Whether you’re a first-time entrepreneur or a seasoned executive, selling your company is an exciting time. You’ve worked hard to build your company into something with real value, and now you’re ready to capitalize on all that hard work with an exit. But the sale of your company can also be a nerve-wracking process given the high stakes involved.
To help you navigate the process and put you in the best position to make it smooth and efficient, here are some tips to prepare you for the sale of your company.
1. Talk to your lawyers!
Whether you’re just starting to think about engaging a broker to help you find potential buyers or have already received a letter of intent (“LOI”) with an offer, it’s always a good idea to engage a mergers and acquisitions (“M&A”) lawyer early. Once you sign an LOI, your leverage decreases significantly. Getting a buyer to agree to deal changes once an LOI is signed is extremely difficult. Even where a buyer does agree to a change, they’ll likely use that as leverage to get you to concede on some other point.
Experienced deal counsel can help make sure nothing gets slipped into the LOI that is usually more heavily negotiated when drafting the definitive documents, and can make sure you address the key points that are important to you up front so they don’t get traded away later. For more on what to look for in an LOI, see here: https://inceptiv.law/ten-things-a-seller-should-watch-for-in-an-ma-letter-of-intent/
In addition to negotiating the LOI, you should also check with your attorneys on other major legal issues early in the process. If you have a significant intellectual property portfolio, talk to your IP counsel to make sure all renewal applications and payments have been made, and get a status update on any pending matters. If you have any pending litigation, talk to the lawyers handling each matter. These are items your buyer is definitely going to ask about, so it’s best to have your team prepared in advance to provide updates and summaries, so it doesn’t slow down the due diligence process.
2. Organize your documents for due diligence
After the LOI is signed, the next step in the legal process will likely be a due diligence request from the buyer. This can be a short-form document with a few pages asking you to provide things in general categories, an incredibly detailed spreadsheet with hundreds of questions the buyer wants answered line-by-line, or anything in between. Either way, the buyer is going to want to review everything they can get their hands on, and if something is missing, they’re going to ask you to find it.
For most modern companies, this is a simple matter of putting existing electronic copies of contracts and other documents into a data room you can give the buyer access to. This can be done with free resources like Box, DropBox, Google Drive, or similar providers, or you can have a more extensive (and more expensive!) one through more sophisticated providers with higher data security for M&A deals. If you’ve been around a bit longer and still have paper copies of older contracts that are still in force, this is a good time to have someone create scanned copies, at least for any that are material to your business.
This is also a good time to make sure your files are complete. If your lease has been amended seven times in the ten years you’ve been there, the buyer is going to want to see each of those amendments (even if they are simple one-pagers extending the term or updating the rent); if you can only find three of them, reach out to your landlord to get the complete file. If you started operating under a key contract but never actually got a signed copy back from the customer, reach out and see if they have one. If you’ve been doing business with a key vendor for years but never bothered to sign a contract, this might be a good time to do that. You might not want to tip anyone off that you’re considering a sale, so getting these kinds of updates done in advance as part of routine file upkeep can be time well spent.
3. Clean up your cap table
To ensure a smooth process and information flow, it is critical to ensure your cap table and stockholder information is fully up to date, especially if you have multiple classes of stock and/or a large number of stockholders.
Whether you manage the company’s cap table through software like Carta or Pulley, use a formal transfer agent, or just keep it in a spreadsheet, early in the process you and your M&A attorney should review the cap table. If you issued options but haven’t entered them, do that now. If people have exercised options, or converted preferred into common, or converted debt under a convertible note into equity, make sure those transactions are accurately reflected in the cap table.
This is also a good time to make sure you have good contact info for all of your stockholders, particularly your larger investors since they are likely the ones you’ll go to first when you seek stockholder approval. It can be very frustrating for both sides when you’ve worked hard for weeks to finalize all the documents and satisfy all the other closing conditions before some defined date by which closing needs to occur, only to learn that you don’t know how to reach a stockholder whose written consent is required for closing.
4. Understand who will need to approve the deal
For a stock deal, you’ll need 100% of your stockholders to agree to sell their shares, by signing either the definitive Stock Purchase Agreement (“SPA”), a “joinder” to the SPA, or some simpler transfer document.
For an asset sale or a merger, you’ll need at least a majority vote of all stockholders. If you have preferred stock, your charter and/or investor documents probably also require a supermajority “Requisite Vote” of the preferred, usually in the 60-75% range. Some charters or voting agreements have even more detailed provisions (e.g., requiring that each class approve it separately, or that one or more specified “Major Investors” approve). Some buyers will insist on an even higher threshold, often as much as 80% and sometimes even 100%, to reduce the risk that a stockholder later objects to the deal, or exercises “appraisal rights” with respect to their shares.
To determine the applicable thresholds, you (or your M&A attorney) should review your charter and investor documents to confirm what votes you’ll need to approve the deal, and determine whether anyone has other rights that will be triggered.
5. Consider looping in key shareholders
As mentioned above, you’ll almost certainly need stockholder approval for your sale. It is never too early to start thinking about which investors will be likely to support the deal, especially those with a large enough number of shares that they’ll help you reach the required threshold.
Consider bringing them into the conversation early, especially if they’re sophisticated, institutional investors, many of whom have internal processes they have to follow before they can sign anything. The more they feel like they were “part of the process,” the more likely they are to be supportive of the sale. They might also have valuable insight to provide on the deal process itself.
6. Review your key contracts
Get ahead of the curve on due diligence by reviewing your material contracts to identify potential issues. Your M&A counsel can help with this.
Identify which contracts will require written consent from the other party in connection with the deal. Note that even if a contract provides that you can’t assign it without prior written consent, structuring a deal as a stock deal or a merger may not trigger that consent requirement. If it says you can’t assign “including by operation of law” then a merger may trigger it. If it says a change in control is deemed an assignment, then even a stock deal likely will trigger it. Regardless of the deal structure, the buyer will often make obtaining any required written consents a condition to closing.
Any bank financing agreements and commercial leases will almost certainly require consent, so be ready to start talking with your lenders and landlords at the appropriate times, as they will likely have their own processes for providing consent.
Identify any key or material contracts that may have expired, or have renewal dates coming up soon. The buyer will want to see evidence of renewal so they know the contract will be enforceable after closing (or that you didn’t miss a deadline for “notice of non-renewal” if it’s a contract you or the buyer would rather not keep in place).
If intellectual property is a significant part of your business, make sure you have contracts with “invention assignment” clauses in place with all your employees and independent contractors.
If you have any key permits or licenses required in your industry, make sure they are up to date and any renewals have been timely filed and paid.
7. Pay your taxes!
Confirm all required IRS filings have been made (or are in process for the current period), and all taxes owed have been paid (unless subject to a pending dispute).
Confirm you are in good standing in your state of organization. Make sure any required annual reports have been filed, and all franchise taxes and other fees have been paid.
If you are registered to do business in any state other than your state of organization, make sure those filings are up to date, any required annual reports have been filed, and all franchise taxes and other fees have been paid.
If you use a third party registered agent, they can help with this. The buyer will want to see evidence that you are in good standing in each state where you conduct business. If your registration has lapsed, it can take several days or even weeks to remedy that and get reinstated, depending on the state.
8. Consider whether a “golden parachute” analysis may be necessary
In many M&A deals, an additional analysis is required to determine whether there are “parachute payments” that trigger additional tax penalties pursuant to Section 280G of the US Internal Revenue Code.
The purpose of the 280G “parachute payment” provisions is to prevent companies from providing excessive payments to executives in M&A deals, in lieu of that value going to stockholders, unless approved by stockholders. This is a highly technical area and requires the involvement of a tax specialist to navigate, but here is a simplified description of how it works.
First, the company will need to identify certain executive officers and other highly compensated employees (referred to as a disqualified individual or “DI”). This determination is a highly technical process to be carried out by tax counsel – something we won’t go into detail on here.
After identifying the applicable DIs in a deal, your tax counsel will need to calculate a “base amount” for each DI – which is usually their average annual compensation over the last five years.
The base amount for each DI is then compared against ALL of the compensation the DI may receive in connection with the deal. What is considered “compensation in connection with the deal” is exceptionally broad for purposes of this analysis. If a DI’s post-closing employment agreement with the buyer includes any performance bonuses, contingent payments, equity compensation, or severance (even if not actually earned unless or until some date or milestone or metric is achieved, or until the DI is terminated), for purposes of the 280G analysis all such amounts are assumed to be earned and received in full (all such foregoing potential payments, the “parachute payments”).
If the total amount of all parachute payments for any DI exceeds three times his or her calculated base amount, then 280G is triggered, which has two negative impacts. First, the DI will be subject to a 20% excise tax on all “excess” parachute payments over his or her base amount. Second, the buyer will not be able to take employer deductions on those excess parachute payments.
However, as noted above, you can “cleanse” the excess parachute payments through a complicated notice and approval process, including the preparation of separate detailed disclosure documents, and a specific process for obtaining a stockholder “cleansing” vote.
Because the cleansing process takes time (often up to two full weeks to prepare the disclosure documents and obtain the vote), and can add upwards of $10,000 to your legal bill for the deal, its best to think about the deal terms and anticipate whether a 280G analysis and cleansing vote may be necessary, and if so, to start that process as early as possible.
9.
Think about timing
If you have the luxury of waiting, consider the best time to sell. If you’re expecting a huge settlement in a lawsuit, it might make sense to wait until you receive that, rather than having the buyer benefit from it shortly after closing. If your business is seasonal, you might get a better price by waiting until after the rush, when your numbers look best. If you just had a terrible quarter but it was due to a specific, one-time, unusual factor and you expect a rebound, it might make sense to wait a bit longer until your numbers even back out.
Of course there are ways to account for these types of things, and a savvy buyer will look at the bigger picture and not just recent results, but put yourself in the best position as a starting point.
Inceptiv
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