How owners can prepare to sell the business Featured

11:07am EDT July 8, 2011
How owners can prepare to sell the business

Eventually, most businesses owners face a decision — whether and when to sell the business. Here, advice and support from competent consultants is paramount to enhance the probability of a successful sale.

Smart Business spoke with Douglas F. Landrum, a corporate transactions lawyer with Jackson DeMarco Tidus Peckenpaugh, to obtain insight into some practicalities of selling a business in today’s climate.

What should an owner do to prepare for a sale?

Owners need to assess current business practices. A good way to identify issues that may inhibit a sale is to perform a pre-sale due diligence audit of the business. Any issues discovered may be resolved prior to the sale process. Any issues not resolved prior to the sale should be disclosed early in the sale process. Disclosure of issues builds trust in buyers that the selling owners are honest and forthcoming. Leaving problems unresolved and undisclosed may seriously impair a successful deal.

Who should be involved in the preparation for a sale?

A competent CPA needs to get the accounting close to compliance with GAAP. Clean books can instill confidence that the business will perform as represented. The owners should engage a corporate lawyer to anticipate issues arising in the sale process. Sometimes corporate records need to be cleaned up before the sale process. Many times management will know who the potential buyers are; nevertheless, an investment banker or business broker who can bring two sides together may be very beneficial.

Once a potential buyer is located, how is a business sale accomplished?

Prior to discussions with a potential buyer, a confidentiality agreement should be executed. Then, business sales break down into three overlapping phases. First, the parties negotiate the basic terms of the sale in a letter of intent. Next, the buyer conducts due diligence. Finally, the parties negotiate final documentation and close the sale.

What is the purpose of a letter of intent? Should a business avoid the expense of a lawyer at this stage?

The letter of intent states basic business terms of a sale prior to the preparation of final documents. Elements of a letter of intent will establish expectations that are difficult to change in final documentation. The basic deal structure, addressed in the letter of intent, as a stock or asset sale, or merger, will have profound tax consequences.

A letter of intent usually contains one or more binding provisions that will affect a selling business significantly. For example, a letter of intent may contain an exclusivity provision restricting discussions with alternative buyers and a break-up provision requiring payments if the deal is abandoned and a substitute buyer is found. In most cases, after a letter of intent is signed, the parties have a duty to act in good faith to move toward closing. Review by a corporate lawyer at this stage is critical because his or her role is to look out for pitfalls in the deal structure and to assess the impact of binding provisions.

What can owners expect during the due diligence process?

After the letter of intent is signed, the buyer usually sends out a multi-page information request covering all aspects of the selling business as part of the due diligence process. Buyers expect sellers to dig out the requested information and provide it to the buyer for evaluation. Today’s technology provides new ways to handle diligence information; it may be delivered over the Internet to electronic due diligence rooms and preserved in electronic form. Delivery of information electronically amplifies security and privacy concerns.

Why does a selling business need to prepare ‘schedules’ if the information has already been provided in due diligence?

A typical purchase agreement will contain distinct sections including basic terms of sale, representations and warranties, covenants related to the transaction, conditions to closing, indemnification provisions and covenants not to compete. Representations and warranties and indemnification provisions constitute the most negotiated elements of an agreement. Representations and warranties may be limited by exceptions provided in ‘schedules.’ Preparation of schedules may seem frustratingly repetitive of due diligence deliveries, but the purpose is different — to establish clear disclosures protective of the seller rather than the buyer. Sellers should understand that schedules serve to limit claims of false or misleading representations and warranties.

Why does the buyer insist on a holdback, escrow or payment of part of the purchase price with a note?

A hold back, escrow or promissory note constitutes a deferred payment amount to provide the buyer with a source to offset claims against the seller. Sellers should understand that cash delivered at closing may be the only proceeds of the sale that the sellers will receive. Many buyers will look for any excuse to deduct damages from any deferred payment amount.

Do you have any other observations?

Cooperation by third parties will be necessary. If a seller’s loan needs to be repaid, then the lender should be contacted early. Obtaining payoff demands and lien releases can be cumbersome. Landlords should also be contacted early to obtain consent to assign real property leases.

Finally, a business sale is complex and time consuming. Skill of competent professionals will increase the probability of success. The information here is intended to provide insight into the sale process for business owners contemplating a liquidity event.

Douglas F. Landrum, shareholder, is a corporate transactions lawyer with Jackson DeMarco Tidus Peckenpaugh. Reach him at (949) 851-7420 or dlandrum@jdtplaw.com.