Selling a Business in 2013? Start With These 10 Steps Now

Originally published by Apex Counsel, LLC on 11/19/2012

[author: Tron M. Ross]

Introduction

With the holiday season upon us, we turn to thoughts of the upcoming year.  Small business owners with a goal of selling their business in 2013 should begin preparing for that transaction now.  The following are ten steps potential sellers should put in motion before the end of this year to help ensure a smooth transaction next year.

1. Obtain Legal Counsel

Competent legal counsel is of utmost importance in the sale of a business.  Most small and mid-sized businesses do not have in-house legal counsel and only work with lawyers when absolutely necessary.  For a business considering a sale, it is important that they begin looking at qualified attorneys sooner rather than later.  By doing so, you can ensure there is a good match between the attorney and your company.  You will also be able to utilize the attorney for guidance in several of the steps that follow.  Look for lawyer that both has the knowledge to steer you through the maze of a business sale and also one who fits well with you and your company personally, as a good relationship here is crucial.  Do not be afraid to ask for an estimate of what the legal fees will be and ask about flat-fee or other alternative-billing structures.

2. Look into Business Brokers (or an Investment Banker)

Depending on the size of the business, either a business broker or investment banker will play an important role in the sale of the business.  Generally, small businesses will utilize a business broker, while larger businesses will need an investment banker.  While their function of facilitating a sale is similar, these two types of professionals offer substantially different services.  A business broker will essentially act in a manner similar to a real estate broker by listing the business for sale, helping find a buyer, and receiving a commission based on the sales price.  Investment bankers generally offer a more sophisticated and interactive process, with a more structured approach.  Investment bankers also receive a commission based on the sale, but will often also receive a negotiated up-front payment.  Retaining a broker or banker is similar to retaining an attorney – meet with several and do not be afraid to ask about fees and for references.

3. Ensure Corporate Records are Complete

Prior to closing the deal, you will need to represent that the company is properly organized, in good standing and appropriately capitalized.  To make these representations, it is important to actually have all corporate records properly organized and in good order.  Many small businesses do not have a system for good record-keeping which can cost time and money to assemble if put off until negotiations are underway.  Furthermore, where the company is a corporation, poor record-keeping can be a basis for “piercing the corporate veil,” which can open the business owner up to personal liability for the company’s debts.  Therefore, ensuring a complete and accurate record of the company’s history is in place should begin as soon as possible.

4. Organize and Analyze Contracts

Contracts are a substantial asset for many businesses.  As such, the purchaser of a business will want to review the company’s “material” contracts. While materiality can be somewhat subjective, it is generally best to gather all contracts with key employees and significant customers and vendors.  Any and all financing agreements, regardless of amount should also be accounted for.  Finally, businesses who work with the government should uncover all of their government contracts.  If not already using a contract management system, now would be a good time to begin doing so.  Having such a system in place is not only is a good business practice, it also demonstrates to potential buyers that the company is well organized.  Once the contracts are gathered, a review should be done to determine the assignability provisions.  Many agreements restrict whether and how the contract may be transferred to another party.  Requesting assignability and providing notice can be a time consuming process – something you don’t want to be concerned with while negotiating the sale of the business, so getting contracts in order now will save trouble later.

5. Intellectual Property

Like contracts, intellectual property can be a substantial asset for many companies.  Now is the time to gather the records of all intellectual property assets to ensure that there are no surprises when the buyer does their due diligence.  A problem with an intellectual property asset found by the potential buyer can be substantial, cost time and money to remedy, and potentially cause the deal to fall through.

6. Analyze Financial Records

Businesses are bought and sold based on their financial outlook.  Providing a prospective buyer with accurate and complete financial statements is therefore a prerequisite for any sale. While some buyers will accept unaudited financial statements, depending on the size of the transaction, most will demand audited statements for the past fiscal year, and possibly more. Auditing statements can be a significant undertaking – therefore, the business need to get their house in order now as regards their financial policies and procedures, controls and any issues that could cause a delay in the auditing process.

7. Prepare a Form Confidentiality Agreement

Before engaging in any detailed discussions with potential buyers, it is recommended they sign nondisclosure agreements, which will require them to keep all of the information they receive about your company confidential for a period of time and to return all this information if the deal is not consummated.  The agreement should also prohibit the potential buyer from soliciting any of your employees should the deal fall through, as they would potentially have access to employee salary information.

8. Consider the Structure of the Deal

When it comes time to sell the business, the parties will negotiate a purchase and sale agreement.  This agreement can be structured in two primary ways: a sale of the company’s assets or a sale of the company’s stock.  Generally speaking, sellers prefer a stock sale and buyers prefer an asset sale.  For non-incorporated companies, the only choice is an asset sale. Those with the choice, however, should discuss with their attorney what the best means of sale would be, as this will have an impact on financing, taxes for both parties, and the seller’s ongoing liabilities.  While this is not the time to fully review this type of agreement, knowing what is in store and what will be expected of you will be beneficial when it comes time to negotiate the numerous provisions in the agreement.

9. Consider Means of Financing the Transaction

Some sellers will only consider a sale to full-cash buyers, while others may consider accepting stock if the purchaser is a larger corporation.  You will also need to think about whether you will offer some means of financing to potential buyers and what the risks are with each of these.  Now is also a time to think about whether you are amenable to an “earnout,” where a portion of the purchase price is withheld and paid in the future based on the performance of the company after the sale.

10. Consider Life After The Business: Continued Employment and Noncompetition

Will you want to stay with the company for a period of time after the sale as a consultant to make a smooth transition?  Will you want to stay indefinitely as an employee, or do you want a clean break after the deal closes?  Depending on what option you choose, employment and/or noncompetition agreements may be necessary.  If you would like to stay on after the sale, discuss with your attorney what type of employment agreement would be appropriate.  Whether you remain with the company or not, you will most likely have to sign a noncompete agreement which will prohibit you from engaging in a similar business for a certain period of time in the same area as the business you just sold.  Start thinking about these issues now so you have a better idea of what to expect when the time comes.

Tron M. Ross, JD, MBA, is the founder and president of Apex Counsel, LLC, a law firm providing innovative, cost-effective transactional solutions for entrepreneurs and small businesses.  He is experienced in corporate and business law matters, including business formation, contract negotiations, mergers, acquisitions, sales and purchases of businesses.  He previously worked as in-house counsel for a Fortune 500 Company and has represented start-ups and well-established companies in a number of industries.  He can be reached at tronross@apexcounsel.com or 888-960-APEX.

This publication contains general information only and the author is not herein rendering business or legal advice. This publication is not a substitute for such advice and should not be used as a basis for any decision or action that may affect your business.

Introduction to Intellectual Property

An area of law that small-business owners and entrepreneurs need to be familiar with is intellectual property, which is important to all businesses and entrepreneurs. It can be a very valuable part of any portfolio if properly maintained. Intellectual property covers patents, trademarks, copyrights and to some extent trade secrets. Patents, trademarks and copyrights are all governed by federal statutes. Trademarks and copyrights will also have some state protections. Trade secrets are governed by state laws.

Patents protect inventions and improvements to existing inventions.

Trademarks are brand names and/or designs that are applied to products or used in connection with services. A trademark clearly identifies your product as unique. It might be a single word or combination of words, a symbol, a logo, a design or even a color. Because people make buying decisions based on a trademark, it can be an infinitely valuable business asset. Companies like McDonald’s� or Kimberly Clark (Kleenex� brand tissues) will go to any lengths to protect their trademarks.

Copyrights cover literary, artistic and musical works. Copyrights are grounded in the U.S. Constitution and granted by law for original works of authorship fixed in a tangible medium of expression. A copyright protects creators of original works in the categories of literature, drama, music and artistic expression. A copyright is meant to keep others from copying the work, distributing it, displaying it or performing it without permission.

Trade secrets are proprietary information. This may include a confidential formula, pattern, compilation, program, device, method, technique or process. It is not common knowledge, but it is not protected by a patent.

Patents and trademarks are registered with the U.S. Patent and Trademark Office. Copyrights are registered with the Copyright Office, which is part of the Library of Congress.

The next several posts will discuss specific types of intellectual property.

Selling a Business

Business owners considering selling their company should utilize as many resources as possible.  The New York Times Small Business Page (see link here) has a wealth of information on this topic.  The linked article provides a good overview of what to consider when first thinking about selling a business.  While not detailed, this article, along with additional resources at the site, are a good starting point.

Some good information in the referenced article addresses three questions owners should ask themselves:

 

Can Your Business Be Sold?

Many elements of a business make it attractive to buyers. For example, does it have a solid history of profitability, a large and loyal base of customers, a competitive advantage (intellectual property rights, long-term contracts with clients, exclusive distributorships), opportunities for growth, a desirable location and a skilled work force?

Are You Ready to Sell?

Make sure you are ready, both financially and emotionally. Think about what life will be like after the sale. What will you do — not just for money but also with your time? Many business owners suffer real remorse after handing over their business to a new owner.

Here are a few indicators that it may be time to move on:

¶It’s not fun anymore. Burnout is a very real issue for business owners, and an entirely legitimate reason to sell.

¶You’re not inclined to invest in growth. You may be comfortable with the current size and profitability of your business and have no desire to make the capital expenditures necessary to take it to the next level.

¶You feel your management skills are overmatched. It is not uncommon for business owners to build their business to a certain point and then realize they lack the skill set required to go further.

What’s Your Business Worth?

Many owners have no idea. On one end of the spectrum, for example, was a client who owned a professional services firm. She felt the firm was worth more than $1 million. After a lengthy search, a buyer paid her less than half that amount. Then there was a client who was about to sell his I.T. company to an employee for $200,000. After advertising the business for sale nationwide, he sold it for one dollar shy of $1 million.

Selling a business is both art and science, and in no other area is this more evident than the valuation. While every seller wants to achieve maximum value, setting an asking price that is too high signals to buyers that you may not be serious about selling.

While there are a number of methods used to value a business, the most common formula for smaller transactions is a multiple of seller’s discretionary earnings (S.D.E.). This type of market-based valuation involves recasting profit-and-loss statements — adding back owner’s salary, perks and nonrecurring expenses — to find the S.D.E. of the business and then using comparable data for similar businesses to arrive at an appropriate multiple. (the rest of the article can be found here)

Of course, Apex Counsel also provides substantial resources for business owners.

Analyzing the Sale and Closing Provision of a Business Purchase Agreement

Continuing the review of Purchase Agreements in the sale of small businesses.  The initial post of this series briefly summarized each section and looked at the relatively simple introductory clause to a purchase agreement.  This installment will analyze what is generally the second part of a purchase agreement, the Sale and Closing.

In brief, this section will establish the logistics for the closing and what the price and terms of payment will be.  The structure of the sale (asset or stock purchase) will be determined as will the form of consideration (cash, promissory notes, stock, or a combination).  The primary components of the Sale and Closing section are as follows:

a.       Assets and Liabilities Subject to Sale

In an asset sale, the agreement will detail the assets to be sold to the buyer and those that will be retained by the seller.  A common, yet not exhaustive, list of such assets will include:

  • Personal property;
  • Real property
  • Inventories;
  • Accounts receivable;
  • Contracts;
  • Intellectual property;
  • Insurance benefits;
  • Seller claims against third parties;
  • Cash and short-term investments;
  • Shares of capital stock held in treasury; and
  • Minute books and stock records.

Similarly, an asset purchase agreement will specify the liabilities buyer will assume and those the seller will retain.  The following is a non-comprehensive list of liabilities that will be included or excluded in the sale to some degree:

  • Accounts payable;
  • Liability to customers under warranty agreements;
  • Liability under contracts;
  • Tax liabilities;
  • Environmental, Health and Safety liabilities;
  • Liabilities related to employment and employees;
  • Shareholder liabilities;
  • Liabilities related to indemnification of directors and officers; and
  • Liabilities related to compliance with legal regulations.

Due to the nature of a stock purchase, a stock purchase agreement will not provide as much detail as an asset purchase agreement in this section, but will identify the number and price of shares that will be sold.  This determination is generally straightforward, but can be complicated somewhat when stock options and warrants are involved.  In these situations, the parties will need to determine whether such options will be assumed by the buyer and included as part of the transaction, which may require an increase in the price paid.

b.      Consideration.

There are three typical ways a business buyer can pay the agreed-upon purchase price in an acquisition, with cash being the prevalent means of payment in a small business transaction.  Cash is often desirable and works well because of its simplicity.  However, payment in cash will need a well-funded buyer and will also result in an immediate taxable gain for the seller.

A promissory note from the seller to the buyer will often be used in conjunction with cash (ie, the buyer pays a down payment and the seller finances the remaining amount of the purchase price).  A note may be advantageous for both parties, as it frees up cash for the buyer and enables a sale in instances where the buyer is unable to secure the full payment in cash.  Further, the seller may receive some tax benefits if offering a note.  If the purchaser is an entity such as an LLC, partnership or corporation, and the seller is providing financing, it is usually a good idea to have its principals personally guarantee the note.

A third means of payment arises when the buyer is a corporation and offers stock as either a full payment, or in conjunction with the other forms of consideration set forth above.  Buying with stock, however, imposes numerous additional burdens on the sale, and introduces both tax and valuation issues into the transaction.

Regardless of the form the consideration takes, the purchase price will often be reliant on earnouts.  An earnout provision makes some of the payment to the seller contingent upon the purchased company reaching certain financial goals in a specified time after the closing.  Earnouts are a way to overcome a stalemate when the parties disagree on the company’s valuation.  Using earnouts, however, creates the very real danger of a future dispute regarding the contingent payment.

Another form of contingent payment arises when the parties agree on the value of the company, but there is a substantial period of time between signing the agreement and the closing date.  In contrast to earnouts, this provision is not dependent on future business operation but rather protects the parties from a fluctuation in the value of the assets from the time the agreement is signed until the time of closing.  While this amount can be substantial in sophisticated transactions between large companies, the difference in price with smaller business is often too insignificant to be worth the trouble.

Finally, the consideration section may utilize a cash (or stock) holdback provision.  Used by buyers with strong bargaining power, such a clause enables a purchaser in a seller-financed transaction to divert note payments for seller’s breach of Representations and Warranties.

c.       Allocation of Purchase Price.

In an asset purchase agreement, the buyer and seller will need to allocate the purchase price.  This important provision determines the parties’ tax consequences from the sale by establishing the seller’s gain/loss on each asset and the buyer’s basis for each purchased asset.  Misallocating prices can have adverse consequences on both parties and, because it affects the depreciation of assets for the buyer, can be felt for years after the transaction closes.  There have been instances where a buyer has reported depreciation deductions on its tax returns based on asset appraisals that were different than what the seller reported.  Where the amounts are substantial, this will raise the suspicion of the IRS, and courts have held that, regardless of the buyer’s good faith appraisal estimate, the price allocated to assets in the purchase agreement control.

d.      Closing.

This provision will set the date, time and location of closing and will establish the obligations of the parties as of closing.  It will state what the seller shall deliver to buyer at closing, which may include:

  • Bill of sale for personal property;
  • Assignment of assets such as contracts, leases, and intellectual property;
  • Deeds for property;
  • Employment agreements for retained employees;
  • Noncompetition agreements;
  • Certifications of no material adverse change between the date of signing the agreement and closing; and
  • Resolutions and consents of the seller’s board of directors approving the transaction.

Buyer’s obligations to deliver at closing include:

  • Cash payment;
  • Promissory note;
  • Assignment and assumption agreement;
  • Employment agreements;
  • Noncompetition agreements;
  • Certification of accuracy of buyer’s representations and warranties in the purchase agreement; and
  • Resolutions and consents of the buyer’s board of directors approving the transaction.

The next installment will look at Representations and Warranties.

See Apex Counsel for additional information

Understanding Stock and Asset Purchase Agreements for the Sale of a Business

Throughout a series of posts, I’m going to analyze the basic provisions of purchase agreements for the sale of a small business. 

Small businesses can be sold in two basic ways: a stock sale or a sale of assets.  Generally speaking, in a stock sale, the buyer is getting the “whole” business whereas in an asset sale, subject to negotiation, the buyer is picking and choosing the assets and liabilities of the business that it will keep and the seller is retaining the rest.  Put another way, in a stock sale, the seller is generally washing its hands of the business at closing while in a sale of assets, the seller will still be intertwined with the business for a period of time.  In actuality, stock purchases still require the seller to be on the hook in various ways, including indemnification provisions, earnouts, and holdbacks, all of which will be discussed later.  In a very general sense, however, a stock sale can be thought of as more of a wholesale divestiture of the business.

Stock Purchase Agreements (“SPAs”) and Asset Purchase Agreements (“APAs”) will differ in numerous ways, but both will address similar major issues.  Here, I will outline the eight provisions at issue and in the next few posts, I will examine each of the clauses in more detail.

1.  Introduction.  Establishes the names of the parties, the nature of the agreement, and notes the factual background that is the subject of the agreement.

2. Sale and closing.  Defines the terms of the sale, the price to be paid, and the manner in which it will be paid.  This section also sets the time, place and circumstances of the closing, which is the time when title will transfer from the seller to the buyer and consideration will transfer from the buyer to the seller.

3. Representations and warranties.  In this generally lengthy section, the parties set forth the representations and warranties on which the parties are relying for the basis of the sale.  Representations are statements made by one party at the time the contract is entered into, regarding a fact which is influential in bringing about the agreement.  A warranty is a promise that a statement of fact is true. 

4.  Preclosing covenants.  This section states the parties’ promises todo or not do certain things prior to closing.  The seller bears the bulk of the responsibilities here, and will generally be required to operate the company in the ordinary course of business, among other promises.

5. Preclosing conditions.  Unlike a covenant, which is a promise, conditions are things that must be satisfied prior to closing.  If any required condition does not occur, a party may walk away from the deal.

6. Postclosing covenants.  As with preclosing covenants, these are things that the parties are required to do, or must refrain from doing, after the closing and may include employee issues, continuing assistance of the seller, noncompetition issues and further assurances, among others.

7. Remedies and indemnification.  This section will set forth the amount of time after closing that the representations and warranties will survive.  It will also specify how the parties will indemnify each other for breaches of the Agreement. 

8. Miscellaneous.  The “boilerplate” section which, nonetheless, contains important provisions related to assignment, governing law, jurisdiction, and parol evidence, among others.

 

 

 

 

Facebook in the Law (“The Facebook Password Law”)

Thought I’d put forth a recurring segment on one of the most ubiquitous companies in the world.  A company with such extreme recent explosive growth like Facebook is ripe for viewing numerous issues related to small businesses.  The first issue we’ll look at is an Illinois law that will be enacted in two months and should be of concern to Illinois employers.  Read on for more details.

Effective January 1, 2013, a new Illinois law will make it unlawful for employers to ask both employees and prospective employees for their passwords to Facebook, LinkedIn and other social media accounts. The Illinois Right to Privacy in the Workplace Act (sometimes called the “Facebook password law”) also prohibits employers from requiring employees and prospective employees to provide access to such networking sites.

While it may seem obvious that employers shouldn’t be allowed to obtain an actual password for an account (and, it has been pointed out that doing so may violate other employment laws), the law came about in part from people complaining that they were, in fact, denied employment because they refused to provide such passwords.

Although the law will prohibit such direct access to individual’s accounts, employers will still be able to search Google and other search engines as part of a background check.  Moreover, information on Facebook that is not restricted by the user may also be viewed.  With the constant changing of Facebook’s privacy settings, potential employees should ensure that these are properly set.

The new law also has no bearing on employers’ policies regarding the use of social media, personal email and general Internet use while at work.  Illinois is just the second state (Maryland was first) to enact such legislation, but others are expected to follow.

Crowdfunding For Small Businesses

“Crowdfunding” is a means of raising capital for early-stage companies by obtaining small amounts of equity from numerous investors.  Websites like Kickstarter have made it relatively easy for start-up companies to present their proposal and request funds from anyone willing to invest in their vision.  However, nothing comes without a price and many companies who try to raise capital this way can run up against SEC rules that restrict public financing of this sort.

Earlier this year, President Obama signed the Jumpstart Our Business Startup Act (the “JOBS Act”) which was intended to ease the SEC regulatory burdens on small businesses.  An important part of the Act relates directly to crowdfunding.  Specifically, the Act allows a business to raise as much as $1 million over the course of a year from an unlimited number of investors.  While there are still numerous restrictions on the businesses raising funds, the Act is expected to make such types of capital raising easier for small businesses.  

Crowdfunding through the JOBS Act is  a work in process.  The Act calls for the SEC to propose specific rules and regulations by the end of the year.  Still, the Act is substantial legislation with potentially large ramifications for start-ups.  There will be much more to report over the coming months so stay tuned.