Key Legal Issues and Considerations When Preparing to Sell a BusinessFriday, June 3, 2016
While most are well aware that the sale of a business is generally a complex and time-consuming process, even sophisticated business owners are surprised by just how much cost and effort is required to complete the sale process.
At Wildeboer Dellelce LLP, we regularly work alongside business owners in preparing for the sale of a business and have advised on hundreds of business sale transactions. From this vast experience, we have prepared the following brief overview of some of the most important legal issues that a vendor should consider when preparing for the sale of its business.
- Tax.The tax implications arising from the sale of a business is a key legal issue that all vendors should consider and prepare for well in advance of a proposed sale of the business. In general terms, there are three typical alternatives to structuring the sale of a business: an asset sale, share sale or a hybrid sale (which is a combination of both an asset and share sale). The ideal structure for the vendor will depend upon a number of factors including the availability of the vendor’s capital gains exemption, the composition of the business assets and the relevant tax attributes available. Given this, obtaining tax advice as early as possible is recommended as this can facilitate the vendor dictating the form of the transaction and can provide sufficient time for the vendor to explore any planning opportunities that may be available.
- Financial statements.The valuation of a business requires access to hard numbers. As such, purchasers will often request audited or unaudited financial statements for a certain number of years, together with supporting information regarding your sales pipeline, cost of sales and other related financial and accounting information. If you are a private company that has not kept your financial records in order, it may be time to get in touch with your auditor or accountant.
- Legal agreements. If any of your current business relationships are being conducted pursuant to oral agreements or understandings you should look into formalizing those agreements in writing as most purchasers will require written agreements. In addition, if any agreements are missing signatures from the counterparty, ensure you have those parties execute the agreement. This issue is of particular importance with respect to those agreements which are material to your business.
- Registered owner. A buyer will want to see evidence of ownership of all assets that a vendor is transferring as part of the sale transaction. A common issue faced by many businesses is that certain assets, often real property or intellectual property, are held in the name of the founder or a related individual or entity as opposed to the company to be sold as part of the transaction. To avoid issues during the due diligence process, it is advisable to consider transferring all assets that are used in the business so that they are held in the name of your company or one of its direct subsidiaries, subject of course to an assessment of the relevant tax and other implications of transferring those assets. Leaving this until you are engaged in the sale process presents risks, including the prospect of the registered owner of such assets leveraging an impending sale to ask for greater consideration for their transfer.
- Consents. Many commercial contracts include a clause which either requires the consent of or notice to the counterparty prior to the sale of all or substantially all assets or a change of control of the company. It is important to carefully review all contracts to which your company is a party to ensure that you are aware of contracts with those types of clauses. Doing so prior to engaging in the sale process will ensure you are able to more accurately assess the time required to complete a sale of your business and identify any potential risks and challenges in securing the required consents.
- Employees. While the addition of employees is generally a sign that your company is growing, keep in mind that if a purchaser is unwilling to inherit all of your employees, you may very well be obligated to pay severance payments associated with the termination of certain employees upon completion of the sale transaction. A careful review of applicable employment legislation and employment agreements in place can assist in determining termination costs, and help guide your growth strategy.
- Minute books and registers. When acquiring a business, purchasers will want to review the company’s minute books and shareholder, director and officer registers. Because most business owners are focused on the day-to-day operation of their business, it is not uncommon for the minute books to have been neglected. However, their significance to a buyer and the time and challenges of updating them should not be underestimated. We therefore recommend that business owners ensure that their minute books are properly maintained at least annually. Failing that, it is advisable to begin getting them in order well in advance of a proposed sale of the business.
- Debt agreements. If your business has incurred debt, you should review all agreements entered into with your lenders to determine whether a sale of your business would trigger any provisions in those agreements which may be adverse to the business. For instance, if a purchaser is unwilling to assume your debt, a prepayment penalty on the debt can add significantly to your transaction costs.
- Technological requirements. Another aspect of a sale transaction which comes as a surprise to many is the extensive use of technology during the sales process. During the due diligence stage, a vendor typically uploads a significant number of documents to a secured web-based portal, commonly referred to as a data site. Unless a substantial number of your records are already digitized, the process of scanning, uploading and managing documents on a data site can be labour-intensive and require investment in adequate equipment. Although many of these functions can be outsourced, consider whether you will need to add additional resources to meet these demands.
- Strong internal team. As you have gathered from reading through this list of potential legal issues, the sale of a business can be time consuming and require the resources of key personnel. In light of this commitment, it would be worthwhile to ensure you have an effective and competent team to run the business in its ordinary course and during the sale process.
This is particularly important if your sale agreement includes an earn-out provision which ties post-closing business performance to the consideration that you receive for your business.
While this list is not exhaustive, it highlights some of the key issues that vendors face when selling their business. If you require further insight into any of these issues or would like to discuss other areas of a sale of your business, please contact Troy Pocaluyko or Rob Wortzman in our Mergers & Acquisitions practice group or John O’Connor in our Tax practice group, each of whom would welcome a conversation with you.
This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.
If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.