How to Prepare for a Sale of Your Business

David Jahnke, Katz Teller

If you are in the beginning stages of selling your business, this article will help you prepare for what is to come. During any sale or merger of a company, the buyer—as a condition to close the deal—will typically require the seller to provide all of its records, contracts, and financials. The buyer, along with its counsel, will go through every document with a fine-tooth comb. This process is known as “due diligence,” and it is often the most strenuous and maddening part of any transaction. Through the due diligence process, the buyer and its counsel are trying to uncover any potential red flags of the seller. For example, if the seller is a defendant in any pending litigation that could result in a material adverse effect to its business, the buyer should discover this fact during the due diligence process. To make this process as painless as possible, the seller will need to be extremely organized, and will need to understand several business issues that are vital to any buyer.

In most transactions, time is of the essence because the buyer wants to purchase the seller’s business as quickly as possible. Thus, it is important for the seller to be orderly so that the transaction is not unnecessarily delayed. However, it is also important for the seller to protect its proprietary information from becoming public; thus, before the seller discloses any information to the buyer, it will seek a confidentiality agreement with them.

A selling company should start the organization process by assembling its financial statements. The buyer will want to review all of the seller’s balance sheets, income statements, and cash flow statements from the last five years so that it can have a clear understanding of the seller’s financial health. These financials will help the buyer determine a purchase price for the transaction, so the seller should have the financial statements audited or reviewed by a third party auditing firm before providing to the buyer.  

After assembling the financials of the company, the seller should then compile all of its current contracts. Buyer and its counsel will review every seller contract to determine whether the contract: (1) requires third party consent for transfer and/or (2) is important to the business moving forward. This might require some digging on the seller’s part, but it is crucial that the buyer has access to all seller contracts.

Other due diligence items that the buyer and its counsel will likely want to review relate to the seller’s: (1) intellectual property, (2) current insurance policies, (3) litigation, (4) tax returns from the last five to seven years, and/or (5) employee handbook.

In almost every transaction, the potential buyer will want to know if: (1) the seller protects its intellectual property and trade secrets; (2) the seller’s key employees are bound by restrictive covenants, so such key employees can’t compete against the buyer directly after the transaction; (3) the seller’s employment practices are compliant with state and federal labor laws; and (4) the seller’s employees will stay on with buyer after the transaction. In order to be the most marketable to a buyer, the seller must answer “yes” to each of these questions. A buyer will be hesitant to purchase any business that answers “no” to one or more of these questions. If necessary, the seller should take remedial actions before the due diligence process to ensure that the seller can answer “yes” to the above questions. These issues can make or break any transaction.

For any company looking to sell its business, the transaction process can be overwhelming. However, if you start by organizing all of your company’s records, contracts, and financials, and have a good understanding of common business issues that arise in most transactions, the transaction process will become a lot smoother.