You, the business owners, have just signed a “Letter of Intent” to sell your business for $10,000,000, “subject to buyer’s due diligence”. Before you start making retirement plans, let’s determine what that means.
The buyer will require copies of all your accounting and financial records, as well as all agreements and written contracts with your vendors, customers, employees and others with whom you do business. The buyer will forward you a rather lengthy list of items they require. Then, if something does not meet with their satisfaction, they may either terminate the potential transaction, or demand a reduction in the purchase price.
How can you, as the seller, prepare the business so that there are no “surprises”?
Many business owners may come to the point where they feel it is time to sell their business and “take it easy”. Having built and operated a successful business for decades, most owners are very knowledgeable about all aspects of their business. However, most owners have never before acquired or sold a business.
Selling a business is a process. Prior to finding a buyer, the seller should conduct its own due diligence. The seller, together with its legal, accounting, and other advisers, considers the following:
• Whether all organization documents are up to date, such as Articles of Organization, Bylaws (or operating agreement), minutes, and ownership records;
• Whether “key employees” are bound by appropriate confidentiality and non-compete agreements;
• What agreements are in place with key suppliers and key customers;
• Whether employee records are up to date;
• Whether there is a union;
• Whether there are any existing or potential claims against the business;
• Whether the lease for the business premises is satisfactory, and the condition of the business premises;
• Whether there are any environmental issues;
• What obligations the business will have after it is sold;
• Whether there are any issues with accounts receivable or accounts payable; and
• Whether there are any licensing or permit issues.
The foregoing items are just examples of some of the things a seller should be examining before entertaining offers to purchase a business. It is better that the seller recognizes any issues affecting the business before a buyer points them out (and asks for a reduction in the price).
Levin Ginsburg regularly represents both sellers and buyers of businesses. We have developed detailed “due diligence” checklists to help sellers and buyers navigate the sale process. If you would like to discuss a sale or purchase of a business, please contact Morris Saunders or any of our partners in our mergers and acquisitions practice.
John Smith owned a small manufacturing business. One day he received a call from one of his competitors who said he was interested in buying John’s business. John was now 75 and this seemed like the perfect opportunity for him to retire and have that “nest egg” for him live comfortably in retirement.
John met with the buyer and they discussed, in general, John’s business. After the meeting, the buyer presented a letter of intent to John, which proposed a purchase price of $10,000,000, subject to the buyer’s due diligence investigation of John’s business. John felt pleased with the letter of intent and signed and returned it to the buyer.
During a long and protracted (and quite thorough) due diligence, the buyer and his accountants and lawyers examined the business and its books and records. Based upon their examination, they advised the buyer of various legal and financial risks that John’s business was exposed to and which could become issues that the buyer would have to face.
John could not produce all of his current contracts with his customers. The contracts which he had contained provisions which could cause the contracts to be terminated upon a sale of the business or a transfer of the ownership of the business. Their key employees had no employment agreements and could compete with the business once they terminated employment. The leases for the business’s facilities could not be assigned.
Despite the issues with the business, the buyer was still interested in purchasing the business. The bad news was that the revised purchase price was to be $8,500,000 with a significant portion to be held in escrow pending resolution of various legal issues.
The above scenario is very common with small business owners. Bigger companies who regularly acquire smaller companies are “professionals” in the acquisition business. They know exactly what to look for and they know how to “string the seller along” until they present a reduced offer which most sellers feel they have to accept.
If you are thinking of selling your business, make sure that your business is ready to be sold and that you have copies of all contracts and leases and that you understand what they provide and how they will be affected upon a sale. Have written employment agreements with all your “key employees.” Pay attention to your inventory, your accounts receivable and other assets which “drive the sales price.” Protect your intellectual property by obtaining patents, to the extent applicable, and trademarks.
If you are considering selling your business and would like a “legal check-up,” please do not hesitate to contact:
Morris Saunders at:
firstname.lastname@example.org or 312-368-0100.