If an opportunity arises to sell your business, there are a number of key considerations that franchisors should turn their minds to in order to ensure that a successful sale process is facilitated. The following article will highlight some of the precautionary initial steps that a business owner should take in the preliminary stages of a sale process, as well as some of the fundamental key terms that should form part of the main documents required in the standard sale process.
During the sale process, the business will undergo a due diligence process which often takes place immediately after the negotiation of a confidentiality agreement or contemporaneously with the negotiation of a letter of intent. Every aspect of the operations of the business will be scrutinized to ensure that there are no hidden problems with the business, to verify pricing on the transaction and to ensure that the purchaser wishes to proceed with the transaction. Problems exposed during due diligence may affect the valuation of the business, the interest rates charged in a financing, the covenants and holdbacks and could even jeopardize the ultimate success of the transaction. Therefore, it is imperative that a business owner adequately prepares for the potential sale process. When a prospective purchaser comes in and discovers problems and/or issues with the business in question, this degree of uncertainty may make such purchaser more risk averse in that it may become concerned about other potential problems and issues which may exist in the business. Taking all of the steps discussed in the previous Franchise Law e-COMMUNIQUÉ, titled Repositioning Your Business for Change: The Pre-Sale Process, will help ensure that your business is well managed and well documented, and will assist in facilitating a smooth and straightforward due diligence process.
As it is uncertain during the due diligence process whether or not the transaction will proceed, you should limit the number of people in your corporation who know about the transaction. Often it is best to assign one key person in each organization between whom all information will flow. Most business owners do not want a team of accountants and business people flooding their premises during working hours as this may cause disruption and uncertainty among their staff, especially given that there is no certainty at this stage that the transaction will go forward.
It is important in the early stages of a transaction for you to involve the corporation’s tax advisors as there may be certain pre-closing organizational steps which should be effected to make the transaction more tax efficient. It is also important that any tax issues relating to the transaction be brought up in the early stages of the transaction as this will increase efficiency and may eliminate unnecessary costs which may be incurred by the parties and their respective advisors proceeding in the “wrong direction” from a tax perspective.
The following represents some of the core documents, including the main provisions of a definitive purchase agreement, which are negotiated and entered into to protect each party’s interests throughout the sale process and following closing.
It is essential for the owner of the business to ensure that whatever information which is provided to a potential purchaser which may be proprietary or confidential in nature is maintained as confidential. This is effected through a confidentiality agreement which not only sets out the confidentiality obligations of the parties vis-à-vis the information which has or will be exchanged, but also may contain non-solicitation covenants regarding the other party’s customers and employees. Notwithstanding the protection afforded by a confidentiality agreement, the owner of the business also may protect itself by being careful as to the scope and nature of the information disclosed to the prospective to the purchaser. To the extent possible, the owner of the business only should disclose such amount of information which the purchaser may require to assess the potential business opportunity, or disclose its confidential information in stages so that the material confidential information is disclosed during the later stages of due diligence.
Letter of Intent
The letter of intent is a preliminary document which is usually non-binding upon the parties but is typically used by the parties to set out the key business terms of the transaction pending the completion of due diligence, the finalization of the definitive purchase agreement and certain other pre-closing conditions.
The Definitive Purchase Agreement
Purchase Price and Payment of Purchase Price
The early sections of a purchase agreement typically set out the purchase price and the method of payment of the purchase price. The purchase price may be a set figure or subject to determination pursuant to a formula set out in the purchase agreement. The purchase agreement may also provide for certain adjustments to the purchase price based on the financial status or performance of the business as at or following the closing. The purchase price may be paid in cash on closing or the purchase price, or a portion thereof, may be satisfied by non-cash considerations such as shares or debt issued by the purchaser. If all or part of the purchase price is satisfied by way of shares issued by the purchaser to the seller, which is a public company, it is important for the seller to understand whether there are any restrictions on trading these shares following the closing and whether any escrow arrangements will apply. If all or part of the purchase price is satisfied by way of a promissory note or other debt issued by the purchaser to the seller, the seller may wish to require such debt obligation to be secured by way of a security interest granted in the assets and/or shares of the sold business or corporation.
The purchase agreement also may contain a holdback or escrow arrangement whereby a portion of the purchase price is held back or held in escrow to act as security for any negative adjustment to the purchase price and/or any claims which may be brought by the to the purchaser following the closing for misrepresentation or breach of warranty.
Representations and Warranties
Representations and warranties contained in a purchase agreement are statements made by either the seller (and sometimes its principals), or the purchaser, to the other regarding its legal status and, in the case of the seller, the business or corporation being sold. They often are the subject of extensive negotiations between the purchaser, the seller and their respective advisors. The seller should review the representations and warranties it is being asked to give carefully with their legal and financial advisors to determine whether they are accurate in their entirety or whether they should be qualified in some way. Often legal and financial advisors will assist the seller in preparing the disclosure schedules which accompany the representations and warranties and which set out (i) exceptions to the representations and warranties contained in the purchase agreement, and (ii) material information regarding the business or corporation such as material contracts, material permits, employee information, etc.
Covenants and Conditions
Covenants are agreements made by either the seller (and sometimes its principals), or the purchaser, to the other as to certain actions which need to be carried out prior to the closing and, sometimes, after the closing. These often include discharging bank indebtedness and other liens, obtaining all necessary governmental and other third party approvals, entering into ancillary agreements such as employment agreements, etc. Conditions are similar to covenants in that they set out the actions which must be carried out or events which must occur before closing may take place.
The indemnity provision in the purchase agreement typically is the obligation of a party to indemnify the other (and certain related persons) in the event that such other party suffers any losses or damages as a result of a misrepresentation or a breach of warranty or covenant. The seller’s indemnity obligation also may extend to certain liabilities of the business or corporation which arose prior to closing and which may be inherited by the purchaser. Typically, the purchase agreement will provide that the ability of a party to make an indemnity claim will be limited to a set period of time after the closing, such as two years. In an attempt to limit its indemnity obligation and eliminate minor or frivolous claims, the seller often will limit its exposure to an amount equal to the purchase price or a percentage thereof and also negotiate a minimum threshold (also known as the de minimis threshold) below which indemnity claims cannot be made by the purchaser.
Non-Competition and Other Restrictive Covenants
As a condition to completing the transaction, the purchaser will typically require the seller and its principals to enter into a non-competition agreement which will contain a non-competition, non-solicitation and confidentiality covenants which are designed to protect the goodwill, customers, employees and confidential information of the business or corporation.
Ensuring that your business appropriately documents its transactions and maintains its records along the way will result in minimizing the cost of completing a successful transaction, reducing the time to complete the transaction and optimizing the purchase price to be derived from the transaction.