Your Business Isn't Ready to Sell Just Because You Are

Most owners begin preparing to sell their business much later than they should. By the time a buyer raises a problem in diligence, fixing it can be expensive, and sometimes there isn't enough time left before closing to fix it at all. 

I have worked on the legal side of mergers and acquisitions for close to 40 years, as a partner at an Am Law 100 firm and as a chief legal executive, and I now lead Fourscore Business Law's new Wilmington office. The problems that slow a sale or lower the price are rarely dramatic. Nearly all of them can be fixed. But they may take time, and they are far easier to handle well before there is a buyer waiting on the other side of the table. 

These are the six issues I see most often when an owner starts preparing a business for sale: 

1. Ownership and governance records that are out of date 
2. Customer and vendor relationships without written contracts 
3. Financial records that have not been properly maintained 
4. Intellectual property owned by the founder or a contractor instead of the company 
5. Informal arrangements with key employees 
6. Too much of the business depending on the owner 

Ownership and governance records that are out of date 

A buyer's lawyers start with the basics. They want to know who owns the company and whether it has followed its own operating agreement or bylaws. For a business that has been running for twenty years, the answers are often scattered across old filings and the owner's memory. A buyer will ask about an operating agreement that was never amended after a partner left, a loan approved without consents the organizational documents required, or a lapsed annual report with the North Carolina Secretary of State. Cleaning up the records ahead of time is usually a few weeks of work. During a deal, the same cleanup can push back the closing date. And may threaten the deal altogether. 

Customer and vendor relationships without written contracts 

A lot of companies in southeastern North Carolina were built on long relationships and a handshake. A buyer is paying for revenue it expects to continue. If the largest customer orders by phone with no agreement in place, the buyer has little assurance that customer will stay a customer after the sale. The same is true for a supplier who has given you favorable pricing for years in the absence of a contract supporting that pricing. It also helps to reread the contracts you already have. Some require the other party's consent before they can be assigned or transferred to a new owner, and many owners don't learn that until a buyer's lawyer points it out. 

Financial records that have not been properly maintained 

Good financial records are critical to a successful sale. Financial statements that have not been regularly maintained, or that do not properly present the current financial position of the company, can be a huge liability to a seller. It’s important to coordinate preparation of the financial statements with a reputable accountant, and to make sure that the story being told to prospective buyers is supported by those financial statements. While primarily an accounting issue, it impacts many legal aspects of a transaction and the types and extent of representations and warranties a seller may have to give. Discovering irregularities during the due diligence process will raise serious concerns and, even if resolved, will almost always lead to a reduction in the purchase price.  

Intellectual property owned by the founder or a contractor instead of the company 

The company name, logo, website, software and customer lists are often part of what a buyer is paying for. Many of those were created before the company was formed, or by an outside designer or developer. Paying a contractor to create something does not, by itself, make the company the owner. Under federal copyright law, work created by an independent contractor generally belongs to the contractor unless there is a signed written assignment. A buyer will want to see that the company owns what it is selling. Assignment agreements and trademark registrations close that gap, and they are much simpler to get while the relationships are still friendly. 

Informal arrangements with key employees 

Owners make promises to the people who helped build the business. A manager may have been told she would get a piece of the company someday, or a sales lead may have a bonus arrangement that exists only in an email. Buyers want key people to stay, and they need to know that any claims to equity or sale proceeds are properly documented. Confidentiality and non-solicitation agreements matter here too. In North Carolina, a noncompete signed by someone who is already employed generally needs new consideration, such as a raise or a bonus, to be enforceable. These are better put in place well before a sale than in the weeks before one. 

Too much of the business depending on the owner 

This one is as much operational as legal. If the owner holds the key customer relationships and is the only person who knows how to price a job, a buyer sees risk. That usually shows up as a lower price, or as more of the price tied to future performance through an earnout, with the owner required to stay on through a long transition. The legal work follows the operational work. That means employment agreements for the next layer of management and contracts held in the company's name rather than the owner's. Of the six, this takes the longest to change, often a few years. 

Starting early 

None of these actions requires a decision to sell. Owners who are three to five years from a transition, or who simply want the option, can work through most of these items at a normal pace. It also leaves room to line up the business with your personal planning, including wills, trusts and how ownership would pass to your family. We have created a free toolkit for preparing to sell your business here. 

Many of the owners I talk to in Wilmington have spent twenty or thirty years building something and are starting to think about what happens to it next. We opened our office at 717 Market Street this month so we can have those conversations in person. If you are thinking about what comes next for your business, even if a sale is years away, I would welcome the opportunity to have a conversation. 

Fourscore Business Law advises business owners, founders and leadership teams on mergers and acquisitions, venture financing, outside general counsel and estate planning, with offices in Raleigh, Wilmington and Silicon Valley. Ideas Deserve Opportunity®. Learn more at fourscorelaw.com. 

This article is for general information and is not legal advice.