Eyeing the Exit: Building Value of a Business for Future Sale

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Deciding to build a company in the start-up phase or for a family business, day-to-day operations and growth objectives tend to consume most of management's time and effort. Day-to-day decisions, however, can enhance or diminish the exit value of the business at some point in the future, or can delay a sale. It is plausible that most business entertain the idea of one-day merging or cashing out in a sale of their business through an acquisition of some form. Regardless of the viewpoint, operating the business with a potential exit in mind can steadily increase the valuation realizable in a future sale. 

One method to focus on for an setting up the business for an easier sale in the future is the transfer of ownership (equity). A clean record of ownership of shares, units, member interests or other equity facilitates the sale of an entity. In reviewing a stock ledger, list of ownership interests attached to a partnership or limited liability company agreement, or list of holders of warrants, options, preferred stock or convertible debt, a buyer will look first at good title to shares or other equity. By updating records on an ongoing basis, a business can be more readily marketed to potential buyers. Be sure that shareholder agreements or other corporate documents limit or restrain how owners can leverage their ownership and avoid liens and other encumbrances that can cloud clean title to equity. Prior mergers and corporate name changes, death or divorce of individual owners, and lost records can delay negotiations with a buyer.

Similarly, preemptive rights to purchase and anti-dilution features can create uncertainty about how much equity is outstanding. 

Additionally, the transfer of ownership of assets will require good title to business assets. This can require clean documentation in public records. Release of old mortgages and security interests can hold up a sale, and becomes progressively more difficult as time passes. In addition, a buyer typically conducts site visits to view property, conduct an inventory count and inspect other assets. Accordingly, key assets should be documented and accessible, and in good order. The business should also be aware how it is leveraging assets so that during the life of the business, the business is not burying itself too deep into a debt hole that it may never climb out of – making itself unattractive to potential acquirers. 

Another great strategy is to conduct periodic risk assessments of the business, which can identify potential risks from a buyer’s perspective that may delay due diligence or reduce sale value. Insurance, hedging, accounting and inventory systems, and other policies and procedures may address risks proactively. Documenting risk mitigation measures can expedite a buyer’s due diligence review and potentially increase the sale price (or reduce indemnification demands from the buyer). Further, third parties, including employees, business partners and affiliates, may hold key rights needed to operate the business, such as leases and intellectual property rights. Assigning and documenting key rights in due course assures the ongoing value of the business, rather than addressing potential claims to these rights as an urgent matter when considering an exit. Attempting to settle claims at the time of an exit generally increases settlement costs if these claims have "hold-up value" in delaying a favorable sale. A risk assessment can also identify these matters early if the business wasn’t keeping track. 

Also, make sure the customer and supplier agreements are favorable agreements, and have proper exit rights and/or able to be assignable in the event of a pending acquisition or sale. Favorable terms in agreements with customers and suppliers, including prices and other terms, should be documented to permit transfer of the business to a buyer. An established course of dealing with business partners may not continue after a sale, and other parties may take the opportunity of an exit to re-trade or reset prices and other business arrangements. Undocumented terms and conditions may reduce the value of the business and lead to disputes with the buyer and other parties after closing. In addition, any consent rights that might apply in a potential sale of the business should be identified and renegotiated if possible, to reduce the risk of delay or disputes. Planning ahead by having an attorney consistently negotiate and review the business’s deal terms is a step in the right direction when the business first opens.

Further, the always unavoidable – taxes will play a big role in any business sale. Tax planning can help owners enhance value on an exit transaction. Advance tax planning can require formation of new entities, restructuring the business or a multi-year program to minimize taxes associated with an exit. In addition, owners may be better positioned to propose transaction terms with more favorable tax consequences. Likewise, accounting will play a role too. Depending on the needs of a potential buyer (especially a public company or buyer who will seek bank financing), audited financial statements and documented internal controls may be required for the business before a sale. Whether or not an audit is required, the buyer will review the accounting records (including aged accounts receivable) to assess the financial performance and valuation of the business. Maintaining accounting records sufficient to satisfy a potential buyer’s requirements can enhance value of a business.

Last but not least, disputes and compliance are two very important items that can be easily forgotten; thus, have a plan to deal with them now before it is too late. Ongoing disputes (whether pending or threatened litigation or low-level business disputes) may diminish the perceived value of the business in the eyes of a potential bidder or buyer. Also, a potential buyer generally reviews compliance programs and records, to assure that the business is in compliance with governmental regulations (and has no potential liability or fines for historical practices). Addressing any areas of non-compliance and maintaining orderly records will facilitate a buyer’s due diligence review and avoid delays in dealing with governmental agencies during negotiations. Governmental consents and approvals required for a sale can be identified in advance and discussed with a potential buyer, along with the anticipated timeline for closing. 

In conclusion, even if you are not selling your business, all of these key pieces of advice will help any company maintain their status and organization, and will be an attractive target for mergers and acquisitions even if that is not the intent of the business owners. A valuation is enhanced when a business is run in the ordinary course in anticipation of a future exit. Advance planning allows for an orderly sale, whether in the near term or opportunistically in the future when market conditions are favorable. Either way you look at it, it is just good business to operate the company as if you are ready to sell your business.