Education technology entrepreneurs and investors who have worked hard to build their company often look forward to selling the company as a means to “monetize” their ownership stake and achieve financial liquidity. While there are many critical times in a company’s life where value can be created or destroyed, the importance of the “end game” – that is, the successful execution of the sale of the company – should not be underestimated. What follows is a list of 15 key legal issues that should be considered when exploring, negotiating and closing a sale transaction. In future blog posts, I will delve into more detail on each of these issues, providing advice on how best to address them.
- Process – will the seller find a buyer by itself, or will it use an investment banker? What will the banker’s retainer and success fee be? What will the length and terms of the compensation “tail” be if the company is sold after the banker’s engagement terminates? Will the seller, whether through a banker or directly, try to use a formal “auction” process?
- Due Diligence – is the seller ready for a potential buyer’s due diligence? Has a document data site been prepared? Have potential legal, tax and accounting problems been identified and addressed?
- Term Sheet Negotiation – how detailed will a negotiated term sheet be? Will it be signed? Will there be an exclusive negotiation period? What key issues beyond the purchase price will be addressed in the term sheet?
- Basic Economics – besides the amount, what will the form, timing and certainty of payment be?
- Earn-Out – if the sale price includes an earn-out, what will the earn-out conditions be, and how much influence will the selling owners have over whether those conditions are met?
- Closing Adjustment – will the purchase price be subject to upward and/or downward adjustment at closing based on the working capital level at closing relative to a target level? How will non-monetary working capital elements, such as tax assets and deferred revenue (based on the unrecognized portion of SaaS subscriptions, for example), be treated? How will the target working capital level be set?
- Taxes – is the seller an ‘S’ corporation, a ‘C’ corporation or an LLC (limited liability company)? How will the proceeds received by the seller be taxed? Will there be two levels of tax (i.e., at the corporate level and, upon distribution to the owners, at the owner level)? Will the seller’s owners benefit from capital gains treatment or ordinary income treatment? Will the seller’s owners benefit from a partial capital gains exclusion due to owning “qualified small business stock”?
- Structure – will the transaction be structured as a sale of assets, a sale of shares by the owners, or a merger? What are the legal and practical consequences of the structural choice? Will all owners agree to the sale or will some owners be forced to sell and possibly unhappy with the sale?
- Ongoing Ownership – will all or any of the seller’s owners continue on as owners of the buyer? Will such ownership come from rolling over their interests in the seller or from new equity grants from the buyer? What protections will ongoing owners have with respect to their ownership? Will the ongoing ownership be required of some or all of the seller’s owners or be optional for them?
- Employees – will the executives and employees of the selling company continue with the buyer? What will their positions, compensation and benefits be? Will they have employment contracts that provide for severance and other contractual advantages?
- Closing – how certain is it that the closing will occur? Will the closing be simultaneous with the signing, or subject to some conditions being met after signing? How restricted will the seller’s operations be during the period between signing and closing?
- Consents – will consents to the sale be required from landlords, customers (including states and districts), licensors, suppliers or other parties? If so, how much lead time will be required to get those consents?
- Representations – will the seller’s representations be limited or extensive? To what extent will they be subject to the seller’s knowledge rather than absolute? Will the seller be liable for unknown intellectual property infringement or ownership issues?
- Indemnification – how long will the buyer’s right to indemnification survive? Will there be a “basket” and “cap” and, if so, how large will they be? What exceptions will there be for the basket and cap?
- Escrow – will there be an escrow to back up potential indemnification obligations? If so, how large will it be and how long will it be held?
Clearly, this list is not exhaustive of all legal issues that must be considered when working on a company sale, but in my experience the 15 items above are the most important ones that business people should focus attention on to ensure that they understand and have carefully considered them before decisions are made or negotiations finalized. In the company sale context, the adage “let the buyer beware” applies equally to the seller. Let the seller beware, lest they find the value they worked so hard to create be needlessly diminished.
Please share your experiences selling a company or ask any questions you may have regarding the issues described above.