Is Your Business Ready to Sell? (Part IV of VI) with Trusted Counsel

(PART IV OF VI): GETTING YOUR LEGAL HOUSE IN ORDER

This week on “In Process: Conversations about Business in the 21st Century,” we continue our third annual series of podcast episodes dedicated to the topic of preparing and selling your business.

In this fourth installment of our six-part podcast series, John Monahon, Partner of Trusted Counsel speaks with firm colleagues Allen Bradley and Valerie Barton regarding the legal side of selling a business. Trusted Counsel has led numerous businesses through the exit process. This interview provides practical advice on what business owners need to do now to get their legal house in order and to build value in the business before an exit.

Review your contracts

Contracts provide tangible evidence to buyers that a seller has transferable relationships and engagements with customers, vendors, employees and independent contractors. Sellers that don’t have legal advisors may overlook key elements when it comes to entering into business agreements. Contracts must be in writing, signed and dated to enhance their enforceability and to make them binding. It is important to note that contracts that support the business’s recurring revenue, enhance the attractiveness of the business to a potential buyer.

Types of contracts to watch out for include ownership and assignment of intellectual property and work product, as well as employee/independent contractor arrangements.  Just because intellectual property is created during the course of an employee’s employment does not mean that the employer automatically will have automatic and exclusive ownership of such intellectual property. Quite the opposite – employers who mistakenly believe that they own intellectual property automatically can pay a high price, either monetarily or through the loss of inventions or improvements, for failing to protect such intellectual property. Effectively securing the rights from an employee or independent contractor requires a written agreement, which assigns to the company any intellectual property created by the employee or independent contractor during the course of her employment or engagement. Without an assignment agreement, the employee may have ownership rights in the intellectual property she created while employed or engaged by the company, even if the employee or independent contractor was specifically hired or engaged to invent a product or process.

Restrictive covenants in buy/sell agreements are common and important to buyers. In general terms, a restrictive covenant is included to prevent specific actions by a seller during a specified time frame or in a specified geographic area. The following are common restrictive covenants that are included in a buy-sell agreement:

  • A non-compete agreement restricts a party from competition for a specific period of time or within a defined geographical location or both. The party that agrees not to compete must be compensated in some way by the other party. For example, the seller of a company may allocate compensation for the sale of the company in exchange for accepting restrictions on her ability to compete with the company being sold after the closing.
  • A non-solicitation agreement restricts a party from soliciting employees or customers after selling a company. It is common for owners and even senior executives such as managers, accountants and CEOs to sign a non-solicitation agreement.
  • A non-disclosure agreement is a contract between a buyer and seller, which prevents the parties from disclosing proprietary or confidential company information and processes for any purpose other than the agreed-upon purpose for disclosure of confidential information, for example, for the purpose of facilitating the sale of a company.

Non-disclosure agreements are also used commonly when a company contracts the services of a freelancer or an independent contractor, who may acquire valuable information during the course of their employment. Business owners invest a great deal of their time and their money in the company, employees and customers. Hence, restrictive covenants are designed as time and money protection.

Speak with an attorney in your state if contemplating entering into restrictive covenant agreements,  as enforceability is specific to state laws.

Taxes and your company structure

Sellers should be clear on the tax aspects of selling. Depending on the company structure, there could be tax implications. For example, C corporations are taxed on two levels, once when the corporation sells the business, and a second time when the proceeds are distributed to the shareholders. Private companies also can be S corporations or limited liability companies, both of which are pass though entities. This means income and loss pass through from the entity to the owners of the business, hence the owners pay tax on the income of the business as opposed to twice when there are two levels of tax, such as in a C corporation.

Maintain your board minutes

Board minutes provide an official record and documentation of the approved events impacting the company, its management and employees. We recommend having routine board and shareholder meetings, documenting what is discussed in the form of board and shareholder minutes.

During the course of the podcast, entrepreneurs, business owners and C-level executives will learn about:

  • The importance of paying attention to contracts
  • Tax issues to understand when preparing to sell a business
  • The importance of having a team of advisors
  • The importance of a well-drafted letter of intent
  • The difference between a stock versus an asset sale

For this series of podcast episodes, Trusted Counsel has united with GrowthPoint Technology Partners, Wilmington Trust, Aprio, Xcentric which sold to Right Networks, and OnBoard Security which sold to Qualcomm. Is Your Business Ready to Sell?” For more information visit our virtual event happening now at www.preppingtheprincess.com.

Don’t miss a single episode of our podcast show! Subscribe to our show In Process Podcast on iTunes and now on Google Play to receive this episode as well as future episodes to your smartphone. Ask your questions or share your feedback at inprocess@trusted-counsel.com. Connect with Trusted Counsel on Twitter @InProcess and connect with Trusted Counsel on LinkedIn.

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Transcription

Is Your Business Ready to Sell: (Part III of VI)

With Partner Allen Bradley & Attorney, Valerie Barton

Trusted Counsel (Ashley) LLC. All Rights Reserved.


Speaker 1:           It’s time for In Process, conversations about business in the 21st century with Evelyn Ashley and John Monahon. Presented by Trusted Counsel, a corporate and intellectual property law firm. For more information, visit trusted-counsel.com.

John:                  Hello. Welcome to In Process. I’m John Monahon. And today, unfortunately, we do not have our normal co-host Evelyn Ashley. But we are fortunate enough to have two other colleagues from our firm, Allen Bradley and Valerie Barton. Welcome to the show.

Valerie:               Thank you, John.

Allen:                  Thank you, John.

John:                  And they will be discussing the legal side of selling your business. So Allen and Valerie, welcome and let’s start talking about how we can help people get their business ready to sell.

John:                     The first thing that we need to talk about, even before someone starts the process is selling, is actually getting their legal house in order. The actual foundational requirements from a legal perspective that they may need to build value within their business. So, Valerie, can you tell us a little bit about what that means from a legal perspective?

Valerie:                Thanks, John. From a legal perspective, what we’re looking for are contracts that, for example, are in writing. It might sound a little bit frivolous to say but oftentimes the contracts that we receive or the contractual obligations our clients have aren’t in writing or they’re in a contract that hasn’t been signed or a contract that has no date on it. For a contract to be enforceable, it’s going to have to all of those elements. So if you’re thinking about selling your business, you need to think, “What is the buyer going to be looking for?” What they’re going to be looking for enforceable and binding contracts, and by binding what I mean is contracts have to be tightly drafted. So they need to support your recurring revenue without creating long term liability as well. So for example, you don’t put in your contracts that you’re going to warranty everything about your services or your products, or your warranty needs to have a definite timeframe. It can’t just last in perpetuity.

John:                     You just mentioned recurring revenue, and that’s something which is really important and something that people who don’t have legal advisors sometimes overlook. They know that revenue obviously is an important part of building value in a company. But they don’t pay enough attention to their contracts. So sometimes they’re year to year, which when someone comes in to acquire, if the contract’s not written well, it can be easily terminated. And what a buyer really wants to know is, “Hey, this will be a certain amount of revenue contractually for a period of time.” So what they would love to see is if there’s some longer term commitment. I think those are things that we often see people looking for in diligence is what’s the strength of the contract supporting the recurring revenue.

Valerie:                Exactly. I think the problem is oftentimes if you’ve had a long term relationship with a customer or a vendor, you’re perfectly comfortable letting the relationship go month to month, and you’re comfortable, you know each other. But when a new buyer comes in, they’re going to think, “Wow. I don’t have that relationship. How can I sustain this if I don’t have a contractual obligation.”

John:                     Yeah. Because you’re right, it’s all about making the new buyer comfortable. And what would make them really comfortable is knowing that they can legally enforce the right to continue to provide those services.

John:                     You also mentioned service obligations ongoing, again that’s a liability of the company to some extent is they’re liable to have to, if they do a warranty on these, how long does that last, and how long does the company committed to providing those. So important that we sort of don’t overdo it on those either, which really just a good corporate attorney looking at some of the contracts can really tighten those up. Of course, the better your contracts look aesthetically even and even from an enforceability standpoint, also reflects on your business. If you’re doing things right in the legal way and signing customers up the right way and have the right paperwork, that also reflects in how you’re probably running the rest of your business.

Valerie:                It’s kind of like when you’re buying a car. I mean, if you were selling a car, you wouldn’t put the car on the market without washing it, cleaning up the engine, vacuuming and everything else. You don’t put your business on the line in front of a buyer without knowing that your housekeeping and your house is in order.

John:                     Right.

Valerie:                So it’s just really critical.

John:                     Yeah. So definitely contracts I think are critical point of reviewing your contracts, what do they say, are they enforceable, and do they support your revenue. Also one thing that we look at all the time is ownership. Have you gotten all of the work assignments that you need from your employees and your independent contractors to actually say that you own the intellectual property to your business? As we know, but most other people do not know, certain work that is made for you and developed for you under copyright law is not actually owned by let’s say an independent contractor develops something for you and writes code. If you don’t have a written assignment to that, it’s actually the contractor that owns that property even if you’ve paid them. And that’s surprising to a lot of people, but that is actually the way the law works. And when you go to sell your business, the acquirer will start asking for all of these work assignments, and if you can’t produce them, it can lead to certain uncertainties about the ownership of the intellectual property.

John:                     I think also, Val, another point that people look at is restrictive convenience.

Valerie:                Right. Because when you’re buying a company, you’re buying the employees. Oftentimes buyers come in and sometimes they want to buy the company and gut all the employees and just simply start from scratch because they’re buying assets perhaps from you, and they want to buy your software, they want to buy your technology. More often I see them actually buying the employees. They want to buy a going concern that’s functional, and you want to keep the employees on staff. But if you look at the employees and find that they’ve been working for you for 10 years and you don’t have any employment agreements, you don’t have any independent contractor agreements, you haven’t done confidentiality agreements, you haven’t bothered with competitive protection provisions or anything of the sort. So you’ve got this nice relationship, again kind of like the other kinds of contracts. You have relationships but you don’t have them documented. When a buyer’s coming in to buy a company, they need to know that they have assuredness.

John:                     Yeah. I think a classic example would be let’s say you have some key salespeople who have great relationships with your top, let’s say your top customers at a company. And if they’re not under a non-solicitation and the relationship is with those top salespeople, if the acquirer comes in, buys the company, and the salesperson leaves, they could possibly take that customer to another company. That’s of course a big loss of value leading the customer away from that company. So I think restrictive convenance, non-competes, non-solicitations are very important to an acquirer. So you-

Valerie:                Even though we do provisions also about non-recruitment of employees, one other thing a buyer’s concerned about is being able to maintain their employee base. And if you haven’t done a so called non-recruitment provision, that employee that you just talked about that left with the customers could also leave, taking a bunch of employees with them.

John:                     Right. Absolutely. And, Allen, there… Allen, being our resident tax expert-

Valerie:                Amongst many other things.

John:                     Exactly.

Valerie:                Amongst many other things.

Allen:                    Thank you, Valerie.

John:                     An extra level of difficulty. Being a lawyer is not enough. He actually had to go and be a tax attorney, which is even more difficult. But, Allen, what are some of the things that people need to look at from a legal and tax perspective when they’re getting ready to sell their business?

Allen:                    One of the first things, John, is to look at whether the company is structured as a C-corporation or a pass through entity such as an S-corporation or an LLC. There’s a big tax penalty to being a C-corporation that is two levels of tax. One tax when the company, when the C-corporation sells the business, the second tax when the proceeds of the sale are distributed to the shareholders. So that’s why in the vast majority of the cases private companies, nonpublic companies are passed through entities. Either S-corporations or LLCs.

Valerie:                What is a passed through entity mean?

Allen:                    That means that the income and loss passes through from the entity to the owners of the business. So the owners pay tax on the income of the business, but again taxes though to only a single time as opposed to twice when you have the two levels of tax in a C-corporation.

John:                     So if you’re taxed as an S-corporation or let’s say as a partnership, you’re a pass through, but a C-corporation is not.

Allen:                    Correct. And most all public companies are C-corporations, and again most all private businesses are passed through entities.

Valerie:                What about limited liability companies? That’s a hot topic these days. I seem to be forming more and more companies in the form of limited liability companies today.

Allen:                    Sure, Valerie.

Valerie:                The same.

Allen:                    Limited liability company is a passed through entity. So there’s only one level of tax. At the end of the year, the owners of a limited liability company gets what’s called a schedule K1. So they pay the taxes on the business. So the owners pay the taxes on the income of the business.

Valerie:                What if they don’t receive any money on the income of the business? What if they don’t receive distributions?

Allen:                    The tax is still owed. So it’s important to recognize that if the management of the LLC decided to hold back the cash and make no distribution, tax is still owed. Tax passes through them on that schedule K.

Valerie:                So you need to be really careful about the offering agreements that you sign for your new limited liability company.

Allen:                    Right. And those need to be in order. We discussed that a little bit earlier about making sure your paperwork is in order before you sell. But that’s one of the provisions in the offering agreement typically that you see. That is a requirement to distribute cash to allow the owners to pay tax.

John:                     That has caught a lot of people flat footed.

Valerie:                It has.

John:                     Over the years who did not realize that this was going to pass through to their personal returns. Another thing though, Allen, is of course there was a big tax overhaul a while ago, not so long ago actually. Before everybody said do an LLC, that was the best thing to form, then some people were saying well, the C-corp’s not so bad anymore. Does the old advice still hold true generally?

Allen:                    Yes, John. I think the old advice still holds true even though the corporate rate was vastly reduced from 35% to 21%. The main target of that benefit were public C-corporations. Small companies still in view the two levels of tax still prefer the pass through entities even though the C-corporation tax has been reduced.

John:                     Right. I think we continue to see that in our practice, and even with the discussions we’ve had going on with a lot of great CPAs, they still tend to think that the pass through is still the right way to go.

Allen:                    Correct. To harken back on your discussion about employees, oftentimes S-corporation, the principles who are the shareholders are also employees of the S-corporation. And the old game is to pay the employees reasonable compensation and pay employment tax on that, the 3% self-employment tax that goes on forever. Try to reduce that through moving some of the compensation to distributions that are taxes dividends and therefore there’s no employment tax on that what’s passed through is the distribution.

Valerie:                How much could that save you?

Allen:                    Typically it’s a total of 3% on unlimited, and that turns into a big number because it’s the gross amount as opposed to a net amount.

Valerie:                Right.

Allen:                    And then the larger piece is social security, and it caps out at the base amount, which is still as high. It’s about $140,000 annual for this year, and it’s indexed to inflation. So it goes up every year.

Valerie:                Right.

John:                     So we talked a little bit about the tax aspects. What about the overall corporate aspects? That’s part of getting your legal house in order, right? We always see this when we go to sell a company, they ask for all the minutes and passed actions of the shareholders and the board. I mean, tell us, what are they looking for there, Val? What’s the importance of those?

Valerie:                Usually what I hear when I ask somebody, “Do you have your board minutes? Do you have your shareholder’s minutes,” it’s like, “Well, it’s just me and Bob. We’re together, we’re running a company.” Somebody who’s buying you, again, just like they’re looking for the formality of contracts to be enforceable, to be in writing, they’re looking for some formality in how you ran your company. So for example, let’s say at the beginning of your company you had four or five people involved and slowly but surely a couple people fell out. If you didn’t do the documentation to explain how they left, what was the chain of title basically to their ownership, you can’t prove to a buyer that you actually own the shares that you say you own or that somebody’s not going to come out of the woodwork someplace down the road and say, “Wait, no. Now that you’ve bought this, I own 10% of that company,” or whatever.

Valerie:                So they’re looking for certainty, what they get is what they’re buying and what they’re paying for. And the only way you can really prove it is by doing the governance stuff, the housekeeping stuff that’s a bit mundane, that lawyers ask you to do. But if you are getting your house in order to sell or you’re trying to get your house over the longer term, just nice and orderly, it’s good to do routine board meetings, to do routine shareholder meetings, and to document what you discuss.

John:                     It’s funny because we always hear somebody say, “Oh, no. I wouldn’t worry about Jim or Sally. They’re cool. They won’t care.” It’s like, “Well, I don’t know. Now you’re selling your business for a lot of money.”

Valerie:                Yeah, exactly. You just made $1 million, I think Sally might come back over and ask you about it.

John:                     There’s a lot of lawsuits that have been waged over this. So people do care. Getting the paperwork is right. But that brings up to shareholder agreements and operating agreements. Shareholder agreements obviously being for corporations. Operating agreements being for LLCs.

Valerie:                I wouldn’t say that’s obvious because lately I’ve received a bunch of shareholder operating agreements. So there’s a lot of confusion about the different types of entities that are out there. That’s why I asked about a limited liability company. People aren’t used to hearing the terms board of directors, but for a limited liability company, typically it’s a board of managers. And you have members instead of shareholders. But for a limited liability company, you’re going to have an operating agreement, and for a corporation, you’re going to have a shareholder’s agreement.

John:                     Yeah. And I guess our experience is someone has legal counsel, they probably have had one that’s pretty up to snuff. Again, that’s a big assumption. It depends who their legal counsel is.

Valerie:                Snuff is a big word.

John:                     Yeah, it is. That’s a legal word.

Valerie:                That’s a legal word, definitely.

John:                     And depends how often they actually contact their attorney. But I think some things that are surprising is operating agreement or shareholder agreement has a lot of things about the actual votes that are required to buy or sell your company, and you’re ability to affect that sale. I mean, how often would you see people maybe do not have the rights that they think they have, right? I mean, can you tell us what drag along rights are as far as forcing someone to sell?

Allen:                    If a buyer is buying the equity interest, whether it be stock or membership interest, can the majority holder who’s perhaps negotiated the transaction require a minority person to sell his or her shares, and the drag along clause says, “Yes, we can require you to sell if the majority of the people that own equity interest desire to sell.”

John:                     Right. So if you’re the majority owner, Allen, and Val and I are the minority owners, even if you’re willing to sell, that doesn’t really do an acquirer any good whatsoever. They might just have 51% of the company.

Allen:                    Correct.

John:                     They want to whole thing.

Allen:                    Most and almost all cases they require 100%.

John:                     Right.

Valerie:                You don’t want the tail wagging the dog. So if you’ve got a minority holder, say somebody owns 10% of your company and you’ve got a great deal on the table to buy your 90%, you don’t want the person holding 10% to be able to hold you hostage.

John:                     Right. I think that’s surprising to a lot of people because they think that just because they have majority control that they also have the ability to do whatever they want, which of course is not always true. The other thing we find sometimes is that if they haven’t documented well, even let’s say the voting percent is 60-20-20, well that’s what the ownership is. But actually their voting is a third, a third, and a third because they have not set up their operating agreement.

Valerie:                They don’t know who’s on their board. They don’t know who’s the officers are.

John:                     Right.

Valerie:                One thing that you… We do try to protect the minority holder though. It’s not just that it’s the big guy against the little guy. There’s something in addition to a drag along called a tag along, and what that means is if the majority holder is selling his or her stock to a buyer, then the minority holder can tag along and put their stock in the mix at the same pricing that the majority holder is going to own. So you can do these protections in both directions just for both majority and minority holders.

John:                     Absolutely. And then of course final thing that a good shareholder operating agreement does is if someone leaves, let’s say they’re not participating in the business anymore and there’s supposed to be someone who is actively in the business, what happens? How do we buy it back? How can we force this person out? Or what if they do something that’s absolutely horrible like commits a felony? What are ways to buy this equity off of people?

Valerie:                Yeah, and it doesn’t have to be something terrible because people go through phases. They die, they become divorced. You can get a disability where you can’t work, and there’s all sorts of events where especially if you have employee shareholders, you’re going to want to be able to transfer the shares either back to the corporation or to the other holders so that you can deal with the gap.

John:                     Yeah. So I think this is definitely important to look at if you’re ready to sell or thinking about selling. But it’s actually just important to look at at any time. I mean, this is one of the most important documents, and I don’t think it gets enough attention. And if you’re lucky, hopefully after you draft it, you won’t have to rely on it too often. But certainly when there’s any dispute, what’s the first thing people say?

Valerie:                Let me see the prenuptial agreement I think is what they said with the new shareholders agreement.

John:                     Right. So it becomes very important later on in time when you’re not expecting it.

John:                     So we talked about some of the agreements that lead up to sell. One of the things I want to talk about is what are some things that a company can put in place to ensure that management stays after a sell? So what are some of the contracts that they might be able to do or ways that they can make sure that post-sell people are sticking around?

Valerie:                Well, one thing people may not realize is if you’re selling the stock in your company, chances are that (A) they’re going to want you to stay on board so that you can continue running the successful company that you’re selling in the first place. But at the same time, part of what they’re buying is a non-competition from you, something that tells them that you’re not just going to set up shop after you’ve left them and start competing with them again. So as you wear your shareholder hat, you’re going to have some limitations on what you can do after the closing. But in the same token, they’re going to want to sign an employment agreement with you or a consulting agreement, something where they can keep you at a certain pay rate or perhaps you can be bonused based upon the future growth or the future revenue of your company.

Allen:                    I think, Valerie, also in addition to the restrictions, sometimes buyers want to use golden handcuffs, which is what we call a change of control bonus or accelerate stock options, for example.

Valerie:                What does that mean?

Allen:                    That means typically stock options have a vesting schedule, and we accelerate the vesting so that the key person can exercise that option on the date of the acquisition as opposed to having to wait. So there are many… But there are tax issues with those golden handcuffs.

Valerie:                There’s always tax issues. That’s what-

Allen:                    There’s always tax issues.

Valerie:                There’s always tax issues.

Allen:                    And one is actually called the golden handcuff excise tax, the tax on what’s or parachute payments. And so there are ways to work around that, but again it has to be considered because the excise tax is imposed on the individuals and the company are excessive.

Valerie:                They’re doing that with Deutsche Bank right now. Aren’t they accusing them of golden parachute problems with so many of the management that they’ve had that are jumping off a sinking ship, and they’re accusing them of golden parachutes for their executives. So it’s a real issue.

John:                     Interesting. Yeah, and I think for the people that are not key but maybe are rank in file, a thing that we see actually somewhat in the opposite is making sure that their incentives actually do not accelerate, so that they do not immediately upon a change of control get a huge windfall. But they still have to stick around to make sure that they work and continue to vest to get that ownership, and then they’ll get the benefit from the sell. So that’s a little bit of stickiness there we see too. But that’s more for the rank, let’s say the rank in file then of course the key executives and key management that you all are talking about I guess.

Valerie:                I like the term stickiness. That’s really good because in some of the change of control provisions that I’ve seen, you don’t get that change of control bonus that you talk about. It accelerates, but only a year after the sell. So that buyer has that certainty of continuity and succession planning.

John:                     Different owners of businesses have different ideas about incentivizing people. Of course it’s always just good to have a conversation about what do these incentives look like. And people like of course, Allen, you structured these routinely. It’s good to rely on sort of that expertise of the different scenarios you’ve seen and what’s the flexibility we can build into that.

John:                     So let’s get into a little bit about understanding the process of a sell, just from a mental and emotional aspect. So we’ve talked about what are some of the agreements that you should look at before and having things in place and look at your service agreements, your customer agreements, your operating agreements. But now you’re, let’s say you’re ready to sell, you’re there emotionally. What are some key points about the process that people should know and maybe that they’re not aware of, Val?

Valerie:                That they’re going to have a second job in addition to their day job.

John:                     Right.

Valerie:                I literally just talked to a client earlier today who’s starting a sales process, and she’s just going through the due diligence phase. So she’s acquiring a company, so it’s that part of the sales process. And she’s going through due diligence on the acquisition. As she comments to me, she doesn’t have time to do her day job because she’s doing the acquisition. You need to have advisors like us that you lean on heavily, but you have to realize it’s going to take a substantial amount of your time to negotiate and actually consummate a purchase or sell of a company.

John:                     Mm-hmm (affirmative). It brings up a good point about not… You have to be open to the process, but not wasting your time on people who are not serious. And that’s one of the reasons you engage professionals who have a sense of this, who can work the process on your behalf to sort of root out all of these inquiries that are not serious because they will consume you and consume your business. And to see these deals after so much effort, because it is disruptive to a business, to see them not be consummated, that’s-

Valerie:                Well, on the same token, you’ve already done your due diligence and perhaps as somebody’s investigating you, they’ve learned a lot about your company. And you have to be careful about confidentiality and about revealing your own trade secrets or your other intellectual property to a competitor, and oftentimes it’s competitors who are coming to buy you.

John:                     What’s the team of advisors that people should have in place?

Allen:                    Typically, John, it’s the accountants for the company, the attorneys, and sometimes there’s an investment banker involved to help negotiate things like price and selecting the purchaser. Those are the three key groups. The attorneys, the accountants, and the investment bankers.

John:                     Mm-hmm (affirmative). I like having investment bankers involved. I know people sometimes are afraid of their fees, but the good investment bankers that we know, they regularly justify their fees. And people are actually horrible negotiators on their own behalf.

Valerie:                Well, we often get the question when somebody comes in, now just out of the blue somebody can get an offer for their company. You offer me $10 million, and the first question for us typically is, “That’s great, isn’t it or is it? How much is my company worth?”

John:                     right.

Valerie:                And I was just talking to Evelyn about this. She asked her client immediately, “How much do you want? How much do you need? How much do you need to do an exit? How much do you think you have invested in your company?” And an investment bankers going to help you talk through all of those issues and come back to a reasonable number. But also knowing the market, can help coach you in terms of what a reasonable number is versus something that you want.

John:                     One thing to know is that it’s important to have this team, not necessarily in place but it’s important to rely on professional advisors beforehand so that you have this sort of network of people that can refer you to other people that they seen do successful jobs, and you will be ready when this day comes to actually sell your business. Of course other attorneys know good accountants, accountants know good attorneys, attorneys-

Valerie:                Attorneys know good investment bankers.

John:                     Right. It’s the cycle. We’ve seen which ones have gotten it done and which ones have not. So it’s important to have that team. What’s the timeline as far as a sell?

Valerie:                That’s going to be a huge it depends.

John:                     Yeah.

Valerie:                It really depends. It depends on whether you’re starting the process as in I’m going to get my house in order. Then I’m going to identify what I want. I mean, some people want to retire. You’ve done your business for 20 years, you’re ready to walk out the door. Some people want their children to inherit their business, or they just want to stay with the business for five years, do a five year plan, and then slowly but surely work their way out of the business. So the business owner has to think in advance, “What do I want? I mean, what do I truly want out of this?” One of our clients right now has one owner who wants to retire entirely from the business, and then the other owner wants to stay with the future company. As you’re negotiating price, one of them wants a lot of money up front, and the other one’s more interested in the compensation package. So you have to think about what your needs and desires are for the future.

Valerie:                The process itself with investment bankers can take days, it could take months. It could take a year. It just depends on what industry you’re in, how good your business is, is your house in order, and is the investment banker readily able to identify buyers for you? And I think the third part is as Allen said the accountants have to become involved because unfortunately we often get a deal put on the table, then no one’s looked at the tax implications of that transaction. And that’s when we call Allen and say, “Fix it.” Basically.

Allen:                    A final point on the accounting is that most small businesses keep their books on the cash basis, and as we have found, many of the larger purchasers want to see the numbers on accrual basis. And so that gets into your issue, John, of that recurring revenue. Even though I got paid a cash payment this year, I may not get to include all of that payment as income under the accrual method, particularly if the contract imposes liabilities on the company.

John:                     Right.

Allen:                    In order to deliver that service. It’s important to understand how much my revenue’s going to decrease if I have to switch to the accrual basis.

John:                     Yeah, absolutely. That’s a critical issue that arises often. You need to look at that. One of the things that I heard when you were speaking, Val, is when you were talking about negotiation, it reminded me even once you get a term sheet or a letter of intent and there is a price, everybody knows what due diligence is. And I think that’s where it becomes very important to have the right contracts in place, the right things that support your business. And of course obviously the underlying value of the business is place as well. That diligence justifies the price, right? We see that price negotiated if the diligence doesn’t work out very well.

Valerie:                Exactly. Also identifies liabilities. One thing that will reduce your price very quickly is learning that there’s a lingering litigation issue out there, there’s an employee claim somewhere. Those things will reduce the valuation of your company as well. And you need to identify all those in advance so that you’re not surprised and the buyer’s not surprised.

John:                     All right. Now that we’ve talked about sort of the mindset that goes into the process, let’s talk about it in a little bit more detail of actual nuts and bolts of each stage. Val, can you tell us sort of the roadmap to the typical phases of a transaction?

Valerie:                It’s going to be whether it’s a push or a pull. So a buyer may come to us, and they maybe trying to buy a specific company. A seller may come to us and have a desire to sell, in which case we’ll find an investment bankers, someone else to work with them, or there’s the pool where we receive an LOI or a buyer or seller has received an offer. And we’re in a position to respond to it. So those early conversations are going to kind of set the tone between the buyer and the seller. You need to ask yourself at that point if you’re selling your company and somebody has approached you, “Do I want to do an auction? Do I want to open this up to a broader group of potential buyers so that I can get a competitive deal?”

Valerie:                So after you’ve had the conversations and you’ve decided for yourself if you’re going to do an auction, if you’re going to hire an investment banker, one of the first things you need to be concerned about is confidentiality. We mentioned before that competitors oftentimes want to come buy you. So they’re going to be looking at your intellectual property. They’re going to be looking at your employment agreements, your contracts with customers, a list of your customers. They’re going to be looking at your financial statements. So a nondisclosure agreement before you start the conversation is critical to protecting the business that you have. We’ve had a client before who didn’t sign their NDA in the early stages of negotiating with a potential competitor only to find that the competitor was using a lot of elements of their platform down the road when the deal didn’t happen.

John:                     That’s rough.

Valerie:                Yeah, that’s not the result that we’re looking for. So the nondisclosure agreement is a relatively short two to three page document that can save you a lot of headaches and a lot of heartache. Before you are purchased, chances are the buyer is going to want to do some pre-letting of intent diligence. So they’re going to want to know something about you. You do that under the nondisclosure agreement, but you need to be very careful in limiting as to what you’re going to… What information you’re going to impart before you do a letter of intent. Doing a letter of intent is critical, having your lawyer involved during a letter of intent stage is also critical. John and I, Allen, we’ve all received signed letters of intent, and looked at them and thought, “Oh wow. We really could’ve impacted the deal terms. We could’ve impacted the process. They didn’t think about taxes.” All sorts of things that just come to mind.

Valerie:                So a letter of intent, the purpose of it is is to have the parties negotiate and principle the big ticket items for a buy or a sell. So you’re talking about the price. You’re talking about whether employees are going to stay or going to go. Are you going to do an asset or a stock purchase? I mean, there’s a bunch of different elements that you could pre-negotiate before you start drafting definitive agreements. But that doesn’t mean that the lawyers need to be involved only when you’re drafting definitive agreements because once you’ve signed a letter of intent and principle, you’ve made a deal. And trying to backpedal and trying to back away from the terms that you’ve negotiated is going to be really difficult.

Valerie:                Next, after you sign the LOI, the buyer is going to do a deep dive into your company. So when we do due diligence on behalf of a buyer, we’re looking at all their contracts, we’re looking at their financial statements, all the things we’ve discussed before. Their intellectual property. Do they own their trademarks? Are their trademarks registered? Do they have licenses appropriately for the software that they’re using? Do they own their real property? Do they lease their real property? Are there environmental problems? I mean, these are all things that we look at in the deep dive to make sure that you’re getting what you’re paying for.

John:                     I always love it when we get to the deep dive and we go, “Okay. Now we’re going to diligence,” and people say, “Oh, we already did that.”

Valerie:                Yeah, that’s already done now.

John:                     No, you did the business diligence. Now it’s the legal diligence.

Valerie:                We dive a little bit more deeply than most of the investment bankers.

John:                     That’s where the time consuming part comes in.

Valerie:                It is time consuming, and it is expensive. I mean, there’s no way around it. It takes a good amount of legal time to go through a company’s basically their book of business and to understand thoroughly what they own and what they may not own. And potential liabilities that you may be assuming.

Valerie:                Assuming you do get through the diligence stage and everybody’s still happy and ready to proceed with he transaction, it is up to us then to draft definitive agreements that memorialize everything that you’ve been negotiating. And that can be one agreement, a purchase agreement, and that could be 10 agreements, depending on how complicated the deal is, how many employees are staying on, and that sort of thing. And then hopefully once you’ve drafted definitive agreements and everybody’s signed, you actually close the deal, and then you start dealing with post-closing integration. So from an owner’s perspective, it just doesn’t stop. This is a very complicated process. But it can be very rewarding too.

John:                     One of the thing, post-closing, that happen is not all the money always gets paid at closing. Sometimes there’s an earn out in a deal. Can you talk a little bit about earn outs? They get a bad rap. Is it deserved?

Valerie:                Do they have a bad rap? Do they really have a bad rap?

John:                     Yeah. I think that’s my question to you is is it deserved or is it not deserved?

Valerie:                I like earn outs. I think it’s important. When people come to the table, sometimes the buyer’s not exactly flush on cash. I mean, just because somebody wants to buy or integrate their business with your business doesn’t mean that they got a million bucks in the bank. So they’re looking at you, and they’re saying, “Look, I do really want to buy you, but I just don’t know how the combined enterprise is going to go. Are the revenues going to be what we’re projected? Is everything going to go as we’re saying? Why don’t I pay you a certain amount up front, and then based upon how the company actually does, I’ll let you earn additional revenue in the next two or three years.” It enables you to do deals where the valuation may not be clear. I mean, face it, we sell a lot of companies that have very good recurring revenue but no profitability. And the profitability hopefully is in the making. It’s going to happen down the road, but as a buyer want to be able to actually protect yourself and make that part of the compensation so that the seller is engaged in the business post-closing, post-closing integration goes well, and you can actually base the overall payment for the business on that actual performance of the business post-close.

Valerie:                So earn outs I think are actually great because they let a lot of deals that otherwise couldn’t be done get done.

John:                     I think that’s the right perspective on them. You’re the beginning of the change of their reputation.

Valerie:                Well, why do they have a bad reputation? What’s wrong with the earn out?

John:                     I think a lot of people see them as money they deserve that they’re not getting or ways that they are going… Because they’re so hard to define ways in which they might get, for lack of a better word, screwed out of some money on the backend.

Valerie:                You have to be careful how you define them. So where people get into big negotiations about earn outs is how you’re going to calculate it. So if you’re going to calculate it based upon net income, income after expenses, well that new company’s going to control expenses. They’re going to control allocations of overhead. They’re going to control your accounting expenses and whether they keep your staff. Maybe they don’t keep all your sales staff, and you can’t hit the numbers. So you really do need a good lawyer to negotiate a good earn our provision, but you can protect yourself and you can protect the buyer and hopefully again achieve a deal that might not otherwise occur.

John:                     Absolutely.

Allen:                    Valerie, I think from the seller’s perspective, to keep it as simple as possible is important. Any complicated calculation goes to the benefit of the purchaser to make it very difficult to ascertain whether the amount paid is a correct amount.

Valerie:                Right. Ambiguity never works for us. That’s a lawyer thing.

John:                     So, Allen, let’s turn to structures now because well, tax is a hard thing. We’ll try our best to-

Valerie:                Keep up.

John:                     Yeah. To keep up and follow what you’re saying. But let’s start with some of the basics. What’s the legal difference between a stock sell and an asset sell?

Allen:                    The asset sell is when I buy the business, the assets of the business and it sales force and the workforce versus the stock sell when I buy the legal entity, whether it be an LLC or a corporation. From a tax perspective, there’s a huge difference in the two methods. When I buy the assets in a technology company, which is mostly what we represent, the large part of the purchase price goes to what’s called goodwill, and I’m able to amortize that goodwill and create a deduction that reduces my taxes every year going forward for 15 years. But if I buy stock, I don’t get that goodwill asset and the ability to amortize it over 15 years. So that means that essentially if I do a stock purchase, unless I make some of the special elections we’ll discuss later, I end up using in effect after tax dollars to buy the business while by doing an asset purchase is before tax dollars. So that’s a big difference in cost to the purchase.

Valerie:                Well, does the buyer want to do one or the other as opposed to a seller wanting to do one or the other? Is there a preference?

Allen:                    Typically the preference is the purchaser wants to do an asset purchase, and the seller wants a stock sell, entity sell. One of the reasons is from a business standpoint, if I sell my assets, have to go to my customers, get their consent to what’s called assignment of the contract to the new purchaser. And that’s difficult particularly if who I’m selling to is a competitor because that means that my competitors are talking to my customers before the closing. So most sellers prefer to sell an entity in which an assignment is not needed, and most buyers want to buy assets because they get the benefit of the tax depreciation plus by buying assets, you are not assuming all liabilities. So that’s a big issue for small, for private businesses is to avoid assuming old liabilities.

Valerie:                So you can buy assets without taking all the liabilities in an asset purchase.

Allen:                    Correct.

John:                     Do you have a buyer and a seller, they have different goals from a tax perspective, who wins? Who gets to dictate this?

Allen:                    Typically the buyer dictates because the buyer is the one that has the money.

Valerie:                Well, let’s talk about so that came up recently. We were doing something and you educated me about a 338(h)(10), which is a great way of saying it’s a tax code provision that Valerie does not understand and that Allen has to keep explaining. So what is a 338(h)(10) election mean?

Allen:                    Again, it’s very specific to the transaction as to whether or not it can be used, the 338(h)(10). Basically if a seller is an S-corporation and the purchaser is an S-corporation, I can buy the stocks so that I don’t have to get assignment of my customer contracts. But for tax purposes, it’s treated as an asset purchase so that the purchaser can amortize the goodwill and depreciate the assets on a new schedule based on the purchase price.

Valerie:                And you said you amortize goodwill over 15 years.

Allen:                    Correct. 15 years.

Valerie:                So that’s a huge tax benefit. Now one thing when we’ve had that tension between the buyer and the seller and the buyer wanting to do the 338(h)(10) election is we’ve actually had the seller ask to share in some of the tax benefits the buyer’s going to enjoy by the, and I’m going to say this wrong probably, stepped up in bases and then the amortization of the goodwill. So you can actually ask to have some tax sharing or some tax benefit sharing between the parties.

Allen:                    Correct. I’ve see that. And many times the benefit of the tax deductions allow for the purchase price to be in a range that is acceptable to the seller.

John:                     In addition to the 338(h), I’m saying it like I know it now. That’s a sign of an attorney there. I now own it. There’s also 1202. That’s a possibility that could be taken advantage of in a stock sell.

Allen:                    Right. So you have these benefits, the 1202 benefit, for example, has been around for decade, and it applies to a specific situation. Typically a C-corporation. So many of our clients are not able to take advantage of it, but in some cases it does apply. It allows the seller to exclude the gain on the sell.

John:                     Yeah, which can be a big benefit, but as you say it’s very particular. In fact, specific as everything under the tax code.

Valerie:                As everything we do is. Yeah. For everything Allen does.

John:                     Right. But I think that’s the importance of getting good advice before the letter of intent is how can we structure this, how can we think about ways to save tax, or maybe make it, Valerie, as you rightly brought up, maybe a deal gets done that wasn’t going to get done, which we exactly we saw that recently when Allen came up with a nice tax structure that helped solve the gap in value between two companies through savings, and the deal was actually able to get completed.

Valerie:                Exactly.

John:                     So these are some reasons why you might want to involve some other people in a deal to help it move along.

Valerie:                And involve them early.

John:                     Involve them early.

Valerie:                I mean, you’re structuring a transaction, and there’s no reason that in your day job you’re supposed to know what a 338(h)(10) election is.

John:                     Right.

Valerie:                So understand what you’re good at, which is running the company and selling the company. I mean, you’ll be able to sell the benefits of the company as you’re marketing it to a buyer. But stay in your lane, and it’ll be really helpful to you from a cost savings or a purchase price maximizing perspective if you let us do what we do.

John:                     So what exactly is a letter of intent?

Valerie:                Letter of intent is going to set forth the terms and conditions upon which you’re going to buy or sell a company. So it’s going to have things like the purchase price, but it should have a bunch of other things in it like when the purchase price is going to be paid, how much is paid at closing, how much is paid in the form of an earn out down the road, is there any deferred compensation, will the key employees be retained or will they go, do you anticipate hiring everybody, will the executives or the owners of the company have a leadership role in the post-closing entity, and what is their compensation package going to look like.

Valerie:                If you’re selling your company, the big part of what you’re going to receive, and Allen and I just counseled a client in this respect, is not just the dollar amount that you’re going to get. It could be the dollar amount that you’re going to get plus a certain amount of equity in the newly formed company, but also plus what your compensation is going to be once you work for them over the longer term. All of those things will be set out but some other things like after you sign the letter of intent. Oftentimes you are then locked in to negotiate with that buyer exclusively. So they want some time to do their due diligence without you stepping out and trying to sell the company to somebody else.

John:                     Right.

Valerie:                It also helps protect you from a confidentiality perspective. So there’s confidentiality provisions, and you can even have non-competes or something like that if you’re actually negotiating with a competitor. I’d say that that was more unusual, but it does help cement the confidentiality restrictions that you had under your NDA.

John:                     So are they binding or non-binding?

Valerie:                Only certain pieces, parts are binding. So since you don’t know, since you haven’t done due diligence and you haven’t finished it. You can’t say definitively when you’re doing your letter of intent that I’m going to go through with this transaction. So the purchase price, the earn out, whether you’re going to buy rollover equity or something like that. Those are typically non-binding, but the things that are binding include the exclusivity provision, so for a certain amount of time you’re going to keep your shop off the market, and the confidentiality provision. Those are often the term of the agreement, the term of the LOI, those are the binding provisions. But typically the letter of intent itself is non-binding.

John:                     Right, and I think you’ll also see some things in there, sometimes you’ll see a breakup fee that might be negotiated.

Valerie:                I’d say that’s in larger transaction.

John:                     Yeah, and then who pays attorney’s fees, which is usually just about a sentence but could be very important. If we’re talking about a very large transaction, who pays who’s attorney’s fees could amount to a nice little chunk of change, and that’s something that a lot of people gloss over. So if that’s already baked in by the time it gets to us, you might’ve just lost yourself a lot of money accidentally because that’s something that’s negotiable as well.

Allen:                    I think it’s important to note that even on the non-binding aspects of an LOI, such as the purchase price. The LOI certainly sets expectations.

Valerie:                Good point.

Allen:                    Rarely is it that they are able to negotiate a higher amount.

Valerie:                Right. I recently received a LOI that had been fully executed by the time it reached us, and then there was some talk about trying to renegotiate the price. And you’re viewed as backpedaling, a bait and switch, that sort of thing. Even though you could’ve gotten more value out of the transaction had we been involved sooner.

John:                     I’m sure it’s coming across fairly clearly how much disdain we have for seeing letter of intents come across-

Valerie:                We can help.

John:                     … executed without us ever seeing them beforehand.

Valerie:                No, we can help. We can help so much before you get to the letter of intent stage if you just let us.

John:                     It just feels like a lot of opportunities lost by that point, which is why it’s so frustrating because there’s a lot of areas where we could improve a situation and maximize-

Valerie:                Whether it’s a buyer or a seller. I mean, you can-

John:                     Absolutely.

Valerie:                … improve the deal.

John:                     Absolutely. Sometimes you just feel bad that that opportunity’s been lost, and we try our best to get back in. But as Allen said, expectations are a little bit set there, whether it’s legally binding or not.

Valerie:                Right.

John:                     That’s difficult. So now we’ve covered some due diligence along the way, but now we’re going to get into that a little bit more in detail. Val, what’s the goal of the buyer versus the seller in the due diligence phase?

Valerie:                Well, actually I tell our sellers to reveal as much as they possibly can. I’m a firm believer in over disclosure. You really do want a buyer to come in and know exactly what they’re getting. You certainly don’t want to argue about it after the deal’s already been signed. The buyer’s going to come in, and if you say that you’ve got 100 customers and you’ve got 100 vendors or you’ve got ownership of a certain amount of proprietary intellectual property, you’re going to have to prove it. And that’s what they’re going to be looking for is documentation to show that you have your corporate house in order, you’ve done your board minutes, you’ve done your shareholder minutes. You’ve kept track of who owns what shares of the company, and that you do own, in fact, everything you say you own. That’s on the plus side.

Valerie:                Then on the liability side, the buyer’s going to be assuming liability for all those contracts in addition to assuming when the contracts are assigned to the buyer, they’re going to get the benefits but they also get the obligations. So that performance is going to be obligatory on the part of the buyer post-closing. So they’re going to have to thoroughly understand everything. And if you do have an abundance of your relationships with your vendors or your customers on an oral basis as opposed to in writing, before you even get to the letter of intent stage, you need to be working on formalizing those arrangements.

Valerie:                During the due diligence phase for the seller, I think what’s important is to make sure that you are revealing as much as you need to, exposing litigation, exposing employee problems, but at the same time, you’re negotiating for yourself. So it’s a bit of a tricky situation to be in, which is why good counsel is so important.

John:                     One of the things that we do in some transactions where it’s warranted is you have to substantiate your revenues, your books-

Valerie:                You have to be prove it.

John:                     … coming from.

Valerie:                Right.

John:                     And sometimes we’re not ready to reveal at a certain point which customers are attached to what dollar figures. So sometimes we have that redacted until we’re very close to the end of the deal, at which point we will… Or we give them abbreviated list, and at the end, we give them the key to match that up. So one of the extra steps of diligence also there’s always the soft source code review for technology companies, and we got to be quite careful about that because the last thing we want is in a competitors review of the source code that they bring in their development team, they figure out how we’ve done everything in the code, and are able to take it back and start reverse engineering it. So we put a very specific NDAs as to (1) how they’re going to review it, and under what circumstances they’re going to review it. Sometimes we say, “Well, you will not get a copy of the source code. You can fly down to our location. We will have somebody in the room who will be with you, and you can review it there.” And that’s it. Of course if anything is ever given, we make sure we have destruction of property provisions on there as well.

John:                     So there’s normal diligence and of course there’s the stepped up-

Valerie:                The heightened due diligence. Yeah.

John:                     Levels that we go through. What are some of the major issues in diligence or just the deal in general that can completely kill a deal?

Valerie:                The biggest deal killer that I find is when somebody doesn’t have the money. I’ve actually gone to a closing table before, gone through all the negotiations, the diligence, the whole nine yards, and been called by buyer’s counsel and said, “I’m sorry. My client doesn’t have the money.” So you need to make sure as you’re negotiating with the buyer that they’ve got the financial wherewithal to actually do the deal.

John:                     Mm-hmm (affirmative).

Valerie:                Another thing that will slow things down substantially is if Allen had mentioned that in some of our contracts you have to have consent from the customer or the vendor to assign their contract to a new owner or new owner of the assets or a new owner of the stock, depending on what the contract says. If you’ve got two of your major customers who are under an agreement that requires consent to assignment and it’s what you just described. When do you actually have the customer learn or become aware that a transactions even going on? Nonetheless you ask their permission to be moved to a new owner. These things can all cause tension between the buyer and the seller because you’ve got competing interest. You want to protect yourself. But you also want to protect the deal. So it’s difficult, and it can cause delays.

John:                     I got something, which is not a deal killer, but it is either… It’s a symptom of a dying deal, how about that, which is pace. Whenever I see there’s a certain pace to these deals, and whenever… You can almost sense when it starts to lose momentum, and it could be for a variety of reasons. But in my experience is once it starts to… Once that moment starts to become lost, it’s hard. It’s an indication that it’s probably a deal that is not going to be successfully completed or someone needs to step in to revive it. Because once it loses momentum-

Valerie:                Time kills deals.

John:                     Yeah, people lose interest, right?

Valerie:                That’s right. Really good point.

John:                     What are some negative effects of a poor diligence review? Let’s say someone goes through… A buyer goes through the diligence, and it just, oh my gosh. What do you got here? This is terrible. What are some of the things they’re going to be asking for in the transaction at that point?

Valerie:                The decisions going to have to be made by the buyer whether they actually think they’re going to get what they pay for. So we’ve mentioned before from the seller’s perspective, you have all these concerns about revealing confidential data and trying to protect yourself from somebody finding out who your customers are or what your financial statements look like. From the buyer’s perspective, you set a price based upon projections, what the earnings before interest and taxes is going to be. You made it a multiple of that. You’ve decided that’s the value of the company. But until you make it through the diligence stage, you don’t know if it’s actually been true and complete, the information that you have, and you may find you want to take deductions because the 10 customers that are your top 10 customers don’t have a contract or their contracts have gone to be monthly recurring contracts, just month to month, that could be terminated at anytime. And that might cause you to actually want to reduce your purchase price.

John:                     Right. Once we do the deal, we have the definitive document, we of course have representations of warranties, which is in line with what you’re just talking about. We’ve said all these things are true, right? Along the way, we’ve said these things are true. Let’s go down the list here. We have ownership of IP, our biggest customers that we have-

Valerie:                Let’s explain reps and warranties first.

John:                     Yeah. Go there.

Valerie:                Just briefly because this is going to be like two thirds of your purchase agreement’s going to be called representations and warranties, and it’s so integral to both the seller and the buyer. The seller’s going to be saying, “I own this company. I own this stock. I own the title to the assets. And it’s clean. There’s no encumbrances on it. I own the real estate. I have these contracts, and these contracts are in force.” You’re making all these representations, and then your warranting that that information is in fact true.

John:                     Mm-hmm (affirmative).

Valerie:                So post-closing, what you’ve opened yourself up to as the seller is a so called indemnification obligation. What you’re saying is, “I’m guaranteeing you for a period of one year, for a period of two years, after the closing, that everything I’ve told you is true, and I’m putting my money where my mouth is. We’re going to actually maybe set some money aside in an escrow account.” Typically anywhere from 5-10% of the purchase price can be set aside to satisfy indemnification claims. So the seller is giving the purchaser an insurance policy to say that, “Yes, I spoke the truth when I told you that I own the title to the assets.” So representations and warranties, as you just said, covers intellectual property, customers, vendors, and really important things like employee relationships, employee benefits, employee pay, and Allen’s taxes. Because how you deal with taxes both before the closing and after the closing is a huge issue in terms of whether either side’s going to get the benefit of their bargain.

Allen:                    I think Valerie, it’s important to recognize that in most of our work, the entity, the company, whether the LLC or corporation as the person that’s liable in a sell of a business, both the company and the individual owners have liability. So there’s individual liability for those reps and warranties that you just described.

Valerie:                That’s a huge issue. If you’re selling your company, think about it, the buyer just bought the company. The buyer can’t sue the company he just bought. So instead you’re going to look to the selling shareholders to say, “Okay. You’re the one who said this about the company. I’m going to be suing you if there’s a claim, and you’ve misrepresented something.”

John:                     Right, and that’s why it’s so important. And we go through them very thoroughly to say, “Is this true? Is this true?”

Valerie:                And here’s all the exceptions. Now from your due diligence, you’re going to come up with what are called disclosure schedules. So you can say accept as I tell you on this schedule over here all of this is true or accept as I have title to the assets except there’s liens on ABC. And if the buyer finds that exception to be acceptable, well you just keep going.

John:                     This has been a lot of fun. I think it’s a great overview about how to prepare a business for sell but then also the sell process as well. You all, Val, Allen, thank you for joining us. A lot of good information today.

John:                     Hope you enjoyed In Process. If you have any questions on this topic, please reach to info@trusted-counsel.com. If you’re interested in learning more about us, please visit our website at trusted-counsel.com. Thanks for joining us.

Speaker 1:           This has been In Process, conversations about business in the 21st century with Evelyn Ashley and John Monahon. Presented by Trusted Counsel, a corporate and intellectual property law firm.

Speaker 1:           Are you interested in being a guest on our show? Email our show producers at inprocess@trusted-counsel.com. For more information on Trusted Counsel, please visit trusted-counsel.com.

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