For those preparing to sell a business, Pepper Hamilton Partner Daniel McDonough suggests listing the most important things they want out of a deal.
“Write those down, and at every turn during this process — whether it's when you're hiring advisers, when to let someone in on due diligence, when to engage in a negotiation of the purchase agreement, when to do the planning — whenever you're facing each of those decisions, always remember what those core principles are,” he says.
By staying oriented to the bigger-picture objective established ahead of the process, transactions go smoothly and owners get what they want, he says.
At the Dealmakers Conference earlier this year in Philadelphia, McDonough talked transaction preparedness, highlighting pitfalls that can trap owners in a deal that doesn’t help them realize their ultimate goal.
Lawyers and LOIs
When preparing for a transaction, there can be question as to when it’s best to bring in deal professionals — investment bankers, accountants, lawyers — to start preparing for due diligence and negotiations. Sometimes an owner will wait until a letter of intent has been signed, but that can paint you into a corner.
“I've had many really wonderful phone calls with clients where they've said, ‘We've got a transaction and we'd like you to represent us,’” McDonough said. “But then the next words out of their mouth will be, ‘And we've signed a letter of intent.’”
In some cases, a letter of intent is more or less benign; it contains appropriate, nonbinding terms that can be reassessed and renegotiated. But there are times when a letter of intent is legally binding. That can muddy up a deal and make conclusions about certain facets when no supporting due diligence has been done, derailing an owner from achieving his or her goals for the deal.
“Before you sign a letter of intent is clearly the best time to involve somebody like me,” he said.
Not only should owners talk with a lawyer, before signing anything, they should also talk to their estate lawyer and tax specialist to ensure the transaction can be executed in a way that's most beneficial for the owner, his or her family and the other shareholders.
McDonough said that when a seller is preparing due diligence, it’s important to think back to the times you might have assumed you were covered on an issue but maybe weren’t.
He offers, as an example, the introduction of the Wayfair rules that redefined what constitutes a sales tax nexus for interstate commerce. Business owners should ask themselves whether they qualified in all the states in which qualification was necessary, whether they’ve been paying taxes in those states and, to the extent that they were selling in those states before they were qualified, whether it is necessary to go back and do a voluntary disclosure.
“A buyer will come in and almost always assume that those issues either don't exist or are not material, so you need to think about those as you prepare your diligence,” McDonough said. “It's not just the organization of the documents, it's how would someone else who is an owner of this business analyze this risk. And what would they be doing? They may not cover every issue, but you need to have documents that show you made a reasonable decision. You've got your ducks in order. You've talked to your accountant about the issue and you’ve gotten the business reasonably comfortable. The board of directors has looked at it, etc.”
Owners should also consider the amount of work involved in selling a company, which can distract from day-to-day responsibilities. McDonough advises owners to appoint someone within the company to be responsible for the diligence, to be the gatekeeper who can be trusted to manage the process.
“If you're charged with running the business plus, ‘Hey, where's the elevator permit?’ you're going to go crazy and the business will suffer because you're focused on the diligence request of the buyers rather than on what's more important to be focused on, which is running that business.”
McDonough said there are certain pieces of a business that owners keep with them after a sale — not sentimental memories or trinkets, but restrictive covenants and indemnification.
“Part of what they're buying is the ability to operate it, and they'll want you around,” he said. “But once they don't need you to consult for that business, they won't want you to compete, so you'll have confidentiality covenants. You'll have a restrictive covenant not to compete, and they won't want you to solicit those same people that you're very familiar with.”
McDonough said there might be someone who is very important to you, someone you believe is an integral part of your next chapter. In that case, talk to the purchaser and address your post-sale plans.
“Have a dialogue,” McDonough said, “because everybody in some sense is replaceable. And to the extent that they have an expectation that you're going to want to work with that person post-closing, most times they'll get comfortable with it, assuming that they understand the rationale.”