Member Article

Knowing what to expect when going into the sale process and teaming up with experienced advisors is critical to making the sale of your business the crowning achievement of all of your hard work. This article discusses several steps in certain business sales, using a hypothetical company named ABC Manufacturing, and provides tips for success at each stage. This article generally assumes an asset sale transaction for a privately held business; steps might change in a stock or merger transaction. Talk to your tax professionals about the best approach for you.

Non-Disclosure Agreement

Before conversations with the prospective buyer get detailed, and before ABC provides any sensitive or proprietary information (e.g., financial statements, tax filings, customers list, business plans, etc.), they need to enter into a confidentiality or non-disclosure agreement (“NDA”) with the prospective buyer. The NDA should provide some protection to the information ABC shares with the buyer from improper use or disclosure, and it can also cover information that the buyer shares with ABC. The NDA might additionally cover the non-poaching of employees or customers and suppliers. NDAs signed in this context will usually provide confidentiality and non-use protections for a period of two to five years, except that trade secrets are covered for so long as they are trade secrets.

Tip: Some information about ABC’s business might be so sensitive that the harm caused by improper use or disclosure cannot be easily remedied through the court system. At this initial stage of the transaction, it might still be advisable for ABC to withhold or redact certain information from their disclosures until a later date or to make special provisions for that information.

Valuation/Initial Diligence

ABC needs to have a sense of their business’s value, with documentation to support that valuation. If they are unsure about the value of their business, ABC might want to hire a financial advisor with experience in business valuations. The buyer might also request corporate records, ownership information, copies of key contracts, employee information, prior tax filings, and asset information to learn more about ABC’s business.

Tip: Having clean and organized financial statements and business records will make this process go smoother and help support ABC’s valuation. A buyer is more likely to value a business higher if the business is well run and has well organized and complete records. Also, not all valuations are the same, and each should be reviewed. For example, a valuation for estate planning purposes or share grants might not be appropriate for the disposition of a business.

Letter of Intent

In some sale transactions, ABC might want to negotiate a letter of intent (“LOI”) with the buyer that details the parties’ understanding of the purchase price and other key terms. If ABC is going to use seller financing, a holdback of the purchase price, or earn-out payments, the LOI is where these terms are documented. There should not be any drastic changes in the sale’s economic terms after the LOI stage. While most of the LOI is non-binding, it still serves as a guidepost for future negotiations in the deal.

Tip: One binding provision that often shows up in an LOI is a “no-shop” or exclusivity provision. This provision prevents ABC from soliciting purchase proposals or negotiating with other potential buyers for a given period of time. ABC should be cautious about signing the LOI unless they are confident they have the best buyer for their business.

Comprehensive Due Diligence

ABC might have thought all the diligence and document requests were just about over after the negotiations on pricing, but unfortunately, they are not. After the LOI is signed, ABC’s legal team and other professionals will start to ramp up their work on the deal and will likely have extensive and detailed requests for information. In addition, the buyer’s acquisition team will ask for copies of ABC’s permits/licenses, details about any past or current litigation or environmental events, assets lists, customer/supplier information, insurance information, and details of related-party transactions, just to name a few. This tedious process is necessary so that the buyer can be in a position to take over ABC Manufacturing upon the closing. The buyer needs to know ABC’s business just as well as ABC does in order to be successful.

Tip: Once again, organization is key. There are usually a massive number of documents that need to be reviewed and shared with the buyer, typically through an online data room. It is important for ABC to provide its diligence materials in an organized manner in accordance with the buyer’s diligence requests. It is also important that ABC has their counsel review all documents before they are shared with the buyer’s legal team so that ABC’s counsel can spot and correct any issues first, preserve any attorney-client privilege, and avoid scaring the buyer team or derailing the transaction process.

Purchase Agreement

The purchase agreement details all the components of the business sale. The initial draft is usually prepared by the buyer’s counsel during the due diligence process and will get exchanged between the parties and modified various times prior to signing. The purchase agreement is often set up with a delayed closing mechanism where the parties sign the agreement and commit themselves to closing the sale transaction, subject to the satisfaction of various conditions set forth in the purchase agreement. Other key provisions in the purchase agreement include representations and warranties about ABC’s business, certain covenants related to the operation of the business between signing and closing, tax matters, indemnification, and restrictive and post-closing covenants (such as non-competition and non-solicitation obligations placed on ABC’s parties). ABC’s legal counsel is integral to navigating the purchase agreement and will negotiate the purchase agreement provisions with a primary goal of reducing post-closing liability.

Tip: The indemnification section is one of the most important sections for ABC Manufacturing to closely review. Sellers are liable for breaches of their representation, warranties, and covenants in the purchase agreement, even if those breaches are unintentional or relate to information or issues about the business that the seller was not aware of. ABC’s counsel will review and negotiate the indemnification provisions and will try to place limitations on the timing, type, and amount of claims that they can be held responsible for following the closing. There is also representation and warranty insurance in some situations.

Deliverables/Business Transition

After the purchase agreement is signed, both parties will be focusing on getting to the closing. They will have laid out various conditions that must be satisfied and deliverables that must be provided prior to closing. One of the bigger efforts during this time involves obtaining third-party consents to the sale, including the consent of ABC’s landlord. ABC might not realize it, but many of their contracts and licenses might contain provisions that prevent them from selling their business without the consent of the counter party. ABC will need to reach out to these parties and obtain their consent. ABC will also likely need to coordinate the payoff of any indebtedness, removal of liens, termination of employee benefit plans, and transition of their employees to the buyer. They might also be negotiating certain ancillary agreements during this time that were only referenced in the purchase agreement, such as escrow agreements, employment agreements, promissory notes, and others.

Tip: ABC should get going on third-party consent items as soon as possible after signing the purchase agreement. Many of these third parties don’t have a vested interest in the sale of ABC’s business and will not be motivated to review and sign the consent letter in a timely fashion. Delays in closing sale transactions are usually a result of third-party items rather than issues between the buyer and seller.

Closing

At this point, ABC has obtained all third-party consents and provided all other required deliverables. Their counsel will prepare a signature page packet for all the items that need to be signed as part of the closing. They might also prepare a funds flow memo to document all the payments that will be occurring at closing so that ABC ends up with a closing statement of sorts and so that everyone understands how the money will move on the closing day. There is usually a short closing call on the morning of closing where ABC Manufacturing and the buyer confirm receipt of all closing deliverables, release their signature pages to each other, and start to wire funds. Time for ABC to pop the champagne and celebrate the successful sale of their business!

Tip: ABC should take a breather after the closing because they have likely been working hard for a number of months to get the sale completed. ABC does need to keep in mind that they will have some post-closing items to take care of. There will likely be a post-closing working capital adjustment that needs to get sorted out with the buyer and that will result in a positive or negative adjustment to the purchase price. ABC will also need to take care of final tax-related items for their business. Additionally, ABC might need to track the progress and achievement of earn-out targets and coordinate the release of funds held back in escrow after the expiration of the escrow period. While these items should not be time consuming, ABC’s sale might not be “final” until a number of years after the transaction.

This article is a brief summary of the sale process and does not constitute legal advice. Please work with your professionals to ensure that you keep as much of the value of your business as you can while limiting your risk and reach out to an attorney for legal advice specific to your situation.