While building a public company, start-up or family business, day-to-day operations and growth objectives tend to consume most of management's time and effort. Day-to-day decisions, however, can enhance or diminish the exit value of the business at some point in the future, or can delay a sale. Operating the business with a potential exit in mind can steadily increase the valuation realizable in a future sale.
Transfer of Ownership (Equity)
A clean record of ownership of shares, units, member interests or other equity facilitates the sale of an entity. In reviewing a stock ledger, list of ownership interests attached to a partnership or limited liability company agreement, or list of holders of warrants, options, preferred stock or convertible debt, a buyer will look first at good title to shares or other equity. By updating records on an ongoing basis, a business can be more readily marketed to potential buyers.
- Prior mergers and corporate name changes, death or divorce of individual owners, and lost records can delay negotiations with a buyer.
- Similarly, preemptive rights to purchase and anti-dilution features can create uncertainty about how much equity is outstanding.
Transfer of Ownership (Assets)
Good title to assets can require clean-up documentation in public records. Release of old mortgages and security interests can hold up a sale, and becomes progressively more difficult as time passes. In addition, a buyer typically conducts site visits to view property, conduct an inventory count and inspect other assets. Accordingly, key assets should be documented and accessible, and in good order.
A periodic risk assessment of the business can identify potential risks from a buyer’s perspective that may delay due diligence or reduce sale value. Insurance, hedging, accounting and inventory systems, and other policies and procedures may address risks proactively. Documenting risk mitigation measures can expedite a buyer’s due diligence review and potentially increase the sale price (or reduce indemnification demands from the buyer).
Third parties, including employees, business partners and affiliates, may hold key rights needed to operate the business, such as leases and intellectual property rights. Assigning and documenting key rights in due course assures the ongoing value of the business, rather than addressing potential claims to these rights as an urgent matter when considering an exit. Attempting to settle claims at the time of an exit generally increases settlement costs if these claims have "hold-up value" in delaying a favorable sale.
Customer and Supplier Arrangements
Favorable arrangements with customers and suppliers, including prices and other terms, should be documented to permit transfer of the business to a buyer. An established course of dealing with business partners may not continue after a sale, and other parties may take the opportunity of an exit to re-trade or reset prices and other business arrangements. Undocumented terms and conditions may reduce the value of the business and lead to disputes with the buyer and other parties after closing. In addition, any consent rights that might apply in a potential sale of the business should be identified and renegotiated if possible, to reduce the risk of delay or disputes.
A strategic buyer may have experienced management to run an acquired business. However, a financial buyer or a buyer new to the industry or location may look for experienced management as a condition to purchase. A pipeline of management talent and retention incentives for skilled employees provides comfort to a potential buyer that the business can continue without interruption. Succession planning enhances value of the business, provides institutional memory and allows the buyer to replicate historical performance successfully after a sale.
Tax planning can help owners enhance value on an exit transaction. Advance tax planning can require formation of new entities, restructuring the business or a multi-year program to minimize taxes associated with an exit. In addition, owners may be better positioned to propose transaction terms with more favorable tax consequences.
Ongoing disputes (whether pending or threatened litigation or low-level business disputes) may diminish the perceived value of the business in the eyes of a potential bidder or buyer. These disputes may be resolved more readily (and at lower cost) by the seller before a sale than after a sale. Preserving legal privilege can pose challenges during a potential buyer’s due diligence review of disputes.
A potential buyer generally reviews compliance programs and records, to assure that the business is in compliance with governmental regulations (and has no potential liability or fines for historical practices). Addressing any areas of non-compliance and maintaining orderly records will facilitate a buyer’s due diligence review and avoid delays in dealing with governmental agencies during negotiations. Governmental consents and approvals required for a sale can be identified in advance and discussed with a potential buyer, along with the anticipated timeline for closing.
Depending on the needs of a potential buyer (especially a public company or buyer who will seek bank financing), audited financial statements and documented internal controls may be required for the business before a sale. Whether or not an audit is required, the buyer will review the accounting records (including aged accounts receivable) to assess the financial performance and valuation of the business. Value of a business can be enhanced by maintaining accounting records sufficient to satisfy a potential buyer’s requirements.
Valuation is enhanced when a business is run in the ordinary course in anticipation of a future exit. Advance planning allows for an orderly sale, whether in the near term or opportunistically in the future when market conditions are favorable.