When a business owner profitably sells his business, you often hear people speak about this being a lucky break, or about how that person was in the right place at the right time to take advantage of an opportunity. However, successful sales are most frequently the result of careful preparation to make sure the business is ready for various opportunities. When the business owner is proactive from the beginning in maintaining the corporation’s records and documenting its affairs, the pre-sale process can be an opportunity to showcase the success of the business rather than highlight its problems. The following article provides guidance on how franchisors can plan for strategic events such as a sale opportunity or liquidity event from the earliest stages of a corporation’s life.
Maintaining Corporate Records
All too often, business owners neglect to keep their corporate records, such as the minute book and applicable corporate filings, up-to-date. As a result, at the time a transaction takes place, it is up to the lawyers and accountants to reconstruct whatever issuances, transfers and redemptions may have taken place. Unfortunately, in these circumstances, the parties that need to sign resolutions or produce share certificates are often no longer available.
If share issuances and the chain of election of directors and appointment of officers are not kept up-to-date in the minute book, when this information needs to be updated as part of a major transaction or financing, it can often be problematic locating the various signatories to complete the gaps in the records. This can affect the ability of a lawyer to give an unqualified legal opinion, and it can also affect the unqualified major representations and warranties that the corporation is able to give.
Updating Government Filings
Similarly, it is important to ensure that government filings are up-to-date. Nothing gives a worse impression than when, as part of its due diligence process, a prospective purchaser does a search with the relevant governmental authorities and finds that the records filed with the government do not match the information provided by the corporation. This is also true with respect to registrations where the corporation is carrying on business. Although these deficiencies are curable, they impact the impression given to a prospective purchaser about the way your business is carried on. The deficiencies also affect the process of completing a transaction, as the rectification of these small issues gets in the way of dealing with the primary transaction at hand.
Preparing for Due Diligence
Due diligence is the process by which a potential buyer examines all of the critical financial, legal and operational aspects of the business in order to ensure that there are no hidden problems with the business, to verify pricing on the transaction and to ensure that they wish to proceed with the transaction. Companies that maintain their records well are able to efficiently and quickly pull together documents that are required for a due diligence process. You need to make sure that you always keep signed copies of contracts. Your lawyers, accountants or both should also have signed copies of documents that are related to the work that they have done for you. You should ensure that the terms of loans, debt financing arrangements, credit facilities, or any other evidence of indebtedness are documented. In addition, when banking or leasing arrangements are terminated, for which security registrations have been registered against the corporation, it is critical to ensure that these registrations are actually discharged. In any kind of transaction, one of the first things which will happen is that personal property security searches and other lien searches will be made against the corporation. If a number of registrations arise which are no longer current, more time and effort will have to be spent tracking down contact people at these companies to discharge the registrations. These extra steps may lead to a number of questions by the potential purchaser and can result in uncertainty, wasted time, and unnecessary costs.
In closely held corporations, the affairs of the major shareholder and the corporation may be commingled. This is not an optimum situation for a potential purchaser. If this is the case, you need to make sure that you at least draw minimum boundaries on your personal and corporate affairs. This will allow you to demonstrate to a purchaser that any arrangements that are in place have been in place and are well documented from inception. Fulsome historical documentation makes it harder for the purchaser to protest about the arrangement and complain that it is something that has just been documented for the purpose of the transaction at hand.
As well, if your business has access to confidential information that are subject to various privacy laws, the purchaser will want to know that you have complied with these laws and have put appropriate privacy policies in place. Similarly, with records retention, which is also now part of good corporate governance, the purchaser will want to know that the corporation has considered these issues, is maintaining its records for the appropriate period of time and has thought about the question of how long and in what form to keep records going forward.
In the context of the sale of a franchisor company, keeping records on franchise law compliance can be critical. Franchisees who do not receive any or an adequate franchise disclosure document can have up to 2 years to rescind their franchise agreements. If a franchisor does not have adequate information in their files regarding compliance with provincial franchise laws, then the price and perhaps the entire deal can be severely impacted. In addition, franchise agreements are a unique form of asset, representing both a stream of cash flow to a franchisor, but also an ongoing relationship with a person, the individual franchisee. Due diligence needs to examine not only the contracts, but the nature and state of that relationship with franchisees, to ensure that that the buyer is getting a system with a harmonious franchisor/franchisee relationship as opposed to one that is based on conflict.
Documenting Agreements with Shareholders
Putting in place an effective shareholders’ agreement is also an important step in ensuring that a corporation is ready for change. In particular, when an entrepreneur issues shares as an incentive to a number of his employees without requiring the employees to enter into any kind of shareholders’ agreement, if the employees quit the corporation, go their separate ways and are never seen again, it may become difficult for the majority shareholder to negotiate an ultimate sale of the corporation or even to carry on its day-to-day corporate functions.
Early Tax Planning
Tax planning can provide you with opportunities for income splitting. It is important to document any tax planning strategies that have been implemented by the business, as it may lend substance and credibility to the situation if it can be shown that the arrangement has been in place for some time.
Protecting Intellectual Property
Depending on the nature of your business and your assets, protection of intellectual property can also be a significant area where you can properly prepare your business.
Employment and Succession Planning
Employment arrangements are also the subject of scrutiny in a due diligence situation. In particular, a purchaser will want to know that employees have signed confidentiality agreements and, where appropriate, non-competition agreements. Once again, it gives the purchaser an increased level of comfort to know that these arrangements have been in place since inception rather than knowing that the documents were signed at the time, or in contemplation, of closing. Similarly, if they are required at the time of transaction, it may be more difficult to get employees to sign these kinds of documents after they have been employed for a period of time and at that stage they may consult independent legal advice, which can have the effect of holding up the transaction. A prospective purchaser will want to know that the key management personnel are going to be around following an acquisition and one way to ensure this is to have appropriate employment terms in place. Therefore, it is not uncommon to provide retention bonuses to employees to ensure that they stay around for a minimum period of time after an acquisition takes place.
As well, as part of your ongoing business process, you should make sure that you have succession planning in mind. If after a sale there is no one who is capable of running your company if you leave, it makes your business less saleable in the long term. Without this kind of succession planning in place, it can be difficult to find strategic purchasers for the corporation.
Intermediaries are professional service providers who, among other things, assist buyers and sellers of companies to find each other, or assist companies to obtain financing. If you are the seller of a company, the intermediary will assist you in determining a range of values for the company and in putting together a sale package or pitch book which provides the potential buyer with a snapshot of all the information they would need to know about your company. Intermediaries are typically very well connected to the financial community and have a wide variety of contacts that will enable them to maximize your opportunity to sell your business. However, the involvement of an intermediary is not always necessary and should be determined on a case-by-case basis. Choosing an intermediary is much the same process as choosing any professional service provider. The best way to find one is by word of mouth through your colleagues, accountant, lawyer, banker or other professional advisor. You should always ensure that you interview several intermediaries and make sure that you find one that has experience in your particular business area, if possible.
The value of your corporation is probably the single most important thing to you. Franchisors should attend to the steps discussed above to preserve and even increase the value of their business. We would be pleased to advise on the appropriate steps and documentation that will prepare your business to take advantage of a potential sale opportunity.