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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.

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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.

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.

 

 

 

 

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.

Dissolution of S-Corp

I was recently questioned on the liability of an S Corporation’s owners for taxes owed for a company that was dissolved.  Fortunately, there was a recent on-point IRS ruling addressing the issue.  The ruling held that the corporation’s S status did not terminate even though the corporation was administratively dissolved by the state of incorporation.  For more information, see http://www.mondaq.com/unitedstates/x/198708/Corporate+Tax/IRS+Rules+That+S+Corporation+Not+Terminated+By+State+Administrative+Dissolution

 

 

To LLC or Not to LLC

Over the past two decades Limited Liability Companies (LLCs) have become a preferred means of forming a business entity and with good reason.  LLCs provide their owners with many of the benefits of other types of entities while limiting their detriments.  In many instances, however, an LLC may not be appropriate, especially in early-stage technology or planned high-growth companies (often one in the same), who plan to go through several rounds of financing and, eventually cash out with a sale to a large company or an IPO.  The following is a brief comparison of oft-quoted reasons for establishing an LLC followed by counterarguments suggesting reasons to not set up this type of entity.

 

  1. Formation is quick and simple.  While Articles of Organization must be filed with the Illinois Secretary of State, the process is relatively painless.  The business owner should be prepared to answer some questions prior to organizing, including who the registered agent will be and whether the business will be “member managed” or “manager managed.”  The owner will also need names and addresses for the agent, the organizer, and the members/managers (in small LLCs, these can all be the same person).  The cost to file the Articles is $500.00 and there is an additional $100.00 fee for expedited filing.  In LLCs with 2 or more members, an operating agreement should be entered into, but this is not a requirement and is not filed with the state.  When the Articles are filed and approved by the state (a process that only takes about a day with expedited filing), the LLC becomes an official entity.

 

1a. LLCs may be difficult to invest in.   LLCs provide unique problems for investors that aren’t present in a corporate structure.  A member of an LLC who receives no cash distributions can still be taxed on the business income.  Venture funds often can’t (or won’t) invest in LLCs, especially if they have tax-exempt partners.  Furthermore, the relative simplicity of investment in a corporation via stock purchase is the preferred means of investment for early-stage growth companies.  Finally, LLCs are unable to perform some stock swaps that corporations can.

 

1b. Raising Funds.  Obtaining additional rounds of financing with a corporate structure is substantially easier than doing the same with an LLC. Tax issues can complicate matters when raising additional capital for an LLC that are not applicable in the corporate realm.

 

  1. The administrative burdens are light.  From a corporate governance standpoint, an LLC is not subject to nearly as many requirements as corporations.  There is no necessity to have a board of directors and, therefore, resolutions and written consents are not necessary for company action.  The only major on-going requirement is the filing of an annual report with the Secretary of State.  This is an important step, however as a failure to timely file the report can be grounds for administrative dissolution. 

 

2a. Difficult Agreements.  Although LLCs are easy to form and have substantial flexibility in the way they may be operated, this freedom actually poses a problem when the entity becomes complex.  While a small or self-funded LLC can get by with a basic operating agreement, a larger company (or one that plans to grow substantially) will need to spell out substantial terms in their agreements, making them unwieldy and a poor choice for a growing entity.

 

  1. Flexibility.  Substantially fewer formalities are required to manage an LLC as opposed to a corporation.  For example, an LLC can be managed by a “manager,” or by one or more “members.”  It can provide for a board of directors and employ officers, similar to a corporation, or it can simply be run by its member(s) or manager(s).  Distributions and allocations of profits and losses can be structured in different fashions in the operating agreement, as can the general operations of the business.  There are also few restrictions placed on who may be an owner of the entity and owners may be active in the day-to-day operations of the business.   

 

3a. Bias towards Corporations.  LLCs are becoming more common and knowledge of them is gaining, but major investors do most of their work with corporations and have a level of familiarity with that structure.  Therefore, even if the above issues are worked out, there is a good chance the documentation necessary for the LLC will be difficult for the investors and more time will be spent on due diligence prior to making an investment decision.  In the world of high growth companies, this extra time can spell doom for a company that needs quick funds to stay afloat.

 

  1. Limited Liability.  As the name implies, an LLC structure provides its owners with limited liability meaning that, while the company itself is liable for lawsuits and debts, the individual members (owners) are not personally liable.  While there is a way to “pierce the corporate veil,” most LLC owners can rest assured that their personal assets are safe regardless of what happens with the LLC. 

 

4a. No Argument.  Corporations were the initial vehicle to provide limited liability for their owners.  LLCs also have this benefit and, other than the veil piercing mentioned above, both entities are good choices for limiting personal liability.

      

  1. Tax Issues.  Corporations are generally subject to what is known as “double taxation,” meaning they are taxed on the income they receive and then taxed, again, when paying dividends to shareholders.  LLC’s, on the other hand, are considered “pass-through” entities, meaning that profits and losses are passed through to the owners and the LLC itself does not pay taxes on the gains, thereby avoiding double taxation.  Of course, the owners pay taxes, but when their tax rates are lower than the corporate tax rate, they will enjoy tax savings.  Furthermore, where the business expects to incur losses early in its existence, the members can claim the losses on their tax returns and obtain a personal tax benefit.

 

5a. Is Double Taxation Really a Problem?  As discussed above, LLCs are not subject to double tax.  However, this may not be an issue for many early-stage companies.   Therefore, the actual effects of double taxation may be overblown, as many early-stage companies trying to raise capital and grow quickly do not plan to be immediately profitable and have no profits and/or distributions to worry about.

 

 

 

Care should be taken in choosing an appropriate business entity.  While LLCs are a perfect choice for many start-up businesses, the particular plans of the company owners should be analyzed prior to making a commitment to business formation.