Selling Your Business Practical Tips for Sellers Part 1: Introduction and Deal Structure

JANUARY 21, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

Introduction Its time to cash out. Youve reached retirement age or some other point in your life where you want to sell your business. Or perhaps your business has reached a point where you cant take it any farther on your own and a sale makes sense. Or maybe youve simply received a great offer. In any event, the sale of your business is probably one of the most significant events in your life, and you should understand the process before you jump in so youre well positioned to get the best deal you can with the least amount of risk. In this series of posts, well discuss the key steps in the sales process from the sellers perspective. Well lay out some of the basic concepts and try to provide some practical advice for potential sellers. Our goal will be to give readers who may be considering a sale some information and things to consider that will be helpful to you along the way. Well cover the following topics, and maybe a few others, offering helpful tips where we can:

Deal Structure asset sales versus stock sales Deal Structure earn-outs and seller financing Term Sheet Negotiation Due Diligence Investigation Negotiation of the Purchase Agreement, including Representations and Warranties Conditions to Closing Indemnification Ancillary Agreements employment, consulting, and non-competition agreements

Deal Structure Asset Sales versus Stock Sales Buyers of a business typically want to buy its assets, not its stock, and sellers usually prefer stock sales. Why is this so? For our purposes, well use the term stock to refer to any equity interest in any entity (e.g., membership interests in a limited liability company, stock in a C or S corporation, or

partnership interests in a general or limited partnership), and the term stock sale to refer to the sale of any such equity interest. Taxes From the buyers perspective, an asset sale results in the best tax benefit. The buyers purchase price is allocated among the purchased assets and the buyers tax basis will equal the purchase price, which will benefit the buyer when taking depreciation and amortization deductions as well upon a subsequent sale of any purchased assets. This is obviously a good result for the buyer. On the other hand, in a stock sale, the buyer will get basis in its stock, which cant be amortized, but the buyer wont necessarily get increased basis in all of the purchased assets.[1] Contrast the foregoing tax consequences for the buyer with those of the seller. If a seller has a C corporation, then, in an asset sale, any gain will be taxed at the entity level for federal income taxes, and then a second level of tax will be imposed when the after-tax sales proceeds are distributed to the seller as dividends. On the other hand, with an S corporation or an entity taxed as a partnership, there will usually be only one level of tax in an asset sale, at the sellers level. However, with a stock sale, there will only be one level of tax to the seller regardless of whether a C corporation or a pass-through entity is involved. State taxes differ based on the state(s) involved. Risk The asset purchase structure is usually better from the buyers perspective in terms of minimizing risk as well. With an asset purchase, the buyer does not normally become responsible for any debts or liabilities of the business (and often, unknown or contingent liabilities are the concern think of things the buyer might not know about, such as a potential lawsuit, environmental issue, tax issue, etc.).[2] On the other hand, with a stock purchase, the purchased business will most certainly continue to be liable for all of these items. Of course, the buyer will attempt to cover these potential losses through contractual indemnification provisions from the seller, but thats certainly not as good as having no responsibility in the first place. From the sellers perspective, there is less of a concern about mitigating risk through structuring the deal as an asset versus stock deal. In either case, the sellers best tool for minimizing risk is to be diligent and thorough in its review of the representations and warranties and the associated disclosure schedules in the purchase agreement. With this backdrop in mind, here are few tips for potential sellers to consider in the initial stage of a sale transaction:

First of all and this is probably pretty obvious address deal structure very early in the negotiation process; if you own a C corporation, for example, and the double tax hit will be too much to make a deal attractive enough for you, then be sure this is clear to potential buyers at the outset. Ive seen many sellers and potential buyers strike a deal for a purchase and sale of the business without considering whether it should be an asset or stock deal and then the deal falls apart in term sheet negotiations. For owners of C corporations, consider whether there may be personal goodwill of the owners that can be sold. In the right circumstances, a sale of personal goodwill may help tremendously with the tax bite if the right facts are present. If youre a seller and your potential buyer insists on a stock deal due to concerns over risk, consider evaluating insurance to cover breaches of representations and warranties. Perhaps such insurance could get a buyer comfortable with a stock deal when the buyer wouldnt otherwise be. (Keep in mind that this insurance isnt cheap.) Identify any warts on your company as early as possible when you get to the point of looking for a buyer, most potential issues that could be concerns for buyers are probably in place and you may not have much control over them. But to the extent you do have control, try to get things in good order. If a sale is a year or more away, identify any potential liability issues and try to address them; get books, records, and contracts in order; and consider having your law firm perform some due diligence (i.e., a thorough investigation) of the type that a potential buyer will be doing to help identify problems and how to solve, mitigate, or appropriately disclose them. Dont underestimate how much time it can take to simply collect and copy all of the documents connected to your business, much less try to figure out what might be missing or inconsistent or problematic just days before a deal is scheduled to close. Get your lawyer and CPA involved at an early stage of negotiations. Too frequently an owner will come to his or her lawyer and CPA with a signed term sheet (all too often copied and pasted from some dubious online source) and say, Here is the deal we agreed on make this happen! If the term sheet fails to include key protections for the seller or actually includes terms extremely unfavorable to the seller and the seller was unaware of it, perhaps because he or she was focused mainly on the economic terms, it is probably too late to get more favorable terms in the purchase agreement without a lot of arm-twisting.

Consider your estate plan a few years before you decide to sell, if possible. Often, substantial wealth can be passed to future generations upon a sale while minimizing estate and gift taxes if planning is done early enough. However, its much harder to accomplish such results if no planning is done until the time of a sale.

Footnotes [1] There are ways for a buyer to get around this by, for example, making a Code 338(h)(10) election for an S corporation so that the transaction is treated as an asset purchase for tax purposes, stepping up the buyers basis to reflect the purchase price, or making a Code 754 election for an entity taxed as a partnership to equalize a new partners outside and inside basis. [2] Buyers can become responsible for liabilities under certain successor liability theories but, generally speaking, asset deals pose little risk of successor liability.

Selling Your Business Practical Tips for Sellers Part 2: Seller Financing
JANUARY 28, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

This is the second in a series of posts discussing the sale of a business from the sellers perspective. In the first post here, we provided an introduction to this series and discussed the very basic consequences of structuring a sale as an asset versus stock deal. In this second post, well discuss another deal structure issue, seller financing, which is very common in sales of privately held companies. Seller financing simply means payment by the buyer of a portion of the purchase price through issuance of a promissory note to the seller. Typically, the buyer delivers a promissory note at the closing of the transaction for the amount to be paid later by the seller, in addition to cash for the amount to be paid up-front. From the sellers perspective, there is (or can be) significant risk associated with not receiving payment of the entire purchase price when seller

financing is involved. To minimize this risk (and maximize the likelihood of payment), sellers should consider the following: How Much Seller Financing how much of the purchase price is the buyer requiring the seller to finance? To state the obvious, the more of your purchase price that you finance, the greater the risk. Creditworthiness how creditworthy is the buyer? If youre a seller and are providing financing for a portion of the purchase price for your business, then think like a bank. Do some investigation to understand the buyers creditworthiness and any past or potential problems. Ask for and review financial statements, projections, and business plans (preferably with your accountant) and check public records for liens, bankruptcies, tax issues, and litigation. You might also look into prior transactions done by the buyer to understand how those transactions were structured and confirm that all notes payable by your buyer were paid in full. Security will the promissory note be secured or unsecured? Ideally, the note will be secured, or collateralized by the assets or stock being sold and perhaps other assets of the buyer. However, often the buyers bank or other senior lenders may not allow collateral for your note. In that case, you will hold only an unsecured obligation of the buyer, which means, if things go bad, you get paid after all secured creditors and on equal priority with all other unsecured creditors. Guaranties consider asking for guaranties, either from a parent entity or from individual owners. This is particularly important if the buyer is setting up a new entity to effect the purchase. In that case, the entity probably has little capital so you should make sure the buyers parent entity is on the hook for repayment too. You dont want repayment contingent on the success of a shell company that may be leveraging itself up with debt to do the transaction. It may also be appropriate in some cases to require a personal guaranty from the individual owners of the buyer, particularly when smaller entities are involved. Relationships with Other Creditors if the buyer has senior lenders, then you can count on your indebtedness being subordinated to that of the senior lenders through subordination and/or inter-creditor agreements. But be sure your subordination and inter-creditor agreements allow payments on your note as long as no default exists under the senior indebtedness and contain other reasonable limitations on payment blockages. Senior lenders (especially banks) are notoriously risk averse and wont likely give you much room to

negotiate but you certainly need to understand the terms of your subordination and inter-creditor agreements and make sure they are reasonable. Other Note Terms consider the terms of the Note carefully to maximize the likelihood of payment. Make sure your promissory note has customary terms defining defaults and the consequences of defaults, such as acceleration of the maturity of the indebtedness, default interest rates, etc. At the end of the day, your promissory note can only go so far in ensuring payment but it can at least make your buyer very uncomfortable in the event of a default, thereby encouraging timely payments. Covenants with respect to covenants, consider typical covenants in a bank loan agreement and think through what can reasonably be required in the context of seller financing in a sale of business. You likely wont be able to negotiate all (or even many) of the same restrictions on the buyers activities that a bank would, but there are probably some covenants and restrictions that can be negotiated (e.g., you might not allow the buyer to enter into more purchases and take on additional seller financing with a maturity date prior to the date of your indebtedness). You should also include terms giving you ongoing access to financial statements and other information while your note remains outstanding. Timing with respect to discussion of all of these points, the earlier in the process they are considered the better from the sellers standpoint. If the buyer requires seller financing and you havent already negotiated key deal terms (such as collateral for the seller financing), then be prepared for very difficult negotiations when they come up before closing. Many senior lenders will simply refuse to allow terms such as collateral if given the choice, so the prepared seller will make such terms a condition of accepting seller financing in the first place (at the letter of intent stage). As this short post demonstrates, seller financing adds significant risk and complexity to the transaction for the seller in a sale of business transaction. Wise sellers will realize this early in the process and consider whether seller financing (or how much) is palatable early on in deal negotiations. If seller financing ends up being a deal point, then the seller needs to thoroughly evaluate the buyer and its creditworthiness and make sure the legal documentation and terms put the seller in the best position to be paid in full. The earlier seller financing terms are negotiated, the better (preferably at the letter of intent stage). In the next post, well discuss another common deal structure term, earn-outs.

Selling Your Business Practical Tips for Sellers Part 3: Earn-outs

FEBRUARY 6, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

This is the third in a series of posts discussing the sale of a business from the sellers perspective. In the first and second posts, we provided an introduction to this series and discussed the difference between asset and stock sales and some of theconsiderations and pitfalls when providing seller financing. In this third post, well discuss another common deal structure issue, earn-outs. An earn-out is a deal structure whereby a portion of the purchase price is contingent on the purchased business achieving some pre-determined goal after closing. Common earn-out terms are attainment of certain revenues or EBITDA by the purchased business in the year or two after closing. Earn-outs are common when a buyer and seller arent quite in agreement on valuation. For example, the seller wants $5 million and is confident post-closing financial performance will support such a price but the buyer is skeptical and thus only willing to pay $4 million at closing. An earn-out might bridge the gap in this example with the buyer paying $4 million at closing and agreeing to pay another $1 million (or more) if post-closing performance proves to be as the seller claims it will be. Earn-outs add significant risk and complexity to deals from the sellers standpoint and need to be thoroughly evaluated. Here are a few issues to consider: Term from the sellers point of view, earn-outs should generally be structured with relatively short terms, often no more than two to three years, and many times much shorter periods. Top Line or Bottom Line earn-outs can be tied to any financial (or nonfinancial) measure, but common alternatives are revenues or adjusted EBITDA. Revenues are generally less prone to producing disputes because they are much easier to measure. Adjusted EBITDA, on the other hand, can be very tricky and needs to be very carefully considered. As a seller, with an EBITDA measure, you need to focus on what expenses the buyer might incur that could be detrimental to attainment of the EBITDA target. It could certainly

be the case that the buyer may want to take actions or incur expenses that it believes are in the best long-term interests of the purchased business even if it hurts EBITDA in the short run. Be aware of this potential and consider requiring covenants from the buyer that will it use reasonable efforts to help the business hit the earn-out targets. Discuss the buyers plans for the business after the transaction and try to determine if there are planned activities that might result in needed adjustments to EBITDA after the closing. Control as a seller, your ability to control or influence the business and its results will be substantially reduced (if not eliminated) at the closing and any post-closing control or influence you have will likely diminish quickly. However, if you will be staying on with the business with the buyer (perhaps as an officer or consultant) for some period of time, then you may have some ability to influence the businesss results. Think carefully about how much influence you may have on the earn-out hurdle (as an officer and consultant) and how important this is to you as the seller. Many sellers will only be comfortable with an earn-out if they are running the show during the period in which the earnout is to be measured. Stand Alone Business or Division will the purchased business be a standalone business post-closing or will it be incorporated into a larger business? If its going to be part of another business, then there are more questions and the earn-out process will likely be more complicated. Will it be tied to the overall business or just the purchased business? How will financial results of the earn-out business be separated from the larger business? How will corporate overhead be allocated to the earn-out business? Will there be audited financial statements for the earn-out business or not? Dispute Process make sure your deal documents include a dispute resolution process. As a seller, you want to make sure you have the right to review and inspect the buyers financial records post-closing to evaluate whether or not the earn-out hurdle was achieved. And there should be some sort of dispute process, such as giving the seller the right to have an independent CPA firm review the financial results of the earn-out business. Payment Terms if the earn-out amount (when determined) is not paid in a lump sum, then the seller will bear the same risks with respect to the earn-out payments as with a seller financing. Other Terms what if the buyer sells the earn-out business before the earnout amount is attained? Should this result in some portion of the earn-out being automatically earned and payable? What if there is a change in

management (e.g., as seller, youre comfortable with the current CEO but hes replaced with a new CEO during the earn-out period)? As with seller financing, earn-outs add significant risk and complexity to a sale of business transaction. A prepared seller will give significant thought to any earn-out terms very early in the deal process and consider ways to maximize earn-out success in the context of the specific business. In the next post, well discuss letters of intent and then move into the due diligence process.

Selling Your Business Practical Tips for Sellers Part 4: Letters of Intent
FEBRUARY 21, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

This is the fourth in a series of posts discussing the sale of a business from the sellers perspective. In the first three posts, we provided an introduction to this series anddiscussed asset versus stock sales, seller financing, and earn-outs. In this fourth post, were moving away from deal structure issues and into the deal process itself, starting with letters of intent, or LOIs (also known as term sheets). Weve previously written about LOIs from the point of view a buyer of a businessand recommended that a lawyer be engaged at the LOI stage. However, in this post we want to discuss some of the important points from the perspective of a seller of a business. Here are four tips for sellers in negotiating the LOI followed by a list of items sellers might consider including in the LOI. Point 1 Get the Maximum Benefit of Your LOI From the sellers perspective, negotiating power is often highest at the LOI stage. However, many sellers fail to take advantage of their relative negotiating strength at this point in the deal process, instead viewing the LOI as non-binding and thus not as important as it really is. From a practical standpoint, after a seller has signed the LOI and started the deal process, the seller has often formed a mental and emotional commitment to the sale (and the cash) and it can be very difficult to negotiate with an experienced buyer concerning items that

havent been previously agreed on. Often, a sophisticated buyer simply says no to what may be important and reasonable requests because they werent included in the LOI, leaving you, as the seller, with the nearly impossible position of risking the deal or giving in. So, point one is to maximize your leverage at the LOI/term sheet stage by broadening the scope of your LOI to include not only business points but significant legal points too. Point 2 Be Clear as To Whats Binding and Whats Not As Ive previously discussed, its imperative to be clear as to which portions of the LOI/term sheet are binding and which are not. Point 3 Be Aware of Expectation Setting Often, the LOI will be the first negotiations between buyer and seller and, thus, the first chance for the parties and their counsel to size each other up. If you treat the LOI lightly and try to sign too quickly without giving it your full consideration, you might be giving the buyer the impression that youre too anxious or want the deal too much, thereby giving the buyer more confidence in its negotiating power. Ive seen many sellers rush to sign something, thinking its non -binding and can be changed which, in my view, only leads to problems down the road. Instead, treat the LOI stage as a critical step in the deal process and be tough, yet reasonable in negotiations. Point 4 Strike a Balance Despite what Ive just said, dont overdo it. The LOI is, after all, an expression of intent for the most part, so dont try to negotiate the entire deal at this stage. Theres a reasonable balance that needs to be maintained negotiate towards a clean, crisp LOI that covers the salient deal points (business and legal) but dont get into the minutia at this stage. Potential Items to Consider With this backdrop in mind, heres a list of items sellers should consider including in the LOI, some obvious and some you might not think of:

In an asset deal, include a generic list of assets being sold and list any significant excluded assets; on the flip side, do the same with liabilities to be assumed by the buyer or excluded. Clearly state the purchase price and payment terms; include basic terms of any seller financing or earn-outs, if applicable. Clearly describe any working capital adjustments and associated assumptions.

Provide a general framework for how the diligence process will proceed and note any items you will retain pending execution of a definitive deal document (e.g., sensitive customer information). Consider stating who will be required to give representations and warranties from the sellers side (will it be the selling entity only, or the individual owners as well?). Note any significant closing conditions e.g., whether the deal is contingent on the buyer obtaining its own financing. List the basic indemnification terms (who will provide the indemnities; what will the baskets, caps, and survival periods be) and consider noting any special terms that might apply in your deal. Consider listing the basic terms of any employment or consulting agreements for the principals of the sellers post-closing (how long you will work post-closing and what your title and compensation will be after closing). List the basic non-competition terms that will be applied to the sellers post-closing (e.g., sellers wont compete for three years after closing). List the buyers intent with respect to sellers employees (will they all continue with the buyer post-closing?) and note whether buyer will be able to discuss the deal with employees prior to a definitive deal document being signed. Note the anticipated closing date and any special terms that might apply (e.g., the deal must close on or before X). Be sure confidentiality and non-disclosure provisions protect your information often, theres a separate confidentiality/nondisclosure agreement. If theres not, be sure to include these provisions in the LOI and make sure they are binding. If there is a separate agreement, make sure the LOI does not supersede the confidentiality/nondisclosure agreement. Be sure your LOI disclaims reliance by the buyer on information it may review during the due diligence process. If you dont get to a definitive deal document, you dont want to be on the hook for claims by the would-be buyer if it claims reliance on preliminary discussions or diligence information. Consider an exclusivity clause. You most often see these clauses in the buyers favor, which is usually reasonable, but you might consider whether its reasonable to restrict the buyer from talking to your competitors while youre negotiating with the buyer. You dont want the buyer pulling out because it finds a better deal in your industry while youre negotiating in good faith and providing the buyer with sensitive information.

Be clear on who pays deal expenses in the event the deal doesnt close. Youll generally want to make sure the buyer is paying its own costs. Include normal contract boilerplate provisions, such as those dealing with governing law, jurisdiction for disputes, etc. Again, if the deal doesnt close, youll want to be sure these items are covered. Clearly list the binding provisions. Add anything thats unique and material to your deal. At a minimum, you want to make sure you and the buyer are on the same page to avoid surprises.

In the next post, well discuss the due diligence process.

Selling Your Business Practical Tips for Sellers Part 5: Due Diligence
FEBRUARY 28, 2013 BY JENNIFER WILSONLEAVE A COMMENT

This post was jointly written by Jennifer Wilson and Casey W. Riggs. This is the fifth in a series of posts discussing the sale of a business from the sellers perspective. In the first four posts, we provided an introduction to this series and discussed asset versus stock sales, seller financing, earn-outs, and letters of intent. In this fifth post, well discuss the beginning of the deal process (after signing of the LOI), which typically begins with a comprehensive review of the sellers business by the buyer (generally referred to by those in the M&A industry as simply due diligence).[1] The due diligence process can often overwhelm sellers who need to be focusing on more important aspects of the transaction. Its incredibly stressful to be working on key aspects of the deal (and simultaneously running your business) while being bombarded with e-mail requests for more and more information, some of which may seem irrelevant or immaterial. To keep your sale progressing smoothly so you can focus on whats important, you need to know what to expect and how to respond before you start the process. Heres a description of the purposes of due diligence and a general outline of the process followed by some tips for handling it efficiently The Purposes of Due Diligence

Due diligence is performed by the buyer to determine if it wants to go through with the purchase of the business. As the seller, you are privy to all sorts of information that the buyer doesnt have and due diligence is the primary way the buyer has of getting at this information. While you may know with certainty that there are no potential environmental issues with your real properties, the buyer doesnt know this but wants to find out in the due diligence process. So keep this in mind when the buyer is asking for all kinds of information, some of which may not be relevant. Due diligence is also used to put together the schedule of disclosures required in connection with the purchase agreement. Well begin discussing the purchase agreement in the next post. The Due Diligence Process Due diligence will likely begin with one or more diligence request lists. You may get one comprehensive list submitted by the buyers law firm which requests accounting, financial, and legal information. Or you may get separate lists (one from legal, one from financial/accounting). If you get a brief list, you can be pretty sure that a longer list is coming later. (If you want to see a sample diligence request list, send us a quick e-mail and well be happy to provide one.) When you get the request list, you will be expected to provide complete and accurate responses to all items requested, and most likely, this will be done by means of a virtual data room. Popular electronic data room providers range from those like Merrill, which offers a full-featured service with extensive security options (for example, documents can be made available on the site for printing only and users cannot download them to a local drive), to cheaper or free options, such as an in-house extranet service or cloud services such as Google Drive or Dropbox. Electronic diligence entails a lot of scanning and organization for you and means, generally, that the parties involved expect instant responses to requests and a constant awareness of what is provided. The due diligence process, on the buyers side, will likely be run by mostly associate attorneys, many of whom may seem to exercise little or no common sense at times. Youll know what I mean when you get repeated requests for a signature page to a postage meter lease. However, to be fair, the associates are charged by their senior partners with running down every contract, document, etc., and arent charged with making judgment calls about what is or is not important at the due diligence stage. The due diligence process may at times seem grueling. It often continues right up to the point of closing with continuing requests for missing or additional

information, all while youre running a business, trying to negotiate a transaction, and attempting to maintain some sanity. With this backdrop of the purposes and process of due diligence, here are some practical tips to make life easier in this phase of the deal: Point 1 Consider a Pre-Transaction Review Consider having your law firm review your books, records, contracts, etc. before the deal process even starts. Your lawyer will have a good idea as to what information the buyer will be looking for and it can help tremendously to have your information organized and collect missing information before the deal starts. Youll be glad you did this when youre in the heat of the deal. Point 2 Provide Complete Responses Many buyers will want to review everything (every contract, financial statement, customer list, accounting record, and on and on), and will expect it to be complete. When you hunt down the documents requested, before scanning them, check them over to be sure that they are the most current version and include all party signatures and all attachments, exhibits, annexes, schedules, and so on. You can be sure that the purchasers lawyers are going to come back and hassle you for anything that is missing. Point 3 Allocate Responsibilities Decide on an allocation of responsibility within your company and between you and your lawyer. Some business owners take charge of going through their files and scanning and uploading all the documents to be provided. Others send boxes of disorganized papers and files to their law firms for junior associates to go through and organize. Yet others work out an arrangement somewhere between these extremes. Whatever you choose, make sure that everyone knows who is responsible for uploading new documents and informing the group that new documents are available. Point 4 Use Reference Numbers and Descriptive File Names When organizing and delivering documents, consider using reference numbers and writing them right on the documents before you scan them. Also be sure to use file names that start with those reference numbers and that include a helpful descriptor. As in other areas of life, the file name Scan00001 is completely worthless to anyone looking for a document and will lead to inefficiency and confusion. Instead, use a name such as 2A Tennessee real property lease.

Point 5 Always Load It in the Data Room Dont assume that just because you e-mailed a document directly to purchaser, or to your accountant, that anyone else involved in the transaction has seen it. Put all documents in the data room, even if any party asks that you e-mail a particular document directly. Above all else, remember to make sure your lawyer sees every single document you provide to anyone else. Point 6 Be Aware of Confidentiality Be aware of where you are in the process and adjust disclosure accordingly. If you are at an early stage and wish to keep customer names confidential, for example, provide customer contracts with the customer names redacted. Number them so that you can provide a number-customer name key once you are ready to reveal the names. If youve allocated the responsibility of uploading documents to your lawyers, be sure to keep them in the loop as to documents that should remain confidential or that should be redacted before being uploaded. Point 7 Use N/A If your company doesnt have any of a certain type of document requested for example, deeds to real property (because all of your offices are leased) be sure to indicate that there is nothing to provide on the request list. If you have provided some documents in a given category, but others are coming, indicate that as well. It is easiest to do that right on the request list. Point 8 Keep the Due Diligence Information Whether a deal closes successfully or fails to close, be sure to keep records of all documents you provided during the due diligence process. It is easy enough to burn a CDROM of the entire electronic data room. If the deal closes, you may need to refer to these documents from time to time, especially if any dispute or indemnification claim arises under the purchase agreement. If the deal doesnt close, you can also use this to make the process go that much more quickly in your next attempt. Dont lose sight of this important step in the aftermath of a deal that fails to close. If you can keep these tips in mind while going through the due diligence process, youll be in a much better position to guide the transaction from a high level. In the next post, well begin discussing the purchase agreement.

Footnotes

[1] On this blog, we previously covered due diligence from the perspective of a buyer. Topics included: an overview of the due diligence process, a summary of legal due diligence, a summary of financial due diligence, and a summary of operational due diligence.

Selling Your Business Practical Tips for Sellers Part 6: The Purchase Agreement
MARCH 12, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

This is part six of our series discussing the sale of a business from the sellers perspective. Weve covered deal structure issues, seller financing, earnouts,letters of intent, and due diligence. In this post, well begin discussing the primary definitive deal document, the purchase agreement. The first draft of the purchase agreement will generally be prepared by buyers counsel and will be divided into several separate sections, such as the following:

Description of the Transaction Representations and Warranties of the Seller Representations and Warranties of the Buyer Pre-closing Covenants Conditions to Closing Post-closing Covenants Termination Survival and Indemnification Miscellaneous or General Provisions

The actual sections included will depend, in part, on whether the deal is structured with a signing date followed by a later closing or, alternatively, as a sign and close transaction where both events happen simultaneously. In the latter case, the purchase agreement is generally simpler and wont include the Pre-closing Covenants or Conditions to Closing sections. The first section, which were discussing in this post, will often contain the major business terms. Heres a brief list of the major terms and tips for reviewing this section of the purchase agreement.

Assets/Interests to Be Sold. The buyers draft of the purchase agreement should accurately describe what is actually being purchased by the buyer (the specific assets in an asset deal or the stock or other ownership interests in a stock deal) and those assets or liabilities being retained by the seller, if any. Hopefully, there is agreement on such big picture terms prior to receipt of the purchase agreement so that there wont be lots of negotiation on these points. As a seller, youll want to be sure all of the descriptions are correct. In particular, in an asset deal, be sure all assets you intend to remain with you (excluded assets) are specifically listed. Typical excluded assets are cash, marketable securities, assets associated with retained liabilities (e.g., 401(k) assets if the plan is being retained), and often certain personal assets (e.g., the sellers vehicle). Generally, the buyer will draft very broad language when describing the transferred assets, such as all assets used in the business, including Therefore, its up to you, as the seller, to carve out assets that should not be transferred. On the liability side, be sure all liabilities that the buyer will take are listed (here, the buyers purchase agreement will usually use very restrictive language such as seller retains all liabilities and obligations except for the following: [list of specific liabilities]). Typical liabilities that the buyer will assume include obligations under assigned contracts and accounts payable. Again, this is only relevant in an asset deal. A stock deal is typically simpler to describe but be sure the description of stock or other interests being purchased and sold is correct. Purchase Price. Often, the purchase price terms will be one of the first subsections of this section. It should include (i) the portion of the purchase price to be paid at the closing and how it will be paid (e.g., $5,000,000 million by wire transfer to a bank account of the seller), (ii) any portion of the purchase price to be paid via delivery by the buyer of a promissory note to the seller (e.g., $2,000,000 by delivery of the buyers promissory note to seller), and (iii) any portion to be paid via an earn-out. Many times there are potential adjustments to the purchase price too (e.g., working capital adjustments), some of which may be made at the closing and others which are made postclosing. Such adjustments should also be very clearly described. Closing. The Closing should be defined and described in the purchase agreement. Most deals now close by exchange of documents by electronic transmission with originals to follow by overnight mail. A specific date for the

closing should be set, especially in a deal that will provide for signing of the purchase agreement before the closing. Also, its common to set the effective time for the closing (e.g., 11:59 p.m. on the date of closing), to eliminate any confusion about events that occur or conditions that apply on the Closing Date but before or after the Closing itself. This first section of the purchase agreement should be fairly straight forward and should not require significant negotiation but it is one of the most important sections because it contains the major business terms. So be sure to think it through and review it very carefully with your lawyer and probably your CPA. In the next post, well discuss representations and warranties in the purchase agreement.

Selling

Your

Business

Practical

Tips

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Sellers

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7:

Representations, Warranties, and Disclosure Schedules

MARCH 21, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

This is part seven of our series discussing the sale of a business from the sellers perspective. Weve covered deal structure issues, seller financing, earn-outs,letters of intent, due diligence, and the first section of the purchase agreement dealing with major business points. In this post, well discuss the sellers representations and warranties and the related disclosure schedules to the purchase agreement. Lawyers frequently debate the subtle and esoteric differences between representations and warranties, but for our purposes, in this post, they are basically statements that the parties make about themselves and their businesses, and well refer to them simply as representations. The purchase agreement will typically contain a comprehensive list of representations that the seller is asked to give. Often, there will be 20 to 30 different sections covering various areas of the sellers business, assets, etc. The following is just a sample:

Due organization and good standing Capitalization

Noncontravention (i.e., the purchase agreement will not contravene the sellers organizational documents, any laws, any governmental orders, etc.) Financial statements Compliance with laws Tax matters Intellectual property Contracts Litigation Employees Environmental, health, and safety Related party transactions Customers

The representations serve three primary purposes from the buyers perspective. First, they further the due diligence process by (hopefully) ferreting out problems or issues with the sellers business or assets so they can be addressed before an agreement is signed or taken into account in arriving at a purchase price; if they are sufficiently grave, the parties may abandon the deal. Second, in the case of a deal in which the purchase agreement is signed and the closing is scheduled for a later date (as opposed to simultaneous signing and closing), the representations serve as a basis for allowing the buyer to walk away from the deal without closing (walk rights) if the buyer learns that the representations are not accurate at closing. Third, they serve as a basis for allowing the buyer to recover some of its purchase price (through indemnification) after closing if the sellers representations are inaccurate and the buyer incurs damages (this latter function is referred to as risk shifting in industry jargon because each party is attempting to negotiate the language of the representations to shift the risk of post-closing events to the other party). Heres sample language from a purchase agreement requiring the seller to represent that it is in compliance with legal requirements:
The Seller is, and has been since January 1, 2010, in compliance with all applicable laws (including rules, regulations, codes, plans, injunctions, judgments, orders, decrees, rulings, and charges thereunder) of federal, state, local, and foreign governments (and all agencies thereof), and no action, suit, proceeding, hearing, investigation, charge,

complaint, claim, demand, or notice has been filed, commenced, or threatened against the Seller alleging any failure to so comply.

As is customary, the buyer has used very broad language in this representation and the seller needs to know how to handle the representation in its negotiations of the purchase agreement. With that in mind, here are some tips for sellers engaged in those negotiations: Tip 1 Consider Who Should Give the Representations. The purchase agreement will typically include a lead-in statement that applies to the entire list of representations, such as the following: The Seller and Shareholders, jointly and severally, represent and warrant to Purchaser that the statements contained in this Section 2 are true, correct and complete as of the date of signing and the Closing Date, as modified in the applicable section of the disclosure schedule accompanying this Agreement (the Disclosure Schedule). This particular language is from an asset deal and requires the seller (the entity) and the shareholders of the seller to make the representations. So task one is to determine if this is appropriate or not. Ideally, in an asset deal, the sellers shareholders will not have to give the representations, but often the buyer will insist that they do (at least perhaps majority owners). The smaller the company and the fewer the shareholders, the more likely it will be that individual shareholders will have to make the representations. Also note that the representations are joint and several meaning that the seller (the entity) and the shareholders are on the hook for the statements. At the end of the day, it may be the case that the entity and the shareholders have no choice but to give some or all of the representations, but think this through very carefully and limit shareholder responsibilities as much as possible. Tip 2 Review and Narrow. The buyers initial draft of the purchase agreement will likely request overly broad representations from the seller as to its business and assets. The sellers initial task is to review the statements very closely and determine those that it can give with certainty and those that are perhaps less certain. As an example, many sellers might react as follows when reviewing the sample representation on legal compliance above: I think were in compliance with all laws but I am not totally sure.

In that case, the sellers goal is to make the statement completely true with as much certainty as possible by either narrowing the representation and/or making adequate disclosures (the latter is discussed below). When reviewing the representations, be sure to get input from others in the organization who might have knowledge of any issues covered by the statements (e.g., a human resources manager). After you have a good understanding of your ability to make each representation with certainty (or not), consider narrowing the representations as much as possible, particularly those that result in significant risk to the seller and its shareholders. Common ways to narrow representations include adding knowledge and/or materiality qualifiers to the statements requested by the buyer. As an example, heres the representation on legal compliance quoted above rewritten from the sellers standpoint (with the sellers additions in bold):
Except as set forth on disclosure schedule [cross-reference section number], and except with respect to any violations which would not have a Material Adverse Effect, the Seller is, and has been since January 1, 2012, in compliance with all applicable laws (including rules, regulations, codes, plans, injunctions, judgments, orders, decrees, rulings, and charges thereunder) of federal, state, local, and foreign governments (and all agencies thereof), and no action, suit, proceeding, hearing, investigation, charge, complaint, claim, demand, or notice has been filed, commenced, or, to the knowledge of the Seller,threatened against the Seller alleging any failure to so comply.

The sellers modified language changes the representations in four ways. First, the seller has added a disclosure schedule in which the seller will note any violations of laws or pending or threatened suits, charges, etc. Second, the sellers version limits the entire representation to legal violations that would cause a Material Adverse Effect (a term that will be defined in the purchase agreement to indicate the negative effect of certain events on the sellers business), but not that there are no violations, period. Third, the seller has changed the applicable date from January 1, 2010 to January 1, 2012. And fourth, the seller has added a knowledge qualifier with respect to issues that are simply threatened rather than actually in process. Taken as a whole,

the representation as revised by the seller poses much less risk for the seller and hopefully the seller can now make this statement with a high degree of certainty. Tip 3 Disclose, Disclose, Disclose! The seller must disclose any items required to make a representation true. So for example, if the legal requirement representation described above is true except that the seller believes it may have violated an employment law and has received an initial notice from the EEOC, then the disclosure schedule can be used to make the representation true. Heres a sample disclosure:
The Seller received notice from the EEOC on [date] that it was reviewing a complaint filed by [ex-employee] alleging age discrimination.

The disclosure schedules are sometimes referred to as insurance in industry jargon, in the sense that they help insure the seller against future claims by the buyer. Tip 4 Update Disclosure Schedules. Most deals are of the sign and close later variety (as opposed to a simultaneous sign and close). When closing follows the signing at a later date, the seller must monitor the representations between the date of signing and the closing. Its almost certain the buyer will require the seller to make the representations at the time of signing and at the time of closing. The seller needs to update its disclosure schedules such that they, as well as the representations they modify, remain true on the closing date. The representations and warranties section of the purchase agreement is often the longest and most laborious section of the document. Knowledgeable sellers will pay significant attention to the statements included and limit their risk by narrowing the reach of the representations and by making adequate disclosures. Dont simply leave these to your counsel and assume they are just verbiage for the lawyers to tinker with know what the representations state about you and your company. In the next post, well discuss conditions to closing.

Selling Your Business Practical Tips for Sellers Part 8: Pre-Closing Covenants and Conditions
APRIL 4, 2013 BY CASEY W. RIGGSLEAVE A COMMENT

This is part eight of our series discussing the sale of a business from the sellers perspective. Weve covered deal structure issues, seller financing, earn-outs,letters of intent, due diligence, and the first two sections of the purchase agreement dealing with (i) major business points and (ii) representations, warranties, and disclosure schedules. In this post, well discuss the portion of the purchase agreement dealing with the period after the signing date and up until the closing. Weve previously noted that most deals are of the sign and close later variety as opposed to a simultaneous sign and close. The interim period between the signing of the purchase agreement and closing (which well refer to as the Pre-Closing Period) is usually necessary to work through issues with parties who arent involved in the transaction. Examples of such issues include getting consents from third parties to the sellers contr acts, obtaining governmental authorizations, getting the buyers financing in place, and working through issues with employees. From the sellers perspective, the Pre-Closing Period is critical. Youve got a deal signed but havent closed and you want to minimize any risk that the deal falls apart. The buyers draft of the purchase agreement will probably include numerous covenants (both affirmative and negative) requiring the seller to take or not take certain actions and will contain many conditions that must be met for the closing to take place. Once the seller executes the agreement, it is committed to the deal but wants as many outs as possible if something goes wrong between signing and closing, if it learns of information it might not like, or maybe even if it changes its mind. Sample affirmative and negative covenants that a buyer might require from the seller include the following: Affirmative Covenants. The seller will (between signing and closing):

Operate the business only in the ordinary course Keep its business relationships intact (those with employees, customers, vendors, etc.)

Maintain its properties and insurance Comply with all laws Update the buyer on any changes or developments concerning the sellers business Continue to keep the deal confidential Continue to assist the buyer with its due diligence

Negative Covenants. The seller will not (between signing and closing):

Increase pay of officers, employees, etc. or enter into termination or severance agreements Terminate customer or vendor agreements Make any capital expenditures Pledge or transfer any company assets outside the ordinary course Negotiate with any other party concerning the sale of the business

And sample conditions to closing might include:

All of the sellers representations and warranties remain true The seller shall have complied with all of the covenants The buyer shall have been satisfied with its due diligence investigation in its sole discretion The seller shall have obtained all necessary authorizations and consents There shall have been no adverse change in or development in the sellers business The buyer shall have obtained financing to fund the purchase price

The buyers draft of the purchase agreement will typically contain language giving the buyer maximum opportunity to get out of the deal if any condition or covenant is not true. The seller needs to do its best to minimize this risk. Here are some tips for sellers in handling these portions of the purchase agreement: Tip 1 Keep the Pre-Closing Period Short. To state the obvious, the longer the period between signing and closing the greater the risk that something will go wrong (e.g., a material adverse development with respect to sellers business). So keep the period as short as reasonably possible while allowing time to get third-party consents and handle other post-signing, pre-closing matters.

Tip 2 Review Covenants Closely and Narrow Them Down. Be sure the covenants are reasonable and necessary to protect the buyer from adverse events specific to sellers business during the Pre-Closing Period and are not overly broad. As an example, be sure the buyers walk right for a material adverse development excludes events such as a downturn in the economy or the industry in which the seller operates. When the purchase agreement is signed, the buyer shouldnt be able to get out of the deal merely because there is a negative development that affects all businesses in the sellers industry. Thats the buyers risk to take. Tip 3 Eliminate Closing Conditions that Are within the Buyers Sole Control. Many buyers will include closing conditions that are within the buyers sole control, such as the example above that the buyer must be satisfied with its due diligence investigation in its sole discretion. From the sellers standpoint, this gives the buyer too easy of a walk right. When the purchase agreement is signed, the seller wants to make sure its a firm deal and will close absent some extraordinary negative development between sign and close. Delete contingencies such as this. Tip 4 Keep It Material. The seller should attempt to introduce materiality or material adverse effect language in its closing conditions. For example, there may be a closing condition that states no lawsuits are pending against the seller as of closing. The seller should limit this to lawsuits that could reasonably be expected to have a material adverse effect of some sort on the sellers business. Another example is the condition that all of the sellers representations and warranties remain true at closing. Again, the seller is best served by limiting this broad condition by using language such as in all material respects. Tip 5 Beware the Financing Contingency. Many deals will be contingent on the buyer having obtained financing on terms acceptable to it in its sole discretion. As a seller, you want to be comfortable that the buyer will in fact obtain the necessary financing before you spend your time and resources negotiating a deal, and certainly before the purchase agreement is signed. Ask for and review the buyers bank commitment letter early on; and if the buyer is telling you that it will have the financing in place, then attempt to eliminate the financing contingency in the purchase agreement. If youre unable to eliminate it, then consider placing a covenant on the buyer that it will use its best efforts or reasonable best efforts to obtain the financing on terms set forth in the commitment letter.

The covenants and conditions to closing sections are very important parts of the purchase agreement and the transaction and should not be taken lightly. Sellers should pay careful attention to these provisions to maximize the likelihood that the signed deal actually closes.