Christopher R. Rodi, Esq.
Properly preparing your business for sale can help you avoid distractions and focus on the important issues. Identifying and understanding these issues before approaching prospective buyers can help you maximize the potential value of your business.
Preparing Your Business
As soon as you consider selling, you should begin preparing your business to be sold. One focus may be corporate records, confirming that:
- accurate minutes exist for board and shareholder meetings, or
- that all of your stock or other equity interests are properly approved and documented.
Another could be financial records, considering:
- inventory write downs,
- reclassifying officer compensation,
- writing-off uncollectible accounts receivable, or
- properly documenting loans to or from owners or employees.
Depending on your business, other preparations may include:
- attempting to resolve any pending or potential litigation,
- ensuring that you have assignment agreements from each person involved in the development of your products or intellectual property,
- reviewing your warranty or insurance claims,
- analyzing your technology to ensure it does not infringe on any third party’s rights, or
The common goal is identifying and resolving issues before they are identified by prospective buyers and become unnecessary distractions for you and your team during the sale.
Identifying the Key Issues Relevant to Your Business
Another important step is identifying and understanding the issues most relevant to you when you begin negotiating the terms of the sale. The following are some common issues that you may face:
Structure. Absent tax or other considerations, a seller will generally prefer to sell stock, passing all assets and liabilities to the buyer. Conversely, a buyer will generally favor selecting which assets to purchase and which liabilities, if any, to assume. New York law generally supports the general rule that a buyer who purchases only assets is not liable for the seller’s liabilities. However, as recently as last year, the 2nd Circuit Court applying New York law acknowledged an exception if "continuity of ownership" exists, where the seller receives sufficient equity in the buyer as part of the sale price that the buyer is considered "a mere continuation of seller." Applying this "de facto merger" exception, the buyer could be deemed liable for all of the seller’s liabilities. One practical effect may be a prospective buyer’s unwillingness to pay with stock in an asset purchase, limiting the total price they may be able to offer.
Minority Shareholder Rights. The rights of minority shareholders may also influence the structure of the sale. In an asset sale, minority shareholders are afforded rights. For a New York corporation, depending on when it was formed, the approval of either a majority or two-thirds of the shareholders could be required to sell substantially all of its assets. Minority shareholders in New York also have "dissenter’s rights," or the ability to demand fair value for their shares if they do not vote in favor of the sale. On the other hand, approval of a majority of the shareholders is always required for a Delaware corporation, and Delaware provides no statutory right for dissenters. In a stock sale, unless your minority shareholders have agreed to a "drag along" or similar right allowing the majority shareholders to force the sale of their shares, the buyer will need to purchase each minority shareholder’s shares individually. This is often seen as a significant negative by buyers, particularly if you have a large number of minority shareholders, favoring an asset sale.
Obligations to Minority Shareholders. Obligations to minority shareholders may also influence the structure. If you are a board member, as owners are, you have a fiduciary obligation to maximize your shareholders’ value. This obligation could conflict with personal benefits received through post-sale employment, deferred compensation or allocating a portion of the purchase price to your non-competition agreement. Each of these could divert value from the purchase price received by the shareholders. One way to overcome this issue and protect yourself from claims is to seek the approval of the "disinterest" directors or the stockholders under Section 713 of the New York corporate law or Section 144 of the Delaware corporate law.
Material Agreements. Although you may not pay attention to the "miscellaneous" terms at the end of an agreement, they may also influence the sale structure. These terms can address, among other things, your ability to assign the agreement to a buyer. If your business depends on a number of agreements with customers or suppliers, leases or other material agreements, each should be reviewed. If the agreements are not assignable or require consents that provide unfavorable leverage to a third party over your sale, this may favor a stock sale which maintains your company’s existence and often does not require an assignment of the agreement to the buyer.
Key Employees or Customers. If the value of your business depends on one more key employees, you should ensure that they are involved in the process as soon as possible. You should consider the need to communicate with them when discussing confidentiality requirements with a prospective buyer. As part of the material agreement review noted above, you should focus on any key employment and customer agreements to understand the affect of a sale of your company. The ability to assign key customer agreements without consent can be of particular importance because a customer who knows their consent is needed for your sale may consider it leverage to seek other concessions in your agreement.
The above issues are only a sample of the many that may be relevant to your business you should identify and understand before discussing terms with prospective buyers. Involving your key employees and outside advisors is important in ensuring you have considered all of the possible issues.
Christopher Rodi is an attorney at Woods Oviatt Gilman LLP focusing on mergers and acquisitions, business formation and capital raising transactions and general corporate law. For more information call (585) 987-2820 or visit www.woodsoviatt.com.