This article1 discusses why it is a serious mistake to postpone planning for the sale of your business until you find a buyer. By not planning in advance for your exit from your business:
- You will lose the opportunity to structure your company and the sale to be as advantageous as possible to you as the owner;
- You will lose the ability to conduct the sale as an auction to create a bidding competition, which usually produces the highest price for your business;
- You will not be able to modify the ownership structure of your company (e.g., to include key executives as minority owners, or to transfer ownership for estate planning purposes), nor change the form of the business entity to be best for you and the company’s employees for tax purposes;
- You will pay higher professional fees than if you had started planning in advance of the sale; and
- Because you have not prepared in advance for the buyer’s due diligence investigation of your business, it will be more disruptive and time-consuming and may cause the buyer to reduce the offered price, or even to walk away.
By planning for the sale of your company in advance of the transaction, you not only avoid those negative consequences, you will be able to resolve issues thoughtfully, in advance, with effective advice from your advisors, rather than reacting to issues under the pressures of an impending transaction. You can put processes in place that will speed up and make routine the buyer’s due diligence. Also, you can negotiate the structure and terms of the sale from a well-prepared position of strength, based on your advance planning with your advisors, including having a well-supported asking price, thereby maximizing the value you will receive from a buyer.
The next three articles in this series will discuss planning in advance of the exit transaction:
- First, the advantages of a protective non-disclosure agreement.
- Second, preparing for the buyer’s due diligence.
- Third, putting the right team in place
Advance Planning For the Sale of Your Company Adds Value
It is too often the case that owners of businesses begin the “work” of the sale only when they “have to sell,” or only after a potential buyer is identified. Owners who wait to plan for the sale of their business unnecessarily fail to recognize much of the value of their business. That’s because, by not planning in advance, owners give the buyer important negotiating leverage on several fronts, which results in a lower price or even missing the sale entirely. Systematic advance planning for a sale or liquidity event (an “exit transaction”) should be part of running the business far in advance of the exit transaction. Advance planning for an exit transaction has many advantages, including a higher price for the business and a quicker, more efficient sale process.
Kerri Salls has written extensively about why advance planning for the business and its sale is critical for an owner to obtain the maximum price when the time to exit arrives. Kerri’s 4 Step Exit Strategy FrameworkTM helps owners start planning early, which gives them greater exit options, choices and control, and prepares them for, and guides them through, the exit transaction process.2
Failing to Plan is Planning to Fail
Waiting to plan for the sale until the exit transaction begins has significant disadvantages for the business owner, including:
- The buyer’s proposal, not the owner’s best interests, will determine the structure of the transaction. The buyer will initiate the exit transaction with the structure and terms the buyer wants, whether a sale of assets, sale of shares, merger, purchase price, payable in stock and cash, with the price paid in full at closing or over time, with or without an earn-out for part of the purchase price, and with or without the owner’s continued employment by the company after the exit transaction.
- Advantageous changes in the company’s tax, personnel, operational and other attributes, which could significantly increase the owner’s return, if implemented in advance of the exit transaction, will likely not be possible under the time pressure of the buyer’s offer.
- Considerations that are specific to the owner will not have been taken into account in the structure or terms of the sale, and advantageous changes in the owner’s business structure (for example, determining whether the entity should proceed with a sale as a sole proprietorship, limited liability company, S corporation, or C corporation), and whether to involve any minority owners or key employees in the process of, or to share in the proceeds from, the sale will be prejudiced or impossible because the time necessary to make such changes will have passed once the buyer begins driving the exit transaction.
Advance Planning has Major Benefits
In contrast to the above negative consequences of not planning, a systematic long-range planning process of preparing for due diligence has positive results, including the opportunity to:
- Discover and resolve operational, accounting and legal issues far in advance of the exit transaction opportunity; saving the cost and confusion of last-minute legal and accounting work and enabling the owner’s advisors to review the materials and prepare the responses to the buyer’s due diligence request quickly and efficiently.
- Prepare efficiently and promptly the complete responses to the buyer’s due diligence requests.
- Implement processes and procedures that facilitate, not only the owner’s response to the due diligence requests, but also speed up the preparation and negotiation of the definitive agreement.
- Minimize the distraction of the owner and key executives from running the business, thereby avoiding any negative impact on forecasted revenue or expenses.
- Enter into an NDA before any confidential information is disclosed to the potential buyer or third parties, thereby reducing the risk that the pending exit transaction will become known to employees, customers, suppliers and competitors.
- Be ready, if a motivated buyer appears, with your due diligence materials prepared, thereby minimizing concerns from buyer’s advisors and reducing the time and cost of their having to dig for problems or inconsistencies.
- Eliminate the buyer’s leverage to reduce the offering price as a result of risks perceived from an incomplete or inaccurate response to the buyer’s due diligence requests.
- Improve the business’ accounting, legal and administrative operations, thereby realizing cost savings from all of the company’s advisors.
Three Key Elements of Planning for an Exit Transaction
- Non-disclosure Agreement (“NDA”)
Most businesses have valuable confidential information that, if disclosed, would be very damaging to the company. Most sellers want the fact that an exit transaction is being planned to be kept confidential so customers, suppliers and employees do not become concerned before the owner informs them. Moreover, buyers sometimes start negotiations to buy a company just to obtain information they can use to improve their business without intending to go through with the purchase of the company. Those are major risks that an owner, planning an exit transaction, should consider. A well-crafted NDA can protect you against such risks and thus is usually the first document you should enter into with a potential buyer in an exit transaction. It is the subject of the second article in this series.
- Buyer’s Due Diligence
Efficient handling of the buyer’s due diligence is critical to the owner’s ability to negotiate the highest price for the business and to obtain advantageous terms in the final agreement. Since the buyer’s due diligence occurs at an early stage of the exit transaction, an owner’s incomplete or delayed due diligence responses can cause the buyer to withdraw. It can also, at the very least, reduce the offering price to take into account what the buyer will perceive as bigger risks within the company as a result of the owner’s unpreparedness to respond Page 4 of 4 promptly to the buyer’s due diligence request. Apart from the direct effects it may have on the exit transaction, postponing due diligence work until the buyer’s due diligence request list arrives, makes the exit transaction more expensive and riskier for the owner because the advisors will have to spend more time preparing the responses, and the risk of an omission will be higher. Thus, planning for a buyer’s due diligence in advance of an exit transaction is one of the most beneficial actions an owner can take in advance of the transaction. Due diligence is discussed in the third article in this series.
- Your Exit Transaction Team
Since an exit transaction is usually a one-time event, the handling of which will not have been built into your business operations prior to the exit transaction, you may not appreciate the value of having a team of expert advisors at your side for the planning and carrying out of the exit transaction. Yet your transaction team, more than anything else you can do, has the capability to make the exit transaction go efficiently, increase the value you receive from the exit transaction, and provide you the post-transaction benefits you want. Why you need and how you build a coordinated exit transaction team is the subject of the fourth article in this series.
The Positive Role of Advisors and Preparation for the Exit Transaction
You should not worry unnecessarily if you, as an owner or key executive, have little or no time available to manage the advance planning for an exit transaction. By beginning the planning sufficiently in advance of the transaction, you can integrate preparation for the transaction into your business and build your team of advisors so that you can make the planning an integral, cost-effective part of running your business in advance of an exit transaction. Effectively using advisors in advance of an exit transaction enables the owner and key executives to direct and supervise the process with minimum use of their time, which should remain devoted to the business.3
Subsequent articles will discuss specific actions to take to prepare for a buyer’s due diligence, why it is so critical for an enforceable nondisclosure agreement to be in effect before the due diligence process begins, and how to build a team of advisors to make your exit transaction successful.
This information is provided for general purposes only and is lawyer advertising. Nothing in this article should be considered legal advice or legal opinion and no attorney-client relationship can be created by this article. John A. St. Clair, of The Law Office of John A. St. Clair, P.C., is founder of Your Legal Manager, which provides in-house general counsel services on an outsourced, as needed, basis, including working with owners to make the sale of their company more efficient and cost effective. Mr. St. Clair can be reached at firstname.lastname@example.org.
© 2016 John A. St. Clair
1 This article is the first of four articles dealing with some of the key legal issues that should be considered by owners in connection with the sale of their company. These articles are directed to owners of private, not public, companies. The following three articles will be published on this site in the coming weeks.
2 Kerri Salls, HARVEST YOUR WEALTH, DON’T MURDER YOUR BUSINESS And SELLING YOUR BUSINESS FOR MAXIMUM PROFIT. Refer to: http://www.thiswayoutgroup.com.
3 For an introduction to this subject, refer to Kerri Salls’ book HOW TO MANAGE A GAGGLE OF ADVISORS TO BUILD YOUR ALL-START EXIT TEAM.