February 22‚ 2012
What You Need to Get Done Now If You Want to Sell
Your Company in 2012
One of today’s most discussed political topics is the
expected expiration of the Bush tax cuts after December 31, 2012. If
Congress doesn’t act, among other things, the individual U.S. federal
income tax rate on long-term capital gains will increase on January 1, 2013
for those earning more than $200,000 per year from 15% currently to 23.8%. (An
approximately 60% increase in the rate!) Furthermore, California Governor
Jerry Brown intends to seek a referendum to increase the individual tax
rate on millionaires from 10.3% to 12.3% after this year — a 20% increase.
The impact of these increased tax rates could be substantial
on the after-tax proceeds realized by a business owner upon a sale. A
typical sale transaction can take six to eight months to complete from the
time the decision to sell is made. Consequently, it is important that any
business owner seeking to sell his or her business in the near term take
immediate steps to ensure the sale will close in 2012 before the rates
The purpose of this alert is to help a potential seller
assess how ready they are to complete a sale transaction in 2012 and
accelerate the negotiation and completion of a definitive sales agreement.
The following are some key questions every potential seller should ask to
assess their readiness and some key steps they should take to make sure
they are ready for a sale.
Are your corporate records up to date and accurate?
Buyers will typically require a seller to represent that its
capitalization and corporate records are accurate and up to date from
formation through the date of a sale. Despite the importance of these
records, industry sources report mistakes in company capitalization and
stock ledger records of up to a third of private companies.1 Mistakes discovered after a deal
expose sellers to liability, and mistakes discovered during a transaction
cost companies valuable time and money. For companies wishing to close a
sale in 2012, such a delay may be more costly than ever.
How many stockholders will need to approve a sale, is any other party’s
approval required, and how likely is it approval can be obtained?
Many private venture-backed companies today have gone through
multiple financing rounds. Some of these rounds may have added new
investors or imposed conditions that must be met or stockholder approvals
that must be obtained in the event of a sale. In addition, if the company
has any outstanding debt or other securities the holders of those
instruments may have separate and independent approval rights. Given the
added time pressure, companies should start evaluating which groups of
stockholders (or other parties) will need to approve a sale and how likely
it is that such approval can be obtained. Waiting until the sale process
has begun under a strict deadline can put a seller in a tough negotiating
position. It may then face having to negotiate key deal terms with not only
a potential buyer, but also with its own stockholders in order to obtain
their approval. If the seller plans to rely upon a voting agreement, that
agreement should be reviewed to confirm what type of transaction triggers a
voting obligation and how extensive that obligation is. Analyzing
stockholder voting rights and understanding the approval requirements under
any debt or other security instruments now can prevent the complexity that
would result from a three-way negotiation among the seller, the securities
holders, and the prospective buyer and save valuable time.
How accessible and assignable are your company’s “material” contracts,
and will the terms of the contracts, particularly employee contracts, be
acceptable to a buyer?
Buyers will likely want to review a seller’s “material”
contracts. Whether or not a contract is material depends on a company’s
individual circumstances, but contracts with officers and other key
personnel, important vendors and customers, financing agreements, contract
templates, and government contracts (if any) will likely need to be
provided to a buyer. If a seller is unable to quickly locate these
documents it may give buyers the impression the selling company does not
efficiently run its business operations. This not only costs time, but also
affects a buyer’s overall impression of a company’s value.
Also, contracts may require approval or a notice to permit
the seller to transfer the contract to the buyer or to permit a change in
control of the seller caused by the sale. Again, in a time crunch, this can
put a seller in the precarious position of having to negotiate with the
buyer and its employees, customers, vendors, and/or financing
sources. Employment contracts with officers and key personnel require additional
scrutiny as the buyers will likely want to retain some or all of these
individuals, and the terms of their employment, severance, and any change
of control payments may need to be renegotiated during the sale process. A
renegotiation of compensatory agreements can take a significant amount of
time and cause management to lose focus on the key terms of the sale
itself. Sellers seeking to close a sale in 2012 should have their contracts
evaluated by legal counsel to determine materiality and transferability and
should have the terms of employment and other compensatory arrangements
reviewed as soon as possible to avoid unnecessary delays.
Are your company’s financial records in good order?
Providing a prospective buyer with accurate and complete
financial statements is a prerequisite for any sale. While some buyers will
accept unaudited financial statements, depending on the size of the
transaction, most buyers will require audited financial statements for at
least the last completed fiscal year prior to the closing of the sale. An
audit, especially a first-time audit, of a company’s financial statements
can take months to complete even if there are no surprises. Companies
should carefully review their internal controls and procedures, financial
policies, and any “off balance sheet” transactions now to avoid any
surprises that could delay the delivery of an auditor’s opinion on the
company’s financial statements.
How strong are your company’s compliance policies?
Almost all business activities are regulated in some way, but
it is often difficult for companies to determine which regulations apply to
their business and to further determine if they are in compliance with all
applicable regulations. Buyers will, nonetheless, expect a company to
comply with all applicable regulations whether a selling company is aware
of these regulations or not, and to make representations to that effect in
the purchase agreement. In light of this, companies should evaluate the
state of their compliance with applicable governmental regulations before
entering into a sales transaction.
How well protected are your company’s intellectual property assets?
A company’s intellectual property is often its most valuable
asset and, for most technology companies, may be a primary reason a buyer
is interested in purchasing the company. Issues impacting intellectual
property rights discovered during a transaction can delay or kill a deal.
Problems found in advance can often be remedied, but these actions may take
time. Consequently, companies should review their intellectual property
portfolio now to determine if there are any risks with respect to their
intellectual property assets.
The Bottom Line
On February 7, 2012, Federal Reserve Chairman Ben Bernanke
urged Congress to finally decide whether or not to extend the Bush tax cuts
past 2012. Companies contemplating a sale in the near term, however, should
not wait for Congress (or California) to act. In order to
ensure your company can close a sale before any increase in the tax rates,
you need to begin the process now and proactively seek to identify and
address any issues that could cause a delay in closing.
* * *
1 Paul Koenig & Mark Vogel, Tales
from the Trenches, Third Edition, printed by R.R. Donnelly and
Shareholder Representative Services, Jan. 2012. (“In SRS’s experience
upwards of a third of the [stockholder ledger] spreadsheets received [from
companies] have issues that require further clarification before
distributions can be made.”)