Selling your business is a lot like selling your house: it should have “curb appeal” and pass a buyer’s “home inspection” with flying colours. In this article, we will look at some of the steps that you, as an owner-manager or officer/director of a mid-sized company, can take to get your business ready to sell.
At the end of the article, we summarize tips to consider in your day-to-day operations and when selling becomes likely.
Objectives and Planning: What do you want to do and when?
Objectives will vary from sale to sale, but they usually include some combination of business, personal and tax objectives. Business objectives may include spinning off a line of business or involving a partner with “deep pockets” to take the company to the next level. Personal objectives may include freeing up the money in your business so that you can retire, or to get out of the business because you no longer enjoy or are capable of running it. Tax objectives may include ensuring that the sale fits your estate plan.
If you are thinking of selling your business, allow plenty of lead time to ensure it is in the best possible shape prior to being put on the market. Preparing for and executing a sale can take as much as two years from start to finish, especially if there are multiple suitors in an auction situation. The actual sale process, including negotiating with the preferred buyer and closing the deal, often takes up to half of that time, if things go smoothly, or longer, if you are not prepared or if the buyer identifies material issues when conducting its due diligence. The more preparation you do beforehand, the more quickly and smoothly the sale is likely to go.
Sale Process: Are you prepared to take all of the steps between now and closing?
Selling a business is a very involved process that will require a significant amount of time and attention from individuals, directors and shareholders. You should “project manage” the process, either by yourself or with the help of an advisor or advisors, to ensure that distraction is minimized, all stakeholders are working together and that the sale is completed in a timely manner in accordance with your financial and other objectives. Sellers generally benefit from a relatively speedy transaction, particularly where they would prefer to keep the sale confidential from competitors and employees until the deal is imminent or complete.
From testing the waters before you put your business on the market through to tying up loose ends once your business is sold, there are many steps to complete the sale of any business. We have outlined some typical steps in the sales process as an attachment to this article. These steps may vary depending on how you sell your business (e.g., by way of an asset sale versus a share sale) and to whom. However, in all cases, advanced preparation can make the entire process easier. In this article, we point out ways to make the sale process easier and more effective not only on the eve of the transaction, but also in the months and years of normal operation that precede a sale.
Value: What is your business worth?
It is trite to say but it is a manager’s and director’s duty (and a shareholder’s desire) to get the best price possible for the company. While it is not as simple to get comparable prices for your company as it is when selling a home, there are sources worth exploring to get a sense of deals done (and prices paid) in your company’s industry. Typically, different industries have different valuation multiples or conventions (such as one times revenue or 3-4 times EBITDA). At the end of the day, your management team and other key employees, intellectual property, goodwill, customer lists, and earning capacity are likely your most valuable assets. However, buyers may value these core assets differently: a financial buyer may put more value on the current management team than will an industry buyer that has its own management team in place already. Consider having a charted business valuators (a specialized designation some chartered accountants attain), corporate finance advisor or an accountant (with the appropriate expertise) appraise your business so you can set a realistic price target.
In negotiating the purchase price, both parties should spend nearly as much time on how and when that purchase price will be paid as they do on the dollar value itself. Will the entire purchase price be paid at closing? Will there be a hold-back or an earn-out? Will there be a loan from the seller (also known as a vendor-take back)? For what term? At what interest rate? With what security? Structuring the payment of the purchase price can be an extremely important element of the deal and professional assistance can be invaluable.
Team of Advisors: Whose help do you need?
The issues that arise on a sale are typically so numerous and complex that it would be foolish to negotiate and close the transaction on your own. Early in the sale process, you should determine which professional advisors you need to retain. In our experience, at a minimum you will be engaging lawyers and accountants with transaction experience. An experienced lawyer will not only ensure that all legal requirements are met, but will also know what terms and conditions in the purchase agreement and other documents are “market” for your type of deal. Accountants will help ensure that your financial picture is clear and current and can help you work through the financial implications of tax and other structuring issues that may arise.
You may also choose to retain business valuators to help you set an appropriate purchase price (as discussed above). If several suitors may be interested in your business, M&A advisors or investment bankers can help identify prospective buyers (discussed in greater detail below) and market your business to them. M&A advisors can draft compelling information/marketing documents about the company and realistic terms sheets, coordinate the flow of information to and from buyers (particularly in an auction process) and run financial analysis of sale scenarios. M&A advisors can also undertake negotiations on behalf of the owner, which creates some emotional distance between the owner and the prospective buyers. It also allows the owner to continue focusing on running the business at the highest level to ensure that there are no dips in financial or operational performance that could scare off buyers or compromise the owner’s negotiating position.
Sellers should take care to retain advisors who have appropriate experience with similar deals (i.e., similar size, complexity, industry, type of buyer, etc.). If you have a trusted relationship with one of these types of advisors, consider asking him/her for referrals to other potential members of your deal team. Sellers should also budget for the costs of these advisors at an early stage of the transaction so as to obtain a reasonable estimate of the expected take-home proceeds from the sale of the business.
Buyers: Who are the potential buyers of your business?
Potential buyers typically fall into one of two groups: (1) industry buyers (also sometimes referred to as “strategic” buyers); and (2) financial buyers such as private equity funds. You may also come across strategic buyers who have partnered with a private equity house and together they constitute a “hybrid” buyer.
Industry buyers are usually looking to grow their existing businesses by acquiring the product lines, capital assets, intellectual property, people, customers, supply relationships, distribution channels or territory of complementary businesses. Industry buyers may have to contend with a higher cost of capital when funding an acquisition and there may be greater regulatory risks with such a deal.
In contrast, financial buyers typically have access to less expensive capital than industry buyers. They tend to target businesses that will generate a desired level of return within a fixed investment horizon (for example, 5 years). They often look for companies that have solid businesses in place but whose valuation could be boosted by implementing operational efficiencies or by injecting new capital into the business. Given their focus on short- to medium-term returns and their use of leverage, financial buyers will be very exacting in their analysis of the financial performance of your business, both before and after the sale closes.
One of the most valuable contributions M&A advisors make to transactions is to help identify the right potential buyers for a business. These advisors have databases, relationships, knowledge and experience as to who and where the most likely buyers will be found and what their motivations may be for doing a deal.
Once you have identified one or more prospective buyers, you should qualify them as real prospects. Working with your advisors, you should try to confirm that each potential buyer is genuinely interested in acquiring the business, has the expertise and financial wherewithal to close the deal, and has the experience and ability to run the business once they have bought it. You do not want to waste your time pursuing a deal that may never close or disclosing information to parties that are on “fishing expeditions” (who may even be competitors, masquerading as buyers, merely gathering intelligence on your business).
Corporate Structuring: Does your current structure make sense for the deal?
Your company’s corporate structure may be the same as the day it was incorporated or may have evolved in response to changes in the business. While the current structure may have made sense in the past, it may not be optimal for the purposes of selling the business due to a variety of factors that may arise in the sale process. If a sale becomes a possibility, sellers should promptly talk to their advisors and prospective buyers to determine whether the corporation needs to be restructured prior to closing the deal. Significant lead time may be required to obtain the benefits of a restructuring because some of the upside of particular ownership structures can only be accessed after ownership interests have been held for a prescribed period of time.
Several considerations come into play when analyzing the pros and cons of a given corporate structure. While the tax treatment of the various steps of the transaction, including transfers between the buyer and seller and distributions of proceeds from the seller to its shareholders, is one of the key determinants of an optimal structure, other factors may also be relevant. These factors could include applicable regulations, third party consent rights, shareholder approval thresholds and other matters. A particular structure may also help (or hinder) a seller that wants to dispose of only part of its business.
As soon as a deal is on the horizon, you should review all aspects of the structure with your advisors and with prospective buyers. What type of entity is used to carry on the business: a corporation, partnership, limited partnership, sole proprietorship, etc.? How do shareholders hold their respective interests in the business: directly or through holding corporations or trusts? How does the company own its material assets and lines of business: directly or through subsidiaries or affiliates? A structure that is optimal for the sellers may not be optimal for the buyers, and vice versa. Any potential restructuring may therefore become a significant point of negotiation between the parties. From the sellers’ perspective, it is likely easier to implement a preferred structure long before a sale is imminent and then put the buyers in the position of having to negotiate changes to your structure once a deal is on the table.
If you determine that a different structure would be better suited to the deal, then you may have to plan a reorganization prior to or as part of the closing. Such reorganizations will add cost and complexity to the transaction, may introduce additional approval requirements (such as shareholder approval of fundamental changes), and could extend the time required to close the deal.
“Seller Due Diligence”: Do you have the answers to all of the questions buyers might ask?
As mentioned above, due diligence is essentially the “home inspection” of your business. You want to ensure that there are no surprises for the buyer that were not disclosed appropriately.
Due diligence usually occurs in three ways: (1) document-based due diligence (i.e., looking at your corporate records and contracts); (2) a site visit where the buyer inspects key assets, such as facilities, equipment and inventory, in person; and (3) management and advisor interviews to clarify and confirm the information gathered from the document review or site visit and to add colour to other due diligence findings. Following due diligence, the buyer’s advisors will likely prepare a due diligence report on your business and it should be your goal to reduce the likelihood that red flags will be raised.
Prior to letting a potential buyer conduct any of these forms of due diligence, together with your professional advisors, you should conduct “seller-side” due diligence. This essentially means collecting all of the information in which potential buyers would likely be interested, going through it to make sure it is complete and accurate, and presenting it in the way that is most favourable to your business in order to attract the maximum number of genuinely interested buyers and to get the maximum purchase price for your company. This takes time. It takes time because it is often undertaken by only a few individuals who know about the pending sale and therefore it takes time (and often a great deal of tact) to extract key documents from employees in the company who may not be aware (and must not be made aware) that a sale is going to occur.
Discussed below are some specific areas which should be addressed in your seller-side due diligence and some tips about how to deal with them.
(a) General Corporate Documents
While it is always a good idea to keep your books and records up-to-date, in preparation for a deal, it is a good idea to have your lawyer go through your books and records to confirm they are complete, accurate and up-to-date. For example, minute books and records should be reviewed to ensure that annual corporate filings have been made, that the current directors, officers and shareholders are recorded, that annual meetings have been held or resolutions passed, and also that there are resolutions or meeting minutes approving major transactions such as the execution of material agreements. Depending on their state, this may not necessarily be a time-consuming or expensive exercise. However, it is important that this be done right as it can set the tone for the due diligence that follows since these are often the first documents that a buyer’s lawyer will review.
(b) Accounting Records, Taxes and Financial Statement
You should also have your accountant confirm that all your financial and accounting records are complete, accurate and up-to-date. Your company’s accountant should also confirm that all of the businesses’ tax returns (income and HST) have been filed, confirm that all tax remittances have been made and identify any tax assets (e.g., loss carry-forwards) that you may need to consider when selling the business. Selling shareholders may also need to consult their personal accountants to confirm what impact the sale may have on their personal finances. Personal accountants may also be able to help identify tax exemptions (particularly the lifetime capital gains exemptions) might be available to help maximize the selling shareholder’s “take home” portion of the proceeds.
Your M&A advisor may also be able to provide suggestions as to how to present your financial situation in the best possible light and in a format that is compelling for particular types of buyers. Buyers may not bother to do any further due diligence if they are unsatisfied with a business’s financial results so it pays to make sure this step is done thoroughly so as to present as attractive a picture as possible to potential buyers.
(c) Material Agreements
Buyers will want to see copies of all of the material agreements into which the company has entered. Material agreements may include customer agreements, supply agreements, credit or loan agreements, real property or equipment leases, unanimous shareholders agreements, employment agreements for key employees, collective agreements (if unionized), government licenses/permits and authorizations that are necessary to run the business, and any other agreements that create current or contingent rights or obligations for the company. Often, buyers will list specific agreements that they know are material and also request disclosure of any agreements over a certain dollar threshold or duration. Having a good document management and retention system in place prior to selling the business can make it much easier to compile and deliver copies of material agreements to prospective buyers.
Are there any business arrangements which are incomplete or undocumented? If so, it would be advisable to get them updated or in writing so that there is no ambiguity about the fact that they exist and the specific terms of the business’s rights and obligations under them. Two examples of agreements that are often done by handshake are employment agreements and shareholder agreements. A properly documented employment agreement almost always benefits the company by putting boundaries on the rights that might otherwise be available to employees at common law. A written unanimous shareholders agreement can be critical in facilitating a smooth sale, as it can clearly define who manages the business, who has approval rights, and who can sell under what conditions. Your business may benefit greatly at the time of sale if you get into the habit of papering these and other types of agreements as they arise, not retroactively at the time of sale.
In addition, material agreements should be reviewed in advance to see whether there are any change of control provisions (if you intend to sell the shares in your company) or assignment provisions (if you plan to sell just the assets) which may be triggered by the sale. For example, if there is a major agreement with a customer that makes up 30% of the revenue of your business for example, and the agreement states that it will terminate automatically if the company is sold, you need to know this in advance so that you can take steps either to remove this provision of the agreement or otherwise be able to demonstrate to a potential buyer that it will not lose an important customer if it buys your business. This is why it is important, if at all possible, to avoid having such provisions in the contracts you negotiate in the first place or to work hard to avoid client/customer concentration issues.
(d) Intellectual Property
For some businesses, the most valuable asset they have is their intellectual property. You should confirm that all of your trade-marks, patents, copyrights and business names are all duly registered and protected. Have you had any intellectual property developed by contractors? Does the business use any software which has been improperly obtained? If so, now is the time to confirm you have proper assignments from your contractors and to obtain legitimate copies of software.
If your intellectual property is one of your more valuable assets, you may want to take additional steps to confirm how it will be valued by prospective purchasers. An IP advisor may be able to explore the landscape in your industry to determine whether your IP is crowded by competitors or truly occupies a space of its own. They may also be able to get a feeling for prospective purchasers’ IP portfolios and how your IP assets could fit in.
(e) Labour and Employment/Human Resources
The issue of whether employees (both staff and management) will be kept on after a sale is often a key one for buyers and sellers alike. Staff and management may be more important to a financial buyer as, unlike an industry or strategic buyer, a financial buyer will not have the ability to run the business itself after the acquisition without keeping all or most of the existing management team in place. If employees are not being kept on, who will be responsible for notice and severance may be a key term of the negotiation and you will need to ensure that the proper amount of notice (or pay in lieu of notice) is given to departing employees in accordance with applicable law.
If the employees are unionized, you will need to make sure that any necessary consultations with the union are undertaken in a timely manner. Applicable legislation and/or the collective agreement may require that any negotiations with potential buyers are disclosed to the union at an early stage. Generally speaking, the buyer of a union operation will step into the shoes of the seller for all purposes with the union. This includes assuming not only the terms of the collective agreement but also liability for any grievances. When negotiating any collective agreement or resolving any grievances with your unionized employees, it is therefore important to ask yourself not only if the agreement or resolution is acceptable to you today, but whether it will be acceptable to a potential buyer of your business in the future.
(f) Real Property
Can you deliver clean title to the real property that you are selling? A real estate lawyer can help determine what is registered on title to your property and whether any such registrations will make it harder for you to convey the property to a buyer. It is therefore important to conduct proper due diligence on each piece of property that you buy before you buy it.
Once a sale is imminent, you may also want to begin discussions with a title insurance company, if you are in a jurisdiction such as Ontario which features title insurance. Many buyers expect title insurance policies, which protect sellers against certain defects in title, to be put in place as a condition of sale of real property. In other jurisdictions, such as British Columbia, you should undertake a thorough land title search of the real properties owned by the business.
Are real property leases properly documented and in good standing? For example, do you have copies of lease agreements and renewals? Leases also generally constitute material contracts of the business so they should be reviewed carefully to see whether the landlord needs to consent to a change of control of the company or any assignment of the lease as a consequence of the sale. You should attempt to have such restrictions removed or at least conditioned when you first negotiate the lease, although landlords tend to be particularly insistent that such restrictions be included.
Consider which licences and permits you need to operate your business. Are these in good standing? Can these be assumed by a new owner of the business or are they subject to restrictions or termination in the event of a change of control or assignment? If your business depends on its permits, you should ensure that you have adequate processes in place to ensure that your business remains compliant with the requirements of those permits.
If you operate an environmentally sensitive business, you should consider putting a more general environmental compliance plan in place that ensures that you comply with permits and environmental law generally and that creates a record of compliance that could be shown to a prospective buyer. You should also consider educating your staff about what to do if an inspector comes knocking, so that they are prepared to respond to investigations in a manner that complies with the law while protecting the company’s legal position. Prospective buyers may perform due diligence with the Minister of the Environment or other authorities. Your position as seller will be enhanced if your business has had only positive interactions with the authorities.
When a sale looks possible, if you company has not recently undergone an environmental assessment, you may want to consider having a Phase 1 environmental assessment done prior to starting the sale process. The Phase 1 EA will help you become aware of any environmental issues, particularly ones that might constitute a “deal breaker” or have a material effect on the purchase price. Note however that savvy buyers may request copies of any such assessment, meaning that you will likely have to disclose both good and the bad news revealed by the assessment.
(h) Disputes and Litigation
If the business is involved in litigation, a potential buyer will want to get an idea of the amount of the claim(s) and also the likely outcome of the lawsuit(s). Consider also threatened litigation or whether there is anything else that could come back to haunt you, such as a disgruntled former employee. If you think there is anything which may fall into this category, you should discuss with your lawyers whether, how and when to disclose such information and, perhaps more importantly, whether you can take any steps to resolve the issue prior to putting the business up for sale or at least prior to closing.
It is always easier to sell a home that has been properly maintained over the years. One important thing to remember when running your business is that, unlike with your home, someone could come along at any time seeking to buy your business. You want to make sure that you are always prepared for that possibility. To that end, consider implementing some of the suggestions outlined in this article long before you decide to sell your business.
Summary of Tips
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Typical steps in the sale of a business
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