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Exit Strategy Planning and Legal Due Diligence

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Exit Strategy Planning and Legal Due Diligence - Article written by a leading Exit Planner and Corporate Lawyer
By Stephen Cummings and Vanessa Grant

Stephen Cummings is the CEO of Rizolve Partners, a leading Exit Planning firm.

Vanessa Grant is a leading corporate lawyer with Norton Rose Fulbright Canada who is skilled in preparing for and executing business transactions for entrepreneur-led private and public companies.

PLANNING YOUR BUSINESS EXIT

There are many areas in your Business Exit where agreements and representations are made to a third-party buyer that he/she will rely on in agreeing to the transaction. Having legal advice to ensure that reasonable bargains are made such that options for recourse are limited by reasonability is important to mitigate risk.

Seeking early strategic advice, followed up by disciplined pre-due diligence planning is key to negotiating a successful transaction and ensuring that momentum in the deal is preserved.

Finally, having a skilled M&A lawyer to negotiate your side of the bargain who understands the current market for appropriate legal terms, conveys to the bidding team that you are serious about concluding a satisfactory deal.

Legal Advice on Planning Your Business Exit

The legal advisor is one of the key advisors to a business owner in planning for and executing an exit. This advisor should be part of your core transition team. Their role has the key objective of ensuring that all of the existing company legal agreements and corporate governance structures are drafted and allow for a transaction to proceed with minimum friction from any stakeholder, including the buyer.

There are two core roles that the legal advisor fulfills in this regard:

  • Ensuring that a company is ready from a legal perspective to navigate the transaction process. This includes ensuring that the existing (and subsequent) legal agreements and corporate governance structures (controls, policies, and guidelines) are drafted in contemplation of a future purchase and sale agreement such that documented acceptance of a transition into third party ownership has been reached, so far as possible, well in advance of a transaction; and
  • The legal advisor has well developed experience in drafting and negotiating a purchase and sale agreements at current market terms. Not all advisors have equal experience and a legal representative who is active in the M&A market is important.

 

Legal Advice for Planning to Sell / Exit your Business

STRATEGICALLY PLANNING A TRANSACTION

In strategically planning a transaction, a legal advisor should be included to offer advice in the review in such matters as:

  • Tax efficiency of the ownership or corporate structure;
  • Capital structure and the approval process for a transaction;
  • The nature and extent of the liabilities contained in the financial instruments held;
  • The corporate governance in any shareholder agreements, the articles and the laws of the company that will impact the ability of the entrepreneur to affect a transaction;
  • Understanding the nature of the outcomes of different exit options.

After making a decision to transition the ownership of the company into different hands, the legal advisor should then be engaged to review, from a tactical perspective, all of the elements of the corporate group structure, agreements governing the rights of shareholders, equity compensation plans and other financial instruments, the articles of the company, the laws and existing legal agreements to ensure that there are no blockers or issues of significance that would cause a problem for the transaction. Examples of the legal counsel review would include the following:

Buy-Sell Agreements
  • Are there any?
  • If so, do these agreements contain documented purchase options?
  • If so, are there any provisions related to the departure of the entrepreneur?
Participation Agreements
  • Are there bonuses or distributions on exit?
  • Are there allocation of profits, distributions or carried interest that activate on sale?
Intellectual Property
  • Does the company have an inventory of its registered and unregistered intellectual property? For example:
    • Patents
    • Trademarks
    • Trade secrets
    • Copyrights
    • Domain names
    • Data
  • If the company develops or has developed its own software, is the software subject to an open-source license?
  • Is it clear who owns the intellectual property?
    • Distinguish between employer, employee, contractor or prior employer
  • Are protections in place to further guard the intellectual property such as:
    • Assignment of intellectual property agreements
    • Confidentiality agreements
    • Prior restrictions
    • Internal policies and procedures
    • Licenses
Financial Agreements
  • What are the financial covenants?
  • Are there personal guarantees that will need to be released on closing?
  • What are the change of control provisions?
Contracts
  • For all agreements:
    • Is there a change of control provision that requires the consent of the counterparty on a change of control (sale) of the company?
    • Are there limitations of liability or unlimited liability?
    • Are there indemnification clauses?
    • Do you have insurance to cover the indemnification provisions in the agreement?
  • Customer and vendor agreements
    • Is it clear which form of agreement takes precedence (look for terms and conditions that are incorporated by reference into purchase orders – do they conflict with the master agreement)?
    • Are the performance terms of the contract clear?
    • What are the termination provisions? Is the contract a long-term contract, or a short-term contract? Is the duration of the contract consistent with industry norms?
  • Leases
    • Leases almost always have a change of control provision – consider the relationship with the landlord and whether there will be any issues obtaining consent for a change of control.
  • Licenses
    • Review intellectual property clauses: who owns any intellectual property?
Human Resources
  • If there are any written employment agreements or offers of employment, do they reflect the current state of employment law?
  • What are the liabilities for vacation pay, potential severance pay, and benefits? Are these clearly documented?
  • Non-compete, non-solicit, confidentiality, and assignment of intellectual property provisions – what are they and what do they affect?
  • Retention – do you intend to provide retention incentives for any employees – all or key only?
Business Litigation and Risk Management
  • Litigation
    • Is there any litigation?
    • If so, is it likely to settle or be resolved prior to any sale of the company?
    • If it is not likely to be resolved prior to a sale, discuss with your legal advisor how best to manage it with a prospective buyer.
  • Reducing likelihood of litigation
    • Do you regularly perform credit and background checks?
    • Are there onerous contract terms that should be flagged for prospective buyers?
  • Insurance
    • What insurance policies are in place?
    • What is the scope of the insurance? Does it cover the operations of the business?
    • Do you need directors’ and officers’ insurance?
    • Does the company have CGL and named insureds?
    • Are professional liabilities covered such as errors and omissions?
    • Is workers’ compensation and employer liability covered, either statutorily or with policies?
    • Do you have cyber security insurance?
    • Do you have employee dishonesty coverage?
Corporate and Regulatory Filings
  • Have all the annual returns been made and are they in good standing?
  • Have all extra-provincial registrations been made?
  • Are all required regulatory and tax filings up to date in each jurisdiction in which the company does business?
  • Does the company have all permits in all jurisdictions to carry on its business?
Minute Books
  • Do you have them completed?
  • Are they up to date?
  • Is the list of shareholders up to date and accurate?

 

PLANNING YOUR BUSINESS EXIT - Legal Advice from Experts

DRAFTING THE TRANSACTION AGREEMENTS

The second major area where you will need skilled legal expertise to help you mitigate transaction risk is in drafting the transaction agreements. Key documents and components of the agreement of transaction terms are:

  • Letter of intent (“LOI”).
    An LOI is a non-binding letter of intent usually drafted by a prospective buyer as an indication in writing of a buyer’s willingness to purchase the company. While the document is of a legal nature, however, it is not intended to be fully binding. The only binding obligations tend to be with respect to confidentiality and exclusivity. The LOI sets out the terms of the acquisition process and provides insight into what the final offer and its terms might look like.
  • Purchase and sale agreement.
    A buyer may elect to purchase the shares of a company or all or some of the assets of a company. The form of transaction (share or asset sale) depends on a number of factors, including tax and business risk. Regardless of the form of acquisition, a business purchase and sale agreement is a legally binding contract that outlines the terms and conditions of buying or selling the business. It specifies the purchase price, assets, liabilities, warranties, any purchase price adjustments, and other important details to protect the interests of both the buyer and the seller. Much of the negotiation of a purchase and sale agreement is around what is the limit to how much a seller has to pay where there is a breach of the representations, warranties, and covenants made. The limit might be an amount equal to the purchase price (not as common as it once was) or a percentage of the purchase price and any holdback or escrows of the purchase price.
  • Documenting and negotiating representations and warranties.
    Representations and warranties in a business purchase and sale agreement are statements made by the seller about the condition and status of the business being sold. These statements cover various aspects such as financial information, legal compliance, contracts, intellectual property, and other relevant details. If any representation or warranty is found to be untrue, the buyer may have legal remedies or options for recourse.

FINAL TAKEAWAYS

In summary, having a legal advisor with the appropriate M&A skills involved in the early consideration of the transaction strategy can save a lot of time and money. As part of the aligned core transition team, this advisor creates the potential for the transaction to proceed with minimum friction from any stakeholder, including the buyer. You can see from the above analysis that there are many areas to consider and having a trusted, knowledgeable legal advisor who knows you and your goals is critical to achieving a satisfactory outcome.

 

For more information about Exit Planning, check out our process expertise tips sheets here.

The Smartest Business Owners Never Leave Money on the Table

Posted on by RizAdmin

Have you heard about the “age wave” that could affect the value you realize for your business when you decide to monetize the wealth you’ve created? Two thirds of private business owners are baby boomers, and their average age is 65, representing over 700,000 Canadian businesses. According to BDC, 49% expect to exit their business within 5 years. That could be good news if you’re looking to buy a business, but the market is about to get much more challenging for owners looking to exit.

Unlocking the wealth in a business is no trivial affair given that 80%-90% of most owners’ financial assets are tied up in their business. Owners are banking on their ability to monetize this wealth to ensure their financial security and lifestyle once they exit.

However, historical transition rates suggest looming issues for the unprepared: statistics show that only 20%-30% of private business transitions are successful. Poor transaction success, high levels of owner dissatisfaction, and low levels of survival for family-owned transfers all threaten retirement plans.

Despite that backdrop, nearly 80% of owners have no written transition plan, and nearly half have done no planning at all. Not having a considered exit plan will close doors to value maximizing opportunities and available tax saving strategies.

Here are five thoughts business owners should keep in mind when trying to optimize value on what they have created.

Know your exit strategy

A successful exit strategy ensures a business owner is financially prepared, maximizes transferable business value and provides a plan to answer the question, “What next?”

There are several factors that come into play.

First, an owner must understand their business and their personal objectives.

Your personal objectives and needs are key inputs to correctly setting your personal expectations and financial plans. Understanding your wealth plan and what must be achieved out of the business sale to enjoy it, represents your bottom line for negotiations.

Understanding that there are different phases in the getting-to-cash process is important, too. The planning phase to maximize value can take up to three years, while preparing and executing the final transaction can take up to a further year. Even after the transaction is completed there may be contract terms that need to be fulfilled.

Having a written plan covering these stages, as well as identifying goals for pre-sale value acceleration, will help chart a course for the owner and give other stakeholders something they can buy-in to.

Focus on value

To optimize value in the sale of a business, an owner needs to look at his or her company through a value lens. This is likely to involve “reframing” their approach from a perspective of purely maximizing profit to one of maximizing value.

To do this an owner needs to understand the value of the business today and what drives that value. The quicker one gets comfortable with the fact that this is not just about sales and growth in profit, the greater the likelihood of having a successful sale.

The more time one allows for “value acceleration” work to be executed, the better the prospect for maximization and creating a return on investment.

What gets measured, gets done

It is important to understand that more than 80 percent of the value of a company lies in intangible assets and goodwill (often off-balance sheet). An advisor team can help an owner identify and measure the components of such assets.

In order to track progress in accelerating value pre-sale, it is important to institute a measurement framework where the unit of measure is enterprise value. Having the value scores for the components of these assets allows an owner to create a targeted plan of improvement around the key drivers of value.

There are various measurement tools, ranging in sophistication, that enable owners to identify winning strategies and transform them into genuine results (e.g. Value Builder and Value Opportunity Profile). Measuring the positive results from improvement actions will help deliver desired outcomes.

Remember the maxim: “What gets measured, gets done!”

Know the end game

There is a defined sales process that occurs when selling a business.

The sales agent (broker or investment banker) invites a group of prospective buyers from a wide variety of sources to engage in the sales process. The agent stages the interaction to funnel down to the buyers who have demonstrable interest and qualifies their ability to execute the transaction. The goal is to orchestrate competition and create “deal tension” to optimize bids with attractive terms.

Some key sales documents, which the market expects to be available when engaging, will be employed in the process. An owner will need to have significant input in their preparation and justification. Having these documents available, with supporting information, is critical for deal momentum and navigating due diligence.

A lawyer skilled in M&A will also draft and provide negotiation support for various legal documents critical in arriving at negotiated price and terms.

Appoint an aligned advisor team

There are a number of key roles that form the backbone of an aligned exit-planning team.

First, there’s a quarterback (the “Exit Planner”) who can help an owner build, orchestrate and implement a plan. Critically, this position will take the business through a process of value acceleration and ensure that the business is transferable and ready for sale.

A personal financial advisor helps compute the minimum number that an owner needs to achieve from the sale of a business in order to fulfill his or her lifestyle wants. This provides a bottom line.

A business tax and legal advisor helps structure business assets so that what is sold is separated from assets not being sold and will organize to minimize tax on net proceeds.

Finally, a transaction advisor will help the owner organize and orchestrate the sale process, which requires independence and skill.

For a business owner, early planning, informed navigation, and careful execution of the exit process can mean the difference between maximizing the value of the business or settling for something less than they have dreamed about for their retirement.