Selling the Company? Get Your House In Order First

1/12/09

The recent downturn in the economy is having—and will continue to have—a significant impact on the ability of many companies to raise money and fund continued growth. This in turn will have significant ramifications on exit strategy. Luckily, for some at least, there are still potential buyers out there with sufficient cash to fund acquisitions. The Wall Street Journal, for example, reported that Oracle CEO Larry Ellison said at the company’s October shareholder meeting, “Acquisitions that we have been looking at for some time may now be more attractive.” As the current economic conditions are likely to move M&A towards a buyer’s market, potential targets should be asking themselves what they can do to make themselves more attractive and to make it easier for a buyer to close the deal.

Let’s face it—many smaller companies don’t spend a lot of time or resources getting their houses in order. They are focusing their primary efforts on R&D and marketing and sales, as they should. But if at some point a potential buyer is interested enough in your business to take a look at you, it would be in your best interest to be prepared as an organization. This includes the formalities related to the business’s legal existence and its relationships with other parties such as customers, vendors and employees.

At the top of the list are corporate organization documents (e.g., charter, bylaws and stock records), corporate administrative records (e.g., shareholder and board minutes and resolutions), contracts (of both the vendor and customer varieties), and employee and contractor agreements. A company has to ask itself: If a buyer knocked on the door tomorrow and wanted to start due diligence, could I find all of these documents? Are they up to date? Has everything been properly signed and dated?

The inability to produce these materials for due diligence could cause a buyer to worry about the state of the business. A lack of shareholder and board minutes books can call into question whether the company’s actions have been conducted with all necessary approvals. A buyer needs to be able to rely on the fact that all prior actions taken by the company or its officers were properly authorized. Without this knowledge, the buyer faces a risk that some prior actions could be challenged. For example, the buyer wants to be assured that critical material contracts have been properly handled.

Improperly maintained stock records prevent proper determination of the various ownership stakes in the company. A buyer needs to know exactly who owns what, which will ordinarily determine how the money is divvied up when the deal closes. Without this information, the buyer doesn’t really know what it is buying and runs a significant risk of becoming embroiled in an ownership dispute involving founders, investors and other stockholders.

Failure to organize properly signed contracts can have numerous ramifications. Do you have all necessary rights to the intellectual property used in your business? Do you own it? A careful review of your contracts with vendors and licensors will be necessary to make this determination.

The buyer will also want to verify that your employees and consultants have signed agreements confirming that the company owns (in the case of employees) or at minimum has sufficient license rights (in the case of contractors and licensors) to all intellectual property used in the business. If it takes a few weeks to find these documents and get them to the buyer’s due diligence team, the team may rightfully wonder whether you have a handle on things.

Demonstrating to a buyer that your company has adequate contracting practices for customer deals is equally important. Your (and eventually the buyer’s) ability to recognize revenue – and the timing of revenue recognition—will be highly dependent on the existence of properly signed and dated contracts. A serious buyer will very likely want some comfort with your revenue recognition practices and will have an auditor take a look at them. If you are selling product, performing services or (heaven forbid) taking revenue without properly signed and dated contracts, you just may alienate a prospective buyer. It is very likely that your buyer will have established contract practices and processes, and no buyer wants to acquire a company only to have to do battle with the customers who were only too happy with loose, pre-acquisition practices.

In addition to the intellectual property issues that need to be dealt with in employee and contractor agreements, buyers will want to see that you have properly addressed other issues as well. These generally include confidentiality, non-competition (where legally permitted) and non-solicitation of customers or employees. In addition to technology, a buyer is often seeking your talent pool and customer relationships. The buyer might be reluctant to acquire a business that has not protected these key relationships. Since nothing would prevent the employee/contractor base from going to a competitor and poaching customers or employees after the closing, the buyer would run the risk that its investment could be significantly devalued.

Companies need to focus on their core business and conserve their capital in trying financial times. But “going it alone” may no longer be a viable option for many companies, and seeking a buyer may be the best alternative. Buyers could be turned off by companies that don’t have their affairs well organized, since it will make it difficult to conduct due diligence and get a solid understanding of the business. Companies would therefore be wise to invest in getting their house in order so that they are prepared to facilitate a transaction if opportunity knocks.

Ari Buchler is senior vice president and general counsel at Phase Forward in Waltham, MA. Follow @

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  • http://www.bayhammocks.com/default.aspx Anne

    Thank you for sharing this very wise advice. It is useful information for any small business person planning to sell a business at some point.