Banking and Business Monthly – September 2024

Introduction

We spend considerable time educating our sell-side M&A clients on the sale process. In this month’s article, I’ll summarize some of the key considerations when helping our clients prepare for a sale of a company.

Timeline

Timelines for the process vary depending on size and complexity. A typical timeline for a private company sale from the signing of a letter of intent (LOI) to closing is around 90 days. This may be a bit longer if there is a lender involved. Note that LOIs often have a period of exclusive dealing with the potential buyer that is somewhat longer, often 120 days or more.

Deal Structure and Tax Consequences

Generally, there are three types of transactions: asset sales, equity sales, and mergers. Early in the sale process, preferably before receiving any LOI, we assist clients in helping them decide which structure is appropriate for them, and we work with their tax advisors to determine whether and how the structure will be taxable or tax-free.

Third-Party Consents and Licenses

Among the considerations in selecting the deal structure is the extent of any regulatory or contractual third-party consents that must be obtained to complete the sale, apart from the typical board and equityholder consents. For many clients, we often need to review their contracts to determine whether the counterparty must consent to a transaction. Some contracts require consent for any assignment of a contract, whereas others state that any change in control of a party is deemed to be an assignment requiring the other party’s consent. Note that asset sales generally require sellers to obtain more consent to contract assignments than equity sales. We also consider whether the company has any licenses that are not transferable, which argues in favor of an equity sale.

Financial Statements

After a confidentiality agreement or non-disclosure agreement is executed and before an LOI is presented, buyers often request the company’s financial statements for the previous three years in order to propose a purchase price in the initial draft of the LOI and any related working capital targets and earn-out provisions. After an LOI is executed and during due diligence, buyers will want more financial information, such as current financial statements, tax returns, and projections. The financial information is used to fine-tune the working capital targets and earn-out provisions, as well as to identify any risks associated with taxes, customer concentration, and the like.

Real Estate

Real estate may be an important asset of a company, so the parties should pay attention to any real estate owned or leased by the company and deal with related issues. If the real estate is leased, the lease’s assignment provisions need to be reviewed and complied with. Buyers may want an assignment of the existing lease, or they may want to enter into a new lease with more favorable terms. If the real estate is owned, then the buyer should decide whether it wants to purchase the real estate too. If so, then during the diligence process, the buyer should conduct a property inspection, review existing title insurance and surveys, order any updates to them, and consider whether to obtain a Phase I environmental site assessment.

Purchase Agreement

During the due diligence process, the parties and their counsel are also often negotiating the purchase or merger agreement. Among the issues that are negotiated are the following:

Employees

Buyers often want key employees to continue their employment, and may also want founders to stick around to assist with the transition. Both can be accomplished through ancillary employment and consulting agreements. Ensuring key employees stay is important to sellers as well, especially if an earn-out is a component of the purchase price. The parties may want to consider stay bonuses and other incentives to maximize the value of the company through closing and beyond.

Restrictive Covenants

Buyers often want to prevent founders from competing with the company once any transition services conclude, and this can be accomplished by way of non-competition covenants, either in the purchase agreement or the above-mentioned employment or consulting agreement. Note that the FTC Rule we discussed here previously has an exception for non-competition agreements related to a sale of a company. We often negotiate various parameters associated with non-competes, such as duration and geographic restrictions, as well as exceptions for any specific activities that founders may want to do post-closing, such as small investments, charity work, or other ventures.

Indemnification

The indemnification section of a purchase agreement is often heavily negotiated. Indemnification protects a party from losses associated with the acts or omissions of another party. For example, a seller may agree to defend, hold harmless, and make whole the buyer for any losses arising out of the seller’s breach of a representation or warranty. Sellers usually want to limit the duration of the indemnity obligation post-closing, as well as the amount of the indemnity obligation. Buyers like to carve out certain representations and warranties as “fundamental representations” that will not be subject to the same indemnification limits as general breaches of representations and warranties. The availability of representation and warranty insurance may favorably impact these negotiations from the seller’s perspective.

Conclusion

The foregoing is a brief overview of some of the important considerations when helping our clients prepare for the sale of a company. If you or someone you know is considering a company sale, please contact me at smigala@lavellelaw.com or (847) 705-7555 for a free initial consultation.