan as the seller, if it is important to the seller. Also key to the relationship is the business owner’s expected role with the company after the sale, which should be clearly identified by the buyer and comfortable to the seller early in the negotiations. The last thing a seller wants is an ongoing contractual relationship with the buyer after a messy and contentious business sale transaction, on terms that were negotiated at the last minute when both parties were experiencing deal-fatigue.
Conclusion: A Long-term Strategy Combined with Proper Legal Representation Goes a Long Way.
It is nearly impossible to create an exhaustive list of advice about issues that may arise for the seller of a small business; however, preparing for these major issues far in advance of a sale gives the seller the ability to focus on the transaction instead of distractions. The seller will maintain much better control over the transaction and be in a position to handle any smaller issues more smoothly, within the framework of a well-prepared sales strategy.