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Just as you planned for the launch of your company, you need to understand how to sell a business.
Whether the sale of your company is your endgame from the outset, an unanticipated development due to a business downturn, or an intriguing offer that has dropped into your lap, you can maximize your exit opportunity through established best practices.
The key to achieving an optimal outcome from the sale of your company is to be prepared for the opportunity when it arises. You can’t seize the opportunity if, for example, your company is sent into a fit of seizures trying to respond to reasonable requests for due diligence information from a potential buyer. The length of your response time could be interpreted as a proportional measure of your organizational health, either bolstering or deflating the buyer’s interest.
Planning well in advance for the potential sale of your company can address preemptively many issues that may arise for your company and your prospective buyer.
Follow these six steps to promote a well-planned M&A exit for your company, which will help optimize the result of this all-important liquidity event:
1. Good Organization: How to Sell a Business
When thinking about how to sell a business, keep in mind that a potential buyer doesn’t want to inherit a mess. Chaos does not breed credibility, confidence, or a clean deal. Don’t fool yourself – first impressions matter…a lot. Buyers are attracted to companies that display a clean front room because they reflect a disciplined management team with a well-organized operational system – important tools to promote a smooth transition for the acquirer. Cast your company in the best possible light by instituting the following organizational guidelines:
Run a tight ship from day one.
You should establish a document management system for your corporation at incorporation (if not sooner). Organize your documents electronically and in the Cloud, grouping them into categorical folders (e.g. corporate records, employment, insurance, agreements, etc.), and use a consistent naming convention for the various files (e.g., “Date – Document Name – Draft #/Execution Status”). This level of organization will facilitate the eventual creation of a due diligence data room and the buyer’s due diligence review, important elements to building buyer confidence.
Constantly monitor the status of key documents.
Ensure that your legal documents are current, executed, and easily accessible, including those related to the formation of your corporation, non-disclosure agreements, proprietary information agreements, financing documents, vendor contracts, leases, and licensing agreements, just to name a few. Buyers will scrutinize the status and details of these documents and you need to reassure them that all is in order.
Have a handle on the nature and terms of all agreements.
It’s no surprise that buyers want to know exactly what they are getting themselves into, and this certainly applies when it comes to your existing contracts. The buyer will want the skinny on each and every document that you have signed on the dotted line for your company. What do your agreements say about contract assignments and change of control transactions? Consent requirements? Post-termination obligations? How many agreements are there and what are the timing issues? Be prepared to outline the answers to all of these questions in order to present a clear picture of all contractual obligations and associated transition and timing requirements.
It is never too late to institute a corporate cleanup.
Even if you have not been proactive about organization, don’t be overwhelmed at the thought of pregame or, in a worst-case scenario, midgame corporate cleanup. Enlist the assistance of experienced corporate counsel and financial advisors to help get your corporate house in order before you start entertaining prospective buyers. They have “been there, done that” and know exactly what to do to whip your business into the best possible shape to court interested suitors. The bottom line is that an eleventh-hour organization is still better than no organization.
2. Know what you own before you get owned
Do you know what buyers hate more than anything? Surprises. Especially post-game ownership surprises. If a buyer encounters such a jack-in-the-box in your corporate playroom, then you can expect one thing: “Pop goes your deal!” And potentially, “Hello litigation!” In order to avoid such an ownership explosion, confirm what your company owns by doing the following:
Lockdown what your company owns.
Your company’s most valuable asset oftentimes is its Intellectual Property, an issue that should be at the front of your corporate mind at all times. Anticipate that this will be the initial focus of your buyer’s questions and resolve any open issues in this area long before any potential sale of your company. Be certain that all Intellectual Property filings surrounding patents and trademarks have been accomplished and related licensing agreements have been secured. In addition, make sure that Proprietary Information and Inventions Assignment Agreements are in place with all employees, consultants, and advisors. The buyer will require signed agreements, even if certain employees, consultants, and advisors are no longer with the company.
Know exactly who owns your company.
It is critical that your Capitalization Table is spot on, reflecting all ownership of your company down to the last Stockholder and the last share of Capital Stock. All shares of Capital Stock and other equity grants, including all Convertible Securities, should be properly approved and documented, with proof of all related securities filings.
Be aware of any approvals needed to sell.
Do not lose sight of the fact that any exit deal that you engineer may need to withstand the scrutiny of your company’s Board of Directors and Stockholders (and sometimes debt holders). Familiarize yourself with the voting requirements set forth in your company’s charter, Bylaws, and Stockholder agreements, which will govern any change of control of your business. Anticipate any potential roadblocks and prepare accordingly to advance the deal.
Model the potential Liquidation Waterfall.
Enlist the assistance of experienced legal counsel to create a financial model for your proposed exit transaction, including the varying rights of debt and equity holders and the resulting distribution of exit proceeds from the Liquidation Waterfall. Having a clear understanding of how the money flows under different deal structures will place you in an excellent position to analyze quickly alternative purchase price offers
3. When thinking about how to sell a business you should anticipate what the buyer wants
Put yourself in the buyer’s shoes and take a good, long look at your company. Do you like what you see? And, more importantly, would you pay good money for it? Anticipate the following questions and be prepared to address the related concerns:
What makes your business attractive?
Identify the most attractive features of your business and hammer them home to potential buyers. Strong selling points can include having a valuable brand, unique intellectual property, a dynamic management team, or encouraging profit margins. Emphasize your strengths in order to attract and hold the interest of potential buyers.
Do not overlook the importance of your image on the Internet, the #1 source of information about your company. Be real: the buyer is going to “Google” your company, and you will need to focus on these points to ensure that it will like what it sees:
- Create a brand and website that are dynamic and encourage interest from your target market;
- Improve your search engine ranking so that your company appears towards the top of the list;
- Ensure that your company is cast in a good light. If the top search results only reveal damaging news stories or financial doom and gloom, then it probably is not the best time to sell; and
- Demonstrate that you have a following on social media by posting regularly on your accounts, including LinkedIn, Facebook, and Twitter.
What is the fair value of your business?
Your desire to sell your business for a healthy return obviously is going to be counterbalanced by the buyer’s determination not to overpay for your business. Consider retaining an appraiser to help determine the value of your company in order to set a realistic sales price. The value of proactively obtaining a valuation of your business is twofold: (1) you may gain credibility with prospective buyers for your honesty; and (2) you will know if you are in a good position to sell. But remember that the buyer may not view the valuation as objective (especially if you pay for it), and you may not like the valuation number – so tread carefully here. A valuation might give you a realistic picture of the value of your company, and whether you need additional time to improve its performance.
Are your accounting records clean and in good order?
Assume that your buyer is going to want to see at least a three-year accounting of your company’s financial records. Although your tax returns might do the trick, you likely will generate better credibility by presenting formal financial statements prepared by an accountant rather than created in-house. Convey the true profitability of your company by separating out and providing documentation for nonoperational expenses like personal automobile leases paid for by the company, and infrequent expenses such as those related to moving or one-off occurrences. This separation will assist your buyer’s analysis of your company’s recurring cash flow. You also might consider hiring an auditor to help you identify and solve any financial issues before your records are scrutinized by a potential buyer.
How will the sale impact existing business operations?
Buyers know that there could be some slowdown of business operations as ownership and management change hands, but you can reassure them of a trouble-free transition by having a business succession plan in place and being available to continue working or offer your guidance after the sale has been completed. Reduce the anxiety that the buyer may have about the loss of key talent, especially your own, by taking these steps long before your departure:
- Reduce the significance of your role by cultivating talent within your organization and promoting them to key management positions;
- Create management teams that autonomously reach effective decisions;
- Secure the commitment of key employees to continue with the company after the sale through strong financial incentives;
- Set uniform business practices that will withstand regulatory and financial audits and establish business continuity; and
- Slowly remove yourself from critical business operations to reassure the buyer that your presence is not essential to the continued success of your company.
A motivated buyer also may put financial and equity incentives in place as part of the deal, in order to facilitate the exit transition.
Why do you want to sell your business?
It is one thing if a buyer approaches you, but it is an entirely different thing if you are courting buyers. Indulge their justifiable curiosity about why you are looking to exit your business. Being able to present a thoughtful, logical response will not only allay the fears of the potential buyer but will solidify your own commitment to the timing of your exit.
4. Assemble your M&A team
Once you have decided to sell your company, plan on it being an intense process that will involve a significant expenditure of time, energy, and resources in order to advance and close the sale transaction. Take the time to assemble a trusted and experienced team to help you seal the deal:
- Internally, you will need to convene a tight circle of key executives or personnel who will assist you in responding to buyer requests for information. They also will help identify and secure key employees who need to stay on board after the sale in order to make the acquisition attractive to the buyer;
- Externally, take the time to carefully interview and hire experienced experts in merger and acquisition deals, including investment bankers, attorneys, and accountants, as well as consultants, an escrow agent, and a paying agent, as necessary.
- Initial discussions with your key staff and outside consultants should be prefaced by their execution of a non-disclosure agreement (if they have not already signed one), and limited to only what they need to know in order to execute their piece of the exit process. Emphasize to every individual involved the importance of keeping your intention to sell private and confidential. When thinking about how to sell a business, do not underestimate the negative effect premature disclosure of the possible sale might have on your employees, suppliers, and customers, all to the potential detriment to the value of your business if such information prompts a mass exodus (e.g. of employees or customers).
5. Make a list, and check it twice
Your attorneys can help you prepare and maintain a deal checklist that identifies key players, responsibilities, issues, and deadlines, in order to ensure that every transaction step is completed from the applicable deal and legal perspectives. These steps include the deal non-disclosure agreement, letter of intent, due diligence, document preparation and negotiation, closing, and post-closing matters. It is important that due diligence materials stay organized and a consistent response style is maintained, because the documents and information involved tie directly into the main acquisition agreement, including its representations and warranties, exceptions thereto, and detailed schedules of your company’s information as the seller. Specific due diligence items that need to be confirmed include the following:
- Certificate of Incorporation, Bylaws, and Good Standing Certificates are in place;
- Corporate records are up to date;
- Board and Stockholder consents have been compiled and fully executed;
- Capitalization Table is up to date and all Stock Certificates have been accounted for;
- Subsidiaries are identified and their current status disclosed;
- Documentation of ownership of Intellectual Property, including Patents, Trademarks, Proprietary Information and Inventions Assignment Agreements and key licensing agreements;
- Insurance policies are current and all outstanding claims and lawsuits have been disclosed;
- Supplier, vendor and customer contracts and leases are identified;
- Employment agreements, which include non-compete provisions where appropriate, are current and executed; and
- Non-disclosure and Proprietary Information and Inventions Assignment Agreements have been executed by all relevant parties.
6. How to sell a business: exit tax
It is important to seek tax advice early on in the deal process so that you understand the financial consequences that will result from different deal structures. A tax advisor will assist you in identifying your best options when structuring a deal, minimizing your tax burden, and maximizing your after-tax proceeds. Remember that the buyer will have its own financial objectives, so there often is some negotiation and compromise when it comes to deal structure.
Issues to discuss with your tax advisor include:
The Qualified Small Business Stock Exception.
If your domestic C-corporation qualifies as a small business under Section 1202 of the Internal Revenue Code, then any stock that you have held for at least five years may open the door to a capital gains exclusion of up to 100% (note that the actual exclusion depends on, among other things, the exclusion amount in effect when the stock was issued). This exclusion obviously provides an enormous tax advantage at the time of a business sale. Ideally, you formed your business entity with this exception in mind, as it is not available to S-corporations or LLCs. If not, then discuss with your advisors whether it is possible to separate out part of your business that would qualify for this exception and treat it as a separate business in order to derive some benefit from this tax exemption.
The ESOP Plan.
Liquidation Waterfall allows a C-corporation to reinvest the cash proceeds derived from the sale of its business into an employee stock ownership plan (ESOP) on a tax-deferred basis. You pay capital gains on distributions, but if you hold onto the securities until you die, then you get a “stepped-up” tax basis and completely avoid paying the capital gains tax on the rollover of the sales gains into the ESOP. Although an ESOP has many potential tax benefits for owners of both C and S-corporations, they also have their limitations and drawbacks which should be discussed with your tax advisor.
It is a well-established principle of success that you should always “begin with the end in mind.” So, act smart from the start and plan far in advance for your M&A exit. If you run a clean house, then you will be in a better position to move quickly on any acquisition offer that comes your way. After all, you wouldn’t want to miss out on what may be the biggest business deal of your life.
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