Many owners of companies may think they will never sell — that is, until an offer is presented. Realizing the value contained in that offer, and the time that will be required to get to closing, will depend on how well the business has been run, how organized it is, and how well connected the sellers are to the right team of advisors. We provide below a number of traps to avoid:

Not understanding the value

To be effective in negotiating the sale of a business, the seller and their advisors need to have a realistic understanding of the value of the business— including not only the top-level enterprise value, but also how that value is derived. For example, if the value is tied to a core group of customers, then the seller should ensure that it has "sticky" agreements (i.e., no early termination, assignable, etc.) in place with those customers.

Not using optimal structure

When it comes time to sell, the optimal ownership structure for a business is one that makes it easy for buyers to acquire the business while maximizing the seller's take-home proceeds. Several considerations therefore come into play when analyzing the structure. The tax treatment of the potential sale, including the ability of the seller to access lifetime capital gains exemptions, is usually the key determinant of the optimal structure. Some strategies cannot be implemented at the last minute, so advance planning is advisable.

No confidentiality agreement

In the excitement of receiving an expression of interest for their business, a seller may start sharing commercially valuable information with a prospective buyer before putting a non-disclosure agreement in place. This can jeopardize the value of the business. Confidentiality agreements help separate serious buyers from those who may have other motives for looking at the business.

Not understanding the buyer

Potential buyers typically fall into one of two groups: industry buyers (a.k.a. "strategic" buyers) and financial buyers (e.g., private equity funds), and their goals can differ significantly. Industry buyers are often looking to grow or complement their existing business and may place a high value on synergies. Financial buyers tend to look for companies that have solid businesses in place but whose valuation could be boosted over a fixed investment horizon (e.g., five to eight years) by implementing operational efficiencies or by injecting new capital into the business. Treating every buyer the same can be foolhardy.

Deferred housecleaning

While every company ought to keep its books and records up to date, the reality is that many do not. Books and records will be scrutinized as part of a buyer's due diligence. If a seller's books are a mess, the buyer's advisors may recommend more thorough diligence on the remainder of the business; this may delay closing and result in additional demands during negotiation.

No link to new contracts

When negotiating agreements with key customers and suppliers, the focus is usually placed on the business terms; however, attention should also be paid to restrictions on change of control, or which may be triggered by a future sale. Removing these types of barriers ensures that the value of the agreement can ultimately be transferred to a third party, thereby ensuring the full value of those deals can be realized on a subsequent sale of the business.

Not protecting IP

For some businesses, the most valuable asset they have is their intellectual property. However, those companies may focus more on building their IP assets than on protecting them. Where IP is critical to the value of the business, a seller should ensure: that it has registered all of its trademarks, patents, copyrights and business names; that it has properly licensed any critical software; and that its employees and contractors have assigned their interests in intellectual property and waived any moral rights thereto.

No shareholder agreement

A written unanimous shareholders agreement can be critical in facilitating a smooth sale, as it can clearly define who has approval rights, who can sell under what conditions and who must sell under certain other conditions.

Ignoring pending liabilities

A company's perspective on pending litigation or regulatory compliance issues may change drastically when an offer is received to buy the business. Where the best strategy prior to a sale may have been to let these issues play out over time, once a sale is imminent, the strategy will likely become to eliminate, or define and contain, any contingent liabilities. To the extent that such liabilities remain contingent at closing, they may become the subject of purchase price adjustments, holdbacks, or indemnity obligations, all of which will diminish or defer the value of the deal for the sellers.

Originally published in The Lawyers Weekly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.