Wait – Before Selling Your Business, Do a Risk Assessment

Whether a strategic buyer, a private equity investor or another type of purchaser, most buyers prefer to avoid risk. So much so, that most buyers will pay a premium if the equity or assets they are purchasing don’t come with excessive legal baggage, liability, or other risks.

Many business owners have given extremely large amounts of time (sometimes several months, sometimes over 40 years) to build their business. But many of these sellers fail to consider how much of an increase in sale proceeds can be obtained by removing legal risks (for the business and potential buyer) prior to exposing the assets or equity to the market for sale.

A “legal audit” will often uncover several legal risks that any buyer will likely uncover during a routine due diligence process for the equity or assets of the business. To name just a few that should be considered by sellers:

• Is your business “doing business” in other states or jurisdictions? If so, is it properly registered in those other jurisdictions to transact business?
• Is your business classifying employees properly (e.g. 1099 v. W2)?
• Are there oral agreements in place that should be reduced to writing?
• Is all of the business intellectual property and related property (think patents, trademarks, copyrights, know-how, trade secrets, domain names, etc.) registered and properly protected?
• Are there written agreements that allow the other side to terminate one or more agreements upon the occurrence of a sale transaction or change in control for your business?
• Is the business too dependent on certain customers or vendors (concentration risk)?
• Does the employee policy and procedure manual (or “handbook”) comply with all laws (drug-testing, discrimination, paid time off, maternity leave, breastfeeding accommodations, etc.)?
• Is the business violating any licensing, environmental, or employee benefit, agreements or laws?
• Is the business complying with applicable state and federal regulations (i.e. HIPAA, ACA, FCPA, EAR, ITAR, SOX, etc.)?
• Does the business have adequate insurance coverage?
• Are there franchisor/franchisee issues that should be addressed?
• Are any written consents required for anything being sold?
• Has the business maintained the security of its data legally and effectively?
• If one or more lease(s) are being assigned, are all leases in order for the buyer? If the buyer is assuming one or more leases, are those leases assignable?
• Is the organizational structure in order?
• Are all stock certificates (or membership interests) accounted for and does the stock transfer ledger have any issues?
• Has the business entity complied with all corporate formalities?
• Is the business in default or breach under any agreements?
• Are key agreements assignable?
• Are there any problems with employee benefit plans?
• Has the company completed all required filings?
• Does the company have trailing product liability exposure?
• Does the company have commitments to issue securities that are outstanding or problematic (i.e. stock options, warrants, restricted stock, phantom stock and stock appreciation rights, convertible securities, etc.)?
• Do any of the company’s brochures, websites, or other marketing materials violate any laws?
• Is there any tax liability that may be problematic for the buyer?
• Can the business handle the departure or death of all key equity holders or employees? If not, does it have systems and/or back-up or contingency plans in place if such an event occurs?
• Are there any other issues that could potentially expose the buyer to successor liability?

The list above is only partial. For certain transactions (depending on size, industry, etc.) the list above could easily be ten times as long.

A “de-risk” assessment can help a seller avoid surprises during a sale process, and can uncover potential issues which can be remedied by the seller to make the assets or equity being sold more attractive to buyers. Such remedies may also enhance the value of the business as a going concern and in connection with a sale transaction, thus increasing the “salability” of the business. Good exit plans will consider all opportunities for value enhancement in order to maximize value (i.e. sale proceeds) for the selling entity and/or its principals.