What You Need to Know When You're Ready to Sell Your Business

David King, Contributor, Forbes

August 4, 2016

What you need to know when you're ready to sell your business

Having gauged the market, reached a decision to sell your company, become familiar with valuation methods, earnings metrics and alternative processes for selling, and having envisioned an ideal buyer, you should then draft a roadmap with a timeline. Sellers should also familiarize themselves with the fundamental deal terms to be negotiated in a letter of intent.

Under ideal circumstances a business can be sold in approximately four months. During the first four weeks, sellers should conduct internal due diligence and prepare marketing materials for a list of potential buyers.

Sellers should make timely efforts to avoid simple mistakes by assembling complete corporate minutes, contracts and financial statements, and making sure that all contracts are fully executed. Don’t look unprofessional when prospective buyers are ready to move.

Weeks three through seven are when to make initial contacts with buyers and distribute marketing materials. In weeks eight through ten, sellers provide marketing presentations to targeted buyers and review any proposals from buyers.

Upon receipt of the first letter of intent from a buyer, a seller should ask for 15 days to formally respond. Taking time for a professional valuation, consultation with counsel and drafting a thoughtful counteroffer is crucial to build a record showing diligence and fiduciary care.

In weeks ten through 14 the seller may select the best offer, and such buyer would complete their due diligence on the company. The lawyers should circulate a draft of the purchase agreement. Finally, in weeks 14 through 16, the parties finalize and sign definitive agreements.

A range of issues will be negotiated and set forth in a letter of intent. The company may be sold through an asset sale or a stock sale.  For privately-owned, middle-market companies buyers generally prefer an asset sale to avoid the seller’s liabilities. This is one good reason why most businesses should be a “flow-through” entity for taxes (generally an S corporation or LLC).

A transaction may be also structured as a merger, which could take the form of a triangular merger or reverse-triangular merger. (Another article will cover alternative structures for business combinations.)

The purchase price is obviously a significant term of the deal, and the form of such “consideration” paid by the buyer is of utmost importance. Will the buyer pay the purchase price in cash, stock, a promissory note, or some combination thereof? If the consideration is paid through a stock exchange, does the buyer offer a fixed or a floating exchange ratio (to accommodate changes in stock prices)?

The buyer might want to structure a portion of the purchase price as an “earn-out,” contingent upon the future operating results of the acquired business. A seller should remember two general rules related to earn-outs:

First, do not assume you will ever receive the earn-out. Second, base any earn-out upon the company’s future revenues, not EBITDA (earnings before interest, taxes, depreciation and amortization). After closing, the buyer will control future costs and take over accounting, leading to disagreements over nearly every income statement balance below revenues.

If the target’s shareholders will receive stock, and thus become shareholders of the acquirer, agreements limiting resale of the stock such as “lock-up periods” (after an initial public offering) or other trading restrictions might make it impossible for the selling shareholders to realize the maximum value of the sale.

Conversely, shareholders of the target might negotiate for registration rights of the acquiring company stock giving the ability to sell their shares as part of a public offering. The target shareholders should consider the pro forma share ownership of the acquirer after closing and their rights to participate in the governance of the acquiring company.

In cash transactions, the parties should focus upon the actual net proceeds to be delivered at closing. The buyer will usually retain a portion of the purchase price as a “holdback” to be paid a year after closing. The seller could request that such funds be held in escrow.

The net cash proceeds will reflect transaction costs (including bankers, lawyers, consent payments, etc.), and any immediate tax liabilities. The buyer will usually expect that a portion of the purchase price be used to retire debt on the target company’s books.

The buyer and seller agree upon a purchase price assuming a given “working capital” balance — current assets minus current liabilities. If the actual working capital on the closing date differs materially from the stipulated balance, the purchase price will be adjusted. Such adjustments for actual closing date balances of debt and working capital are often completed after the closing.

Although it seems a finer detail and somewhat “legalese,” the letter of intent may cover the post-closing indemnification survival periods. In a future article, I’ll write about indemnification and the buyer’s recourse for losses suffered post-closing.

This article was written by David King from Forbes and was legally licensed through the NewsCred publisher network.

The views of the author of this article do not necessarily represent the views of First Republic Bank.