Six Ways to Prepare for a Capital Raise or Sale of Business
June 22, 2016 by Brown Fox
Business owners tend to focus most of their attention on day-to-day operations to ensure that the company achieves success. Although this is a good and necessary approach, such emphasis on operations can cause business owners to find themselves unprepared or ill-equipped to either raise capital or ultimately sell the company when the time is right.
Preparing for a capital raise or an exit (sale of your business) prior to interest from a third party offer will not only improve the chances of closing the eventual transaction, but will also often improve the price terms and reduce the time necessary to close. Advance planning also can improve efficiency and ensure the company’s continued compliance with applicable legal requirements.
This article will focus on a few of the more fundamental (and important) ways you can prepare your company to be an attractive target for purchase or investment.
- Corporate Clean-Up of Records
One of the first things a potential purchaser or investor will notice in the due diligence process is whether your company’s internal corporate governing documents are in order. We have seen deals die before they can get off the ground because the target company lacks some critical piece to its corporate governing puzzle. Examples are numerous, but include putting good operating/voting agreements in place, establishing a sound business succession plan, imposing transfer restrictions on the company’s equity, and maintaining complete and accurate records relating to minutes of meetings, corporate resolutions, equity ownership, or other internal records. It is important that you take time to fill any gaps in your internal corporate governing documentation, not only to ensure timely compliance with relevant corporate formalities, but also because providing a potential purchaser or investor with a thorough and complete set of corporate records that will portray the company in the best light possible. Deals are not necessarily closed based on a pristine set of corporate governing documents, but they can certainly be derailed.
- Relationships with Employees
You can expect that potential purchasers or investors will want to examine all agreements with key personnel and other employees and contractors of the business, including all employment, non-competition, non-solicitation, confidentiality, and non-disclosure agreements; and any other document intended to protect the trade secrets or proprietary rights of the business. Additionally, potential purchasers and investors will want assurances that current key personnel of the business will be precluded from competing with the business or soliciting clients or employees of the business after completion of the sale or capital raise.
Thus, if you do not currently have any agreements that prohibit employees from competing with the business or soliciting clients of the business after termination of his or her employment, you may consider entering into such agreements in the course of preparing for a sale. If any such agreements are already in place, you should begin collecting these agreements and consider engaging legal counsel to review them for legal compliance.
- Contracts with Third Parties
You should be prepared to provide a potential purchaser or investor with evidence of the business’s relationships with customers, vendors, landlords, and other third parties. For those relationships that are not evidenced by written contractual arrangements, you should consider formalizing them in writing. If written contracts are already in place, consider reviewing their terms to ensure that each contract: (a) has not lapsed or otherwise expired; (b) does not restrict assignment to a potential purchaser or preclude a change in control of the company; or (c) does not restrict the company’s ability to conduct its business in the future (i.e., overbroad exclusivity and non-competition provisions).
Identifying potential problems in existing agreements ahead of time will help reduce the time necessary to close the future transaction and may avoid raising unnecessary red flags in the eyes of the potential purchaser or investor.
- Legal Claims, Liabilities, and Encumbrances
Before initiating any sale process, you should try to resolve or finalize any legal claims, outstanding liabilities, and significant contingencies affecting or encumbering the business or its assets. Potential purchasers tend to evaluate contingent liabilities on a worst-case basis, which will likely reduce the perceived value of the business. Regardless, interested parties will want to know the history of legal claims and other contingent liabilities for the business, likely for the immediately preceding five (5) years. You should therefore begin collecting and reviewing your records of past claims, and analyzing recent correspondence for potential future claims that may arise during or after a potential sale.
You should also review and evaluate any encumbrances or security interests currently placed on the assets of the business. A potential purchaser and investor will scrutinize your company’s debt-to-equity ratio and will want to understand how the company’s debt fits with its overall objectives.
- Accounting and Financial Practices
The ability to provide an interested party with a full and complete record of the business’s historical accounting and tax practices will go a long way in placating any fears or anxieties about your company. You should locate and review complete financial and cash flow statements of the business for the preceding five (5) years and work with your accountant or chief financial officer to understand and be able to explain your tax strategies.
- Intellectual Property
Even if intellectual property is not perceived as a key asset to the company, there can still be substantial value in such assets assuming the business actually owns, or has valid licenses to use, all of the intellectual property used in its day-to-day operations. Prospective purchasers or investors will require that the company validly owns or has the right to use all of its intellectual property, including trade secrets and proprietary information. Accordingly, you should evaluate your company’s rights to the intellectual property critical in the operation of your business.
Additionally, you should examine all materials and information related to any registered intellectual property, such as any patents and patent applications, trademarks and trademark applications, registered and unregistered copyrights, and any internet domain names. The ability to provide a potential purchaser or investor with confirmation of the foregoing registrations will not only provide assurances of the business’s ability to transfer such rights to the potential purchaser, but will also speak well of the business’s record-keeping as a whole.
It may seem counterintuitive to prepare for a capital raise or a sale of your business before you perceive the need to do so. However, first impressions are critical. Taking steps now (including those listed above) will help you showcase your company in the best light possible to a prospective purchaser or investor.
Samantha Cooper is an Associate at Brown Fox and focuses her practice primarily in the areas of corporate transactions, business litigation, and employment matters. To learn more about Samantha, click here.
Adam Fox is a founding partner of Brown Fox PLLC and the Chair of the firm’s Corporate & Securities practice group. To learn more about Adam, click here.
