In the first two parts of our series on selling your business we walked you through preparing your business for sale and then, once you snagged a buyer, what should be included in the Letter of Intent (“LOI”). Now you’ve got a deal… in principle. Time to break out the champagne, right? Not exactly. This is when the real work begins. In fact, don’t be surprised if the deal is re-cast on several key points and the negotiation continues right up until closing. So what can you expect post LOI?
Due Diligence
I could write several articles on this topic alone but you may lose the will to ever sell your business if I do. Depending on your buyer, it may feel more akin to a proctology exam then a review of your “stuff.” But here is a very general list (Due Diligence Checklist) of what most buyers want to see.
- Your corporate books and records
- Financials (audited) for the past three years + interim (current) + credit reports + accounts receivable (A/R) + your general ledger + accounts payable + inventory + indebtedness + depreciation and amortization schedules + schedule of inventory
- Physical assets
- Intellectual property (“IP”) assets (patents, trademarks, tradenames, copyrights), work made for hire agreements, consulting agreements (to make sure you own the IP)
- Employee and employee benefit information (plan documents, agreements, current salaries, bonuses, health and medical insurance, 401(K), profit sharing, a roster of employee claims in the last three years, worker’s comp claim history, unemployment insurance claims history, stock option plans, etc.
- Licenses and permits
- Real estate including any environmental issues attached to it
- Taxes (returns from last three years, TPT information for three years, tax settlement documents if any, employment tax filings, excise tax filings
- Material contracts including copies of all guaranties, security agreements, loan agreements, installment agreements, non-competes and non-solicits
- Customer or client information - schedule of the 10-12 largest customers (usually redacted), credit policy, etc.
- Vendor or supply chain information, supply or service agreements
- Past or present litigation
- Insurance coverage
Preparation of the Asset Purchase Agreement (“APA”)
Depending on your LOI, drafting of the APA could happen either concurrent with the Due Diligence or immediately after.
In smaller purchases, the parties may believe that Due Diligence should be nil to non-existent but that is a mistake for both buyer and seller.
Why? What the seller provides to the buyer and what the buyer sees is key to the disclosure schedules that form the basis of the representations and warranties (your promises to each other).
What does that mean? The due diligence documents ultimately become disclosure items referenced in the APA and those disclosures are represented by you to be true and complete.
A breach of these representations and warranties (lying or not disclosing pertinent information), depending on the severity, could tank your whole deal or, even worse, end up in a lawsuit.
Due diligence isn’t just form or for “big companies” - it is the heart of the agreement.
The Most Critical Parts of an APA
Ask a seller or business broker what the most critical part of an APA is and you will likely get the answer “Closing!”
However, a lawyer will likely say one of the following: (a) allocation; (b) tax provisions; (c) insurance; (d) indemnity or (e) dispute resolution.
Why? Because nothing is ever “smooth as silk” after the Closing. There will likely be an issue or disagreement and these boring lawyer provisions spell out how to deal with those issues.
Allocation is the percentages of the purchase price that goes into distinct buckets (goodwill, IP, assets, etc.). It is very rare that this is final when the LOI is signed. Usually, it says that the parties will mutually agree to the allocation in the definitive agreement (APA). There is usually a tussle over this for obvious reasons: taxes. (See Item ‘b’ above). The seller wants as much of the price as possible allocated to assets. The buyer wants to put it elsewhere. This is why you need to have your team on the same page. Discuss and plan for this ahead of time and negotiate hard. It most likely means money out of your pocket if you don’t. If you’re not clear on options for or implications of allocation, don’t hesitate to involve your CPA or have your lawyer reach out to tax counsel with questions.
In sophisticated deals, the tax provisions are another area of the APA that require patience and persistence. Again, the financial arm of your team (CPA, CFO, comptroller, tax advisor and tax lawyer) is critically important.
Stay with me, items (c) through (e) are where I lose most folks.
These provisions, (Indemnity, Insurance and Dispute Resolution) boring though they may be, are THE KEY. Regardless of how well-drafted contracts they are, there is always room to interpret provisions differently (aaahh the skill of a litigator). Don’t gloss over these.
Make sure your insurance broker really understands what coverage you have and what you need for your business AFTER the closing. Whether your current policy is claims-made or occurrence-based is going to be really important to determine what kind of post-closing insurance (tail or closed business) you need, if any.
When it comes to dispute resolution, I always counsel clients to try and work it out with a mediator before proceeding to court. This is particularly important in deals where there is an ongoing relationship between the seller and buyer.
Finally, if you have a deal that involves real estate, other large assets or some ongoing payment, make sure you negotiate for cross-defaults.
This means if the other party breaches one of the agreements (there will be a few) in your transaction – say they stop paying on a promissory note - you would have the option to default them under another agreement where you may have some leverage – such as discontinuing work under a transitions services agreement. These terms will give you the most safety and flexibility if there is a default of any kind.
This concludes our three-part overview of the anatomy of a sale.
While it is a daunting endeavor, I have experienced, dozens of times, the transformative, life-changing joy that comes from both buying and selling a business. Or as Teddy Roosevelt said,
“Nothing in the world is worth having or worth doing unless it means effort, pain, difficulty.”
