Are you considering selling your business? The negotiation of terms, structure of the deal, and getting to closing can wreak havoc on a seller’s nerves. But, there are things you can do ahead of signing a term sheet which will make your life easier before you start the transition from owner to seller. Take a look at our suggestions below for getting ahead of the process.
Get ready to pay off the debt
Many buyers don’t want to purchase a business that has debt. Accordingly, they may request a “debt-free” deal. When we say debt, we mean loans from financial institutions or private lenders. (Ongoing contracts which the company is obligated to pay are not a big concern.) If your business has high capital needs, or is in the process of an expansion, there may be a good chance your company carries debt. If you have a prospective buyer who doesn’t want to inherit that debt, you may be required to pay it off before closing. If possible, it may be a good idea to pay it off before the deal even starts.
There are several benefits to paying off the debt early. The most obvious is that you will pay less in accumulated interest by paying it sooner. Additionally, the deal itself will be less complex: lawyers who charge hourly may get involved in supervising the loan payoff process, and that can get unnecessarily complicated. Lastly, it simplifies the negotiation of the sale price. Buyers will typically insist on a reduction in the purchase price by a dollar-for-dollar amount on any outstanding debt. Tracking the payoff amount and subtracting it from the sale price is a process which needs to be constantly monitored and adds complexity – and often higher legal fees – to a deal.
Despite the benefits of paying off debt early, keep in mind that if the sale of your company falls through, you may be left short of cash needed to continue operating the business. If you have significant debt and need the proceeds of the sale to pay it off, then you should wait until closing. However, even if you do wait until closing, you can still coordinate with your lender(s) to make sure they are prepared to give you the documents you will need to prove that the debt is paid. This will usually include a statement of the payoff amount and a payoff letter signed by a corporate officer of the lender.
Gather the corporate records
Remember that lease for the copier you signed in 2011? I know, probably not. Chances are it has renewed automatically without much attention for the past decade. And it’s not something you pay much attention to. So why does it matter now? The simple answer is disclosure. When you sell your business – especially if that sale is structured as a stock sale – the buyer will want to know what kind of contracts and other obligations the company has. The most dependable way to do that is by asking to see every contract that is still in effect.
There’s good reason to get all of your corporate records, contracts, and filings together before you hire an attorney. During the negotiation of the sale and in order to work towards closing, you’ll be busy doing a lot of things. Your lawyer will be requesting a veritable library of documents from you. Added to that, the documents will have to be in electronic form, so they can be easily produced for the buyer and his or her attorneys. Producing those will be time-consuming. The sooner you start getting them together, the easier it will be.
Coordinate with your co-owners
If you co-own your business with other people, you may have to get their approval before making a significant decision like selling a controlling stake in the company. Ideally, everyone is on board with the sale, and you’ve been having open discussions with co-owners about your exit plans. Your co-owners may also be selling their stake in the company, or they may be staying on while you depart. Either way, you likely have agreements in place – a shareholder agreement or buy-sell agreement – which mandates how and when you can sell your stake in the company.
Another consideration to keep in mind is whether anyone can claim a right to future ownership in your company. Have you issued stock options, restricted stock, or another type of equity compensation which entitles someone to an equity stake in the company? If so, at the very least that fact will need to be disclosed to the prospective buyer so he or she can make an informed decision about their purchase.
Review some representations and warranties
We totally understand that you’re probably not super interested in reading through complex legal documents. The reason we suggest taking a look at some sample representations and warranties is that you will have to anyways, and it is probably better to familiarize yourself with them so that (i) you can begin collecting information needed to comply with them, and (ii) you can shorten the amount of time you spend with your lawyer, who will want you to understand and appreciate what you’re agreeing to. As an example, you might read a representation that says the company’s tax returns have been filed for the past few years, and that there are no lingering tax liabilities. Is this a true statement? Or did you miss a year on your returns? It’s a fair question, and by looking at it ahead of time, you can think about how best to correct it before the deal starts to come together.
Think about your role post-sale
When you sell your ownership stake in your company, are you going to ride off into the sunset and never look back? A lot of former business owners are looking to shake off the burden of everyday corporate decision-making, but perhaps aren’t ready to abandon the industry just yet. If that sounds like you, then you might be a good candidate for staying on as an advisor. If an earn-out is part of the deal in selling your company, then it’s in your best interest to see that the business does well over the coming months and years, since your compensation will depend on the company’s performance, even if it’s under new management.
Are you going to hold papers after the sale, or are you getting paid in cash? A lot of buyers will finance the purchase of a business, and sometimes they will request that the seller accept payments over a number of years. If that sounds like your plan, then a big part of your job will be tracking payments from the buyer and making sure he or she sticks to the terms of the loan agreement. This process can get contentious very easily, and for this reason we encourage our clients not to act as lenders in the sale of their business.
Large sums of money often come with large estate planning or financial implications. So, with your cash in hand, one of the wisest decisions you can make is to visit an estate planning attorney and a financial advisor. You’ve earned it, so make sure your money continues to work for you. Whichever path you choose after closing, it’s better to start thinking about your options early; the sale of your business will take up plenty of your time and these considerations will crop up soon.
Finally, every deal is unique, and presents challenges which you should work through with trusted professionals. Accordingly, not all of the suggestions above may apply to you. To talk about the succession plan for your business, reach out to an attorney at Peak.
Bob Baker is a founding partner of Peak Corporate Counsel. He has worked with numerous founders on a variety of issues specific to startups. When he’s not advising innovators, he can be found at networking events, playing rugby, or hiking with his kids.
This article is for informational purposes only, and may not be considered legal advice.