Sales agreements start with a conversation and end with a contract. Each
line of the sales document can have huge ramifications on the value of the deal
for the buyer and the seller. But before a
company even begins sales negotiations, it
should prepare and review all of its existing documentation that supports its business operations and can impact its selling
price.
“Companies should periodically review
their contracts and documentation to be
certain that they accurately reflect their
relationships with suppliers, vendors and
customers, and current methods of doing
business,” says Howard Berrington, partner at Levenfeld Pearlstein, LLC. “This is
particularly important when preparing for
a sale.”
Smart Business spoke with Berrington
about how to use documentation to position your business for a successful sale.
Why is it beneficial to review contracts and
documentation before putting a company up
for sale?
Contracts are typically considered assets,
such as agreements that lock in suppliers
of goods and services for extended periods
of time at favorable pricing. However, contracts can also be liabilities, like a long-term agreement to supply a substantial
customer with goods and services at less
than a company’s standard profit margin.
Existing contracts could also be obstacles to completing a sale. Many written
contracts provide that neither party may
assign the contract without the prior written consent of the other party. If the supplier, vendor or customer will not consent
to the assignment or requests additional
financial concessions or accommodations,
the buyer may reduce the purchase price
or make the sale contingent upon receiving
the consent. If the seller proceeds with the
transaction without assigning the contract
and after the sale has no ability to perform
the contract, the seller may be liable for
damages for breach of contract.
If a business decides to structure the
transaction as a sale of stock, it doesn’t
need to receive an assignment of the contract. However, many contracts have termination rights and other consequences
upon a ‘change in control.’ Also in a stock
sale, the buyer assumes all of the seller’s
known and unknown liabilities. The risk
associated with unknown liabilities may
result in a reduced purchase price, deferral
of a portion of the purchase price and/or
contingencies to the payment of a substantial portion of the purchase price to the
seller.
How can companies’ contracts enhance their
value before they go to market?
When companies do business on a handshake, the buyer may want to defer a significant portion of the purchase price contingent upon the customers and business
retained after closing. Many times, the
transaction will be structured as an ‘earn-out,’ where the deferred portion of the purchase price is based upon the business,
sales, customers or profits retained by the
buyer. This form of contingent purchase
price is not advantageous to a seller.
This issue should not arise if the customers are contractually committed to the
company for a period of years. When written contracts exist, it is very easy for the
seller to demonstrate the cash flow and the
profits, which the buyer should realize as a result of the sale.
How should companies structure their contracts with suppliers in preparation for a
sale?
It’s always preferable to enter into contracts that are freely assignable without the
consent of the other party. But if this provision is reciprocal, this type of agreement
may or may not be advantageous. Another
alternative is to make the contract assignable upon a sale of substantially all of the
company’s assets out of the ordinary
course of the company’s business.
What else should companies consider before
they look to sell?
Before a sale, a company should consider what assets it may wish to exclude from
the sale. For example, a buyer may not pay
very much for the potential revenue or
profits from a new line of business. If this
line of business is not competitive with the
buyer, it may be preferable to spin it out to
the seller for continued post-closing operations.
Similarly, when the purchase price for a
business is based on a multiple of revenue
or profits, capital assets may not be valued
at their highest level. We recently worked
with a company with real estate that was
far more valuable as a stand-alone asset
than as a portion of business’s assets.
Before the sales discussions, the real estate
was spun out into a separate entity and
leased back to the company. Eventually,
the company was sold to a competitor who
wanted to consolidate a significant portion
of the business operations into its existing
facilities. The real estate was subsequently
sold to a developer for purchase price far
above what the competitor would have
paid.
HOWARD BERRINGTON is a partner at Levenfeld Pearlstein,
LLC. Reach him at (312) 476-7504 or [email protected].
