Most owners of privately held businesses consider selling from time to time, and almost all of them at some point do sell their businesses. Whether a business is large or small, this article will address several topics that should be addressed early on in the process.
Timing — The timing of marketing and selling a business is a function both of the overall economy and the circumstances of the business in question. Obviously, the availability of credit and the health of the economy and the particular industry will influence timing.
Timing also will be affected by the personal situation of the owner (e.g., lack of family to take over or need for liquidity.) The performance of the business in question also will affect timing. The best time to sell a business is when it has shown a record of several years of solid performance and growth, and can project a continuation of the same. Generally, it is not advisable to sell right after the business has experienced an “off” year. This is because buyers typically value businesses on the basis of a multiple of EBITDA (earnings before interest, tax, depreciation or amortization.) While historical and projected EBITDA are considered, the period immediately prior to a sale tends to be most important in buyers’ valuation.
Financial statements — The financial information of the business is of paramount importance to any seller. Anyone considering the sale of a business should make the
investment necessary to have several years of financial statements audited by a reputable firm before attempting to find a buyer.
Most potential buyers will ask their accountants to carefully vet the target’s financial statements, and some (depending upon who they are and the size of the deal) also will hire an accounting firm to do a “quality of earnings” review of the target financial statements. If the financial information presented by a target has not been audited by a reputable third-party firm, that target will be harder to sell.
The deal team — Anyone looking to sell a business needs the assistance of a lawyer and an accountant who are knowledgeable about buying and selling businesses. He or she might also want to hire an investment banker or business broker.
An investment banker or business broker is hired to find a buyer for the business, and usually is paid a commission or a combination of a minimum fee and commission. The difference between the two is that a broker usually acts purely as a sales agent, while an investment banker typically is involved in larger transactions, charges more, and becomes more involved in the process of preparing a company for sale. An investment banker or broker can provide invaluable assistance identifying and soliciting potential bidders, and creating a competitive bidding process.
However, if an owner has received an attractive unsolicited offer, or already knows bona fide buyers who are interested in the transaction, then the owner might conclude that a business broker or investment banker is not necessary.
Anyone thinking of selling a business should begin identifying and talking to advisors with whom they would be comfortable working.
Power to sell? — Unless he or she is the sole owner of the business, the person wishing to sell must consider whether he or she has the power to cause a sale of the company. This involves looking at the articles and bylaws (or limited liability company operating agreement) and applicable law to determine what level of shareholder (or member) and board (or manager) approval is necessary to legally cause the sale of the business to occur. This depends in part on the form of the transaction - whether it is structured as a sale of assets, sale of equity, or merger transaction.
Often, owners of a business will have entered into a stockholders’ agreement or operating agreement at the time a business is formed that, among other things, grants power to a certain group or a percentage of the owners to require all the other owners to sell their interests.
Careful recordkeeping and documentation— It is important to keep clear records in the years leading up to the sale of a business. A first-time seller is often very surprised at the volume and depth of records that a potential buyer will want to review as part of its “due diligence.”
Typically, a buyer (and its lawyers and accountants) wants to see it all -- stock records, board and shareholders minutes, insurance information, all records relating to customers and suppliers, financial records, real estate records and leases, any contracts, details regarding any litigation or regulatory proceedings, permits and correspondence with the agencies who issued the permits, tax filings, etc. So, the clearer, more organized and complete this documentation is, the better.
One very important form of record keeping is the record showing who owns the stock or limited liability company interests of the business. These records aren’t always as clear as they should be. For example, sometimes a promising employee will be offered stock to come on board, but that employee doesn’t work out. The records can be murky as to whether and on what terms the employee was given stock or options.
Likewise, equity can be transferred carelessly and informally among family members. This is especially problematic if family members become estranged or die. Having unclear records in this regard can bring a planned sale to a grinding halt; and often the “solution” is for the owners to put significant amounts of the sale proceeds in escrow to cover potential losses if someone comes “out of the woodwork” claiming to own equity in the company. This is not an attractive solution for the seller. So, keeping careful ownership records is critical.
Customer and supplier records also are an important aspect of a potential buyer’s due diligence. High-quality purchasing and sales documents should be used, warranties and limitations on warranties (given and received) should be clearly delivered in writing, and no long-term commitments should be signed without careful review, preferably by a lawyer. Buyers (and their lawyers) will be very concerned about onerous contract terms to which a business has committed itself in writing, even if the seller assures them that such terms have never been enforced.
Confidentiality — Even before the sales process gets underway, a seller should be focused on confidentiality. The value of most businesses is tied fundamentally to the fact that its know-how, customer lists, marketing strategies, pricing, costs and processes are confidential. To preserve the value of a business, all confidential information must be protected and disclosed to a buyer only at the right time. It is protected via the use of clear, tight and enforceable confidentiality agreements and by limiting the number of people who have access to confidential information and the timing of that access.
For example, some sellers will limit access to confidential information to a select limited group of serious buyers, and even within that group they may differentiate by holding back certain information from bidders who are also customers or competitors, at least initially. It is never advisable to begin discussions with any potential acquirers or consultants without obtaining a tight, comprehensive and binding written commitment from them to maintain the confidentiality of, and refrain from using, any information that is provided to them.
Furthermore, oftentimes a seller will include in the confidentiality agreement a commitment from potential buyers that they will not solicit or hire employees of the business for a stated period of time. This can prevent poaching from a prospective seller.
At present, there are owners who might want to sell their businesses to get away from tough market conditions, but realize that it is generally not a good idea to sell a business in a down cycle. Still, while it might not be an opportune time to sell a business, it is a great time for planning and preparing for the sale of the business. The considerations set forth above are a good place to start.
Susan Apel is a partner at K&L Gates LLP in Pittsburgh, and the former general counsel of Ellwood Group Inc. She is a practical transactional and commercial lawyer who advises clients with respect to mergers & acquisitions, domestic and international joint ventures, and commercial and corporate governance matters. Contact her at [email protected].
