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SELLING YOUR CLOSELY HELD BUSINESS
What You Need to Do Before the Purchase Agreement Arrives

If you’ve ever thought of selling your closely held business, you’ve probably focused your attention on the terms that would be included in the purchase agreement, particularly the purchase price. In addition to how much you would receive, you may have thought about how it would be paid -- whether the purchase price would be paid in cash at the closing, or partially in cash with the remainder paid over time, or partially in cash and partially in stock of another company. You may have thought about whether you would sell for a specified, fixed amount, or whether there might be some additional “earnout” or “upside” based on the Company’s future performance. If you’ve been involved in a prior sale of a business or know people who have, you may even have given some thought to the other provisions of the purchase agreement, such as representations and warranties, and indemnification. But if you are seriously considering selling your closely held business and you’ve been thinking only about the purchase agreement, then you are getting way ahead of yourself.

This article briefly describes four steps you should take if you are considering selling your business. As you will see in the discussion below, you will have to take the first three steps anyway. The beauty of doing them in advance of an actual proposed transaction is that it will facilitate the sale, reduce the level of tension and anxiety that accompanies any sale of a business, and may even result in an increase in the purchase price. For purposes of this discussion, I have assumed that your company is a corporation; however, the same principles apply to the sale of a partnership or a limited liability company.

Step Number One: Get Your Corporate House In Order. By this I mean that you should see to it that your corporate and business records are complete and accurate. In that regard, you should have your attorney review your corporate records, with a view toward confirming that the corporate records can provide answers to the following questions: Who are the stockholders? If there were prior stockholders, were their interests validly transferred to the Company or to the current stockholders? Who are the officers? Who are the directors? Are there signed copies of the Company’s material agreements with third parties? Are there signed copies of any material agreements with key employees? Do any material agreements require the consent of the other party if the Company is sold, and if so, would there be any problem in obtaining that consent? Does the Company have accurate and complete financial records? If the Company is involved in litigation, are its litigation files complete?

The reason this is important is that these questions inevitably will be asked by the purchaser and its counsel in their examination of various business and legal issues relating to the Company. This process is known as the purchaser’s “due diligence” investigation, and during the course of the investigation the purchaser and its counsel will look at the ownership of the Company, its business and finances, its material agreements and liabilities, whether it has complied with applicable laws, the risks involved in purchasing the Company, and the Company’s prospects after closing the acquisition.

In anticipation of the purchaser’s due diligence investigation, consider the repercussions for the potential sale if the corporate records do not show who the owners of the Company are. In that case the purchaser may not have the assurance it needs that it is negotiating with the right people, or that after the closing other persons (who were unknown at the time of the closing) may claim to have an ownership interest in the Company. Similarly, the purchaser will not be certain that the correct people have approved the transaction. If signed copies of material agreements with third parties or key employees cannot be found or do not exist, the purchaser may feel that there is too great a risk of disruption to the Company’s business after the closing if material third parties or key employees were to terminate their relationships with the Company. If the Company’s financial records and litigation files are not in order, how will the purchaser be able to assess the Company’s financial position and the results of its operations, or the risk of an adverse result in the litigation? Rather than trying to assuage the purchaser’s concerns in the midst of doing the transaction, it would be much better to take care of these issues in advance. As a not insubstantial side benefit, having your corporate house in order at the time the purchaser begins its due diligence investigation should also make the purchaser comfortable that it is dealing with a buttoned-down, well-run operation. Compare that to the concerns that a purchaser may have regarding the potential for unknown liabilities in what it perceives to be a sloppily run business. A purchaser who does not have to worry about the unknown risks of purchasing your business is more likely to proceed with the purchase, and possibly even pay a higher price when it does so.

Step Number Two: Assemble Your Team. Actually, it would be a good idea to take step one and step two at the same time, although it is not critical that you do so. The downside of not doing so is that once you get advice from your team, you may have to redo some of the actions that you take in step one, with the attendant duplication of time and expense. In addition to you, your team should consist of a lawyer, an accountant, and possibly an investment banker (see step three below), who are experienced in the field of mergers and acquisitions. It is likely that you already have a lawyer, and if he or she has the relevant experience, then the first member of your team may already be in place. However, if he or she does not have that experience, you should retain an “M&A” (mergers and acquisitions) lawyer. There are countless issues that will arise in the course of the transaction that will require that you obtain advice from your lawyer. Just as you wouldn’t consult only with your general medical practitioner if you had a particular, serious medical condition, you shouldn’t consult only with your general practice lawyer with regard to one of the most significant transactions in the life of your Company. An experienced M&A lawyer will know how to protect your interests and at the same time help facilitate the transaction.

With regard to your accountant, it is probably less critical that he or she have M&A experience, so long as you are comfortable that he or she is competent and “plays well with others.” Your accountant will be heavily involved in the transaction, both in interacting with the purchaser, its lawyer and its accountant in the course of the purchaser’s due diligence investigation, and in dealing with the tax aspects of the transaction. You need to be certain that your accountant can handle both of these tasks.

Step Number Three: Finding a Purchaser. Now that your corporate house is in order and your team is in place, you need a purchaser. Unless a purchaser has contacted you, or there is a particular purchaser that you want to contact, an investment banker may be in the best position to find a purchaser. It may be that the best purchaser is another closely held company in your industry, or a private or public company doing a “roll-up” of several closely held businesses, or a company looking to diversify into your industry, or an equity fund that would view your Company as an attractive, stand-alone acquisition or as a platform to grow your business further. An investment banker will discuss these possibilities with you, and then undertake to find a purchaser. An investment banker will also help you determine what the range could be for the purchase price and, if there is more than one potential purchaser, will advise you on selecting from among them. For example, one potential purchaser may offer a lower purchase price, payable all in cash, while another potential purchaser may offer a higher purchase price payable partially in cash and partially in deferred payments. An investment banker can also help you negotiate the terms of the transaction, sometimes with the participation of other team members, keeping you above the fray. Of course, an investment banker will add a significant expense to the cost of doing the deal. Whether the benefits outweigh the burden of that expense is something you should discuss with the other members of your team.

Step Number Four: Entering Into A Confidentiality Agreement. So, your corporate house is in order, you’ve assembled your team, and you’ve found a purchaser. The purchaser will want to begin the due diligence process discussed above, which brings us to step four, entering into a confidentiality agreement. A confidentiality agreement usually provides that the purchaser cannot disclose to any third party any confidential information that you disclose to the purchaser, and also that the purchaser cannot use the information for any purpose other than evaluating the potential transaction. There may be other provisions that may be appropriate to include in a confidentiality agreement, depending on the competitive landscape at the time.

Once the confidentiality agreement is signed, there are still two things to keep in mind. The first is that good people are more important than good paper. The best confidentiality agreement in the world only gives you the right to go to court if the potential purchaser breaches the agreement, which of course is significant, but which means that you will be spending time and money on litigation while the other party is disclosing or using your information. Better to have some assurance, before you enter into the confidentiality agreement and disclose confidential information, that you can trust the other party. You can check into the background and reputation of the potential purchaser, and ask whether it has it been sued in the past for breaching similar agreements, whether it has successfully closed other acquisitions, and, in general, what is its reputation in the industry or the business community at large. The second thing to keep in mind is that you may not feel it appropriate to disclose your most sensitive information at the outset of the due diligence process. Not every potential transaction proceeds to a closing, and although you will have to disclose the sensitive information at or prior to the closing so that the purchaser can complete its due diligence, you should wait until you feel that the transaction is heading toward a closing before disclosing your most sensitive information.

If you have any questions about the foregoing article or any related issues, please feel free to contact the following attorney at our firm:

Stephen A. Albert

212-981-2320

salbert@sillerwilk.com

This article was prepared as a service to our clients and friends. This article does not constitute legal advice and should not be relied upon as legal advice by the reader or any other party.