In a perfect world all privately owned businesses would have impeccably maintained corporate records, contracts, employment relationships and regulatory filings. While such businesses do exist, in our experience they are the exception and not the rule. Unfortunately, when legal deficiencies are discovered, it is often by purchasers performing due diligence in the context of a purchase and sale transaction. Depending on the severity of the deficiency, the discovery could lead to a renegotiation of price or a decision not to proceed. Below are five steps that all private business owners can take to enhance the value of their business and facilitate an efficient purchase and sale transaction.
1. Clean-up Your Corporate Records
The problem
In selling their business, vendors often want to take advantage of the $750,000 lifetime capital gains exemption. This is more difficult to do if the vendor company’s corporate records are not in good order. In our experience, it is extremely rare for a target’s record book to be free from corporate deficiencies. Defects can range from missing annual resolutions to improperly issued shares or options. In most cases, especially when the target’s record books have been maintained by a good corporate law firm, the deficiencies are minor and can be remedied with relative ease. However, in other cases, the defects may be serious and require time and expense to remedy. As a vendor, you do not want to learn from your purchaser that your company’s records are a mess, or worse, that there are serious defects with the records that require time consuming remedial action.
The remedy
Do not wait for a transaction to reveal deficiencies. If you are at all concerned about the state of your corporate records, have a corporate lawyer review them and, if necessary, remedy any defects. You want your purchaser to have a good impression of your records and you want to be worry free when making representations and warranties about those records.
2. Organize and Understand Your Supplier and Customer Contracts
The problem
It never ceases to amaze us how many business owners fail to properly organize and diligently manage their relationships through contracts. A target may have terrific business arrangements with suppliers or customers, but if those arrangements are not formally documented in binding contracts they are of limited value to a purchaser. In the absence of a binding agreement, it is impossible for a purchaser to know whether a supplier or customer will continue an arrangement after closing. Well drafted contracts provide certainty and enhance the value of your business. You can be certain that during the due diligence processes the target’s contracts will be closely scrutinized by the purchaser and purchaser’s legal counsel. As a vendor, you do not want to face a price grind at the due diligence stage because you are unable to demonstrate that your business relationships will continue to have value to the purchaser.
The remedy
Prepare a table listing all of your important business relationships and gather and organize all of your contracts and documents relating to these relationships. Are any of these contracts expired or about to expire? Do the contracts allow for a change of control or assignment? Does your business have any important relationships which have not been formalized with a contract? Do any of the contracts place restrictions on the disposition of assets? Do you have any agreements which should be renegotiated? Do you have important contract templates which should be reviewed? Discuss any concerns with your lawyer.
3. Employment Agreements
The problem
Privately owned businesses often operate without written employment agreements or with a mixed bag of employment letters and agreements that have been cobbled together over the years. The certainty created by having well drafted employment agreements can be an extremely valuable asset of a private business. Well drafted employment agreements will include customary employment details including position, title, duties, salary, benefits, bonus, the duration of the employment relationship, and obligations on termination. Additionally, such agreements often include non-competition and non-solicitation provisions, non disparagement clauses, intellectual property rights clauses and confidentiality provisions. These and other additional employment provisions can enhance the value of the business.
The remedy
Develop excellent employment templates appropriate for your business. Ensure that you and your lawyer review the templates on an annual basis to address any changes in the law and your business. Have all new hires enter into your standard employment agreement. You may also ask existing employees to enter into such agreements but if you do so you must provide them with additional compensation to enhance enforceability because the lack of new consideration may render the agreements unenforceable.
4. Protect and Enhance Intellectual Property
The problem
Whether or not you are in the technology sector, it is likely that your employees or contractors will create work that carries intellectual property rights. Purchasers will be looking for either an employment agreement or an intellectual property rights agreement whereby the employee or contractor agrees that the rights to IP created by him or her belong to the target company. Purchasers want to know that the employees and contractors of the target will not be claiming intellectual property or moral rights to IP that the purchaser believes it is acquiring. In the absence of an agreement, especially for contractors, there may be some uncertainty about the ownership of IP rights which could diminish the value of the business or cause a buyer to walk. Similarly, purchasers will expect employees and contractors to be subject to enforceable confidentiality and non-disclosure provisions prohibiting employees and contractors from disclosing confidential information during and after employment.
The remedy
When you hire employees and contractors, have them enter into appropriate intellectual property, confidentiality and non-disclosure agreements. You may ask existing employees and contractors to enter into such agreements but if you do so you must provide them with additional compensation to enhance the enforceability of the new agreements. Finally, treat confidential information as confidential. Courts are more likely to protect confidential business information where the employer has consistently made efforts to keep the information confidential.
5. Ensure you have (and comply with) all of the Permits and Licenses necessary to operate your business
The problem
Provincial and local governments impose all sorts of permitting and licensing requirements on operating businesses. A business may have overlooked the need to have certain permits or licenses or the business may be non-compliant with its existing permits and licenses.
The remedy
Research and determine if your business holds all requisite permits and licenses. Conduct an audit to ensure your business is compliant with its permits and licenses. If any orders have been issued to the business by governmental agencies, ensure the business is taking reasonable steps to comply with those orders.
It is important to recognize that these steps are best carried out well in advance of a purchase and sale transaction. You never know when your business might be the subject of an unsolicited offer which is too good to refuse – you want to be prepared.
