In Parts I and II of this blog series, we touched on how important it is for the seller/business owner to begin putting in place a more sophisticated financial reporting “backbone” at least 3-5 years in advance of any sale transaction. In Part III, we focus on the need to give similar advance consideration to the legal structure of the business and the key relationships that form the foundation of the seller’s operations.
As most would expect, experienced buyers will want to gain a very detailed understanding of the seller’s corporate ownership structure by reviewing the entity’s organizational documents and other contractual agreements that are in place between the seller’s equity owners. In addition, buyers will want to review any agreements with key employees, customers, and suppliers, lease agreements for mission critical facilities and equipment, loan documents, intellectual property agreements, along with other important license, franchise, distribution, manufacturing, pricing, and other important arrangements that give the seller its competitive advantage in the market.
Having the above structure and relationships well-documented, vis-à-vis written agreements, gives the potential buyer confidence that he or she knows exactly (i) what is being purchased, and maybe just as important, (ii) the extent of the potential risks related to the acquisition. Few things shake a buyer’s confidence more (and reduces their willingness to pay more) than when a seller is unable to provide the potential buyer with key legal agreements that should form the very foundation of the seller’s business.
Putting yourself in the shoes of the buyer, consider the reluctance you might feel upon discovering that (i) the seller has no long-term written commitment from its most important raw materials supplier, (ii) that none of the seller’s senior executives have signed confidentiality/non-compete agreements, (iii) that the seller’s most important retail or manufacturing location is operating under a hold-over lease arrangement, (iv) that a critical portion of seller’s product offerings are utilizing third-party intellectual property without the benefit of a written license agreement, (v) that certain key personnel have been previously granted a “profits interest” in the seller’s business without any formal agreement outlining its terms, or (vi) that one (or more) of the seller’s equity owners has been granted a right of refusal related to any potential sale of the business but no agreement has been executed outlining the scope of this right. These are just a small sampling of the kinds of issues potential buyers can face when conducting due diligence; any one of which could derail the transaction in its entirety, or negatively impact the price the buyer may be willing to pay to the seller.
As a general proposition, buyers are not inclined to pay a premium for an operation that is disorganized, fails to attend to critical details, or is otherwise going to require an inordinate amount of work after closing in order to bring the business up to the buyer’s expectation level. We often assist our clients by examining what critical agreements need to be in place as a precursor to any sale transaction. The farther in advance of closing these types of agreements are implemented, the more benefit the seller derives, and the more comfortable the buyer will be that these agreements represent the seller’s standard operating procedure, and not merely last-minute window-dressing.
Call us if we can assist you.