04 Nov Remove Roadblocks to a Timely Closing
The biggest barriers to business sale bliss are low or declining profit and revenue source concentration. After all, it’s steady and dependable profit that drives value. Add consistent growth and buyers will line up at your door. But many a slam-dunk deal is derailed by latent defects uncovered during due diligence.
What are these bugaboos that can rise out of nowhere to snatch defeat from the jaws of victory? Here are the most common:
Real Estate. In three classic situations, real estate can bite you. First, location is critical, but you can’t convey this to the buyer at a price certain for a sufficiently long time into the future. The second, you are obligated to a long-term lease, but the buyer wants to relocate the business. Third, you own the facility occupied by the business, the buyer wishes to relocate it, and you’re not confident you could find another buyer or tenant.
Unresolved Litigation. Business buyers avoid acquisitions that include assumption of unquantifiable liabilities. Unresolved disputes, litigation and threatened litigation are unquantifiable liabilities. That is, they carry a cost—in both time and money—that’s difficult or impossible to estimate.
Environmental Liability. Business buyers test the ground and groundwater beneath any business they consider purchasing. If contamination is found, the deal is as dead as the tree your letter of intent is made from. If there’s any chance you could have an issue here, talk to your lawyer about it—before you move to sell—going ahead and investigating the facts and remediating any problems.
Assignment of Contract. Any time a landlord, lessor, franchisor, distributor or licensor must approve a sale or transfer of control, the deal is not entirely in the hands of the buyer and seller. The time to avoid or minimize the clauses is when the agreements that contain them are established, or at the very least, well in advance of an attempted business sale.
Title Issues. Whenever rights to an asset are critical to the ongoing revenue stream or profitability of a business, buyers want total assurance that after their contemplated purchase they will have use of the asset. In some cases, assurance of exclusive usage is required. To the extent that buyers can secure use of the important asset but at an inflated price, the business purchase price goes down commensurately.
Unlicensed Use of Copyrighted Works. If you’re using a software program or other intellectual property on an unauthorized basis, your buyer may not be willing to “risk it” as you have been doing. Most buyers—during the pre-purchase audit—identify all intellectual property used by the company and then investigate whether the company’s use is authorized. If unauthorized use is identified, most buyers want to figure out the total cost of “going legit.” Such may include penalties plus ongoing costs. If the expense can be pinned down pre-closing, the purchase price can be reduced dollar for dollar. If it cannot, you may have a problem.
Debt Prepayment Penalties and Re-Price Triggers. Typically, interest-bearing debt of the seller is paid off in full at closing (by the seller, using monies paid by the buyer). If said debt has a prepay penalty, it could put a dent in the seller’s sale economics. Conversely, if the seller enjoys debt financing that’s attractive to the buyer, so-called change-of-control covenants could spoil the party.
Double Taxation. Uncle Sam takes a healthy cut whenever a gain is realized, but few sellers pull back from the closing table because of the taxes, that is, except when the selling entity is a C-corporation. C-corporation sellers face double taxation when the buyer buys assets. Yes, the seller could require the buyer to purchase the stock instead, but it’s not that easy. Buyers pay less when they are forced to acquire C-corporation stock. There are a few strategies for reducing taxes in a C-corporation asset sales (click here to read A Means For Reducing C-Corp Sale Taxes), but it’s an uphill battle. The best strategy is to convert to S-corporation status well in advance (eight or more years) of the anticipated sale date.
Minority Shareholders. If you don’t own 100% of your company, your deal could get held up. First, if the parties choose to effect the sale by purchase of stock, any minority shareholder could hold up the deal if you don’t have agreements in place that force them to accept terms agreed to by the controlling shareholders. This is because buyers almost always want to buy 100% of the outstanding stock. Second, minority owners can hold up asset sale transactions if a so-called super-majority provision exists in your governing documents.
When it comes to selling a business for maximum value, timing is everything. Start the process when the business’ performance is trending up, the economy is strong and buyers are aggressive. Get multiple buyers working and you’ve got it made—so long as you’ve cleared away the deal killers in advance.
Concentration risk is lack of diversification in revenue or profit sources.
Kenneth F. Albright, a tax lawyer and transaction lawyer partner at the firm of Albright, Rusher and Hardcastle, contributed expertise to this article.