Ten Things to Do Before You Sell Your Business

For many owners of small businesses, the business represents their most valuable asset. Not only does the business provide much of the family’s income, but it also the assets which will fund the founder’s retirement and any wealth to be passed onto future generations. Very few family businesses survive the death of the founder. In most cases, the business is sold by the founder. The decision to sell the business, for many business owners, is the key step to funding retirement, or to fund the estate planning.

Many owners of small businesses will have only one chance to sell their business. Just as a homeowner would not list his home without taking steps to make it as attractive as possible to buyers, the business owner needs to take steps to make the business attractive to potential purchasers. Having a business with a successful history and good prospects is an important sales factor, but by itself will not command the best price. In addition to having a good business, its important to take steps to make the legal structure of the business efficient, appropriately document the business’s legal relationships with its employees, vendors and customers, and fix existing or potential legal or tax problems.

Following is a brief list of ten steps that a business owner should consider prior to trying to sell a family business.

  1. Does the Tax Structure of the Business Need to be Changed? Most closely-held businesses are formed either as corporations or limited liability companies, and they elect to be taxed as S corporations or partnerships. The advantage of either S corporation or partnership status is that the income and losses are passed through to the owners of the business, and not taxed to the business as a separate entity. In contract, the income of a C corporation is taxed once at the corporate level, and a second time when the income is distributed as dividends. If the business was organized as a C corporation, the feasibility of changing to an S corporation or LLC is something that should be examined long before a sale is contemplated. Although there may be some costs associated with the change, with the current depressed value of assets, it may be timely to consider whether the costs of converting to an S corporation or an LLC taxed as a partnership may be justified by the tax savings on sale of the business.

  2. Consider Transferring Part of the Business to Family Members. Gifting programs can be an important part of planning for a future business sale. Before the business has substantially appreciated in value, interests in the business can be given to children or grandchildren through trusts and similar entities. Any appreciation in value of the business after the gift is transferred to the recipient, without gift tax cost to the donor. Furthermore, because the gifts usually consist of minority interests with limited control rights, valuation of the gift may be discounted. As a result, it may be possible to transfer significant value to children and grandchildren over time, without incurring gift or estate taxes. The earlier in the business’s life such gifts are made, the more value can be transferred out on a tax-advantaged basis.

  3. Consider Making Gifts to Charities. For business owners who are charitably inclined, there are a number of techniques to make charitable contributions of appreciated interests in the business. Such gifts may include a gift of the stock of the business prior to its sale. Not only will such a gift avoid recognition by the owner of some of the taxable gains from the sale, but the charitable deduction will ordinarily be for the fair market value of the stock. In addition to outright gifts of stock, stock may be used to fund charitable trusts (such as charitable remainder trusts) which provide the donor with a charitable deduction as well as income during life.

  4. Are Your Business Records Well-Organized? Before closing the purchase of a business, buyers conduct their due diligence of the business, its financial results, its assets and operations, and its liabilities. An essential part of the due diligence is review of the company’s accounting records and audits, loan and financing documents, contracts with its suppliers and customers, owned and leased real estate, permits and licenses, benefit plans offered to employees, insurance, income and sales tax returns, and the company’s intellectual property. The buyer will usually present a detailed due diligence request immediately after a letter of intent is signed. It is important to be able to respond to the due diligence request in a timely and comprehensive manner. Buyers are impressed with a seller that is able to provide the requested information in an organized and comprehensive manner. In contrast, sellers who are unable to provide the requested information in an organized manner, or who dribble it out in disorganized bits and pieces may leave the buyer with an unfavorable impression of the quality of the business. Raising such concerns in the mind of the buyer can make the process take longer, or may decrease the price that the buyer is willing to pay. The sales process can be made more efficient by assembling the due diligence materials well in advance of having a transaction in place. An attorney who is experienced in business sales can help identify and organize the due diligence materials that are likely to be requested.

  5. Do You Need Confidentiality or Non-Compete Agreements With Employees? If the business has trade secrets, confidential customer or supplier lists or other confidential information which gives the business an advantage over its competitors, it is important to protect that information. For that reason, it may be advisable to require employees with access to confidential information to enter into an agreement requiring them to maintain that confidentiality. In addition to confidentiality agreements, the business may have to take other appropriate steps to protect confidential information, such as labeling materials as confidential, restricting access to such materials, and the like. In some businesses, it may be appropriate to ask employees to enter into non-competition agreements. These agreements may be very important to potential buyers. Buyers want to know that when they buy a business, its confidential information will not be used to compete with the business they are buying.

  6. Are there key employees that a buyer will need to retain? Many businesses have key employees who, although not owners, are critical to the success of the business. If key employees become concerned about the possibility of a sale, they may look for opportunities elsewhere. Accordingly, it is important to keep such employees fully engaged in the business and available for the buyer upon the sale. One way to do this is to enter into retention agreements with such employees which provide them with a “stay bonus” if they continue to work towards a sale, or a success bonus if they continue to be employed through the closing. Such bonuses may be conditioned upon the key employees’ willingness to continue employment with the buyer after the sale.

  7. Have You Protected the Business’s Intellectual Property? Many businesses have intellectual property, such as patents and trademarks, trade names, and domain names. Long before considering a sale of the business, the owner should think seriously about what kinds of intellectual property is important to the business, and how should rights to the intellectual property be protected. Protections may include patent, trademark of copyright protection, or reliance upon maintenance of confidential information as a trade secret. It may also be important to conduct a survey of the business’s technology and trade names to identify potential infringements of another business’s rights, or potential infringers. If issues with a business’s intellectual property are identified prior to a buyer enters the scene, the seller may be able to fix problems and take steps to protect important intellectual property . If these issues emerge later, as a buyer is conducting its due diligence, the problem may have an effect on the buyer’s willingness to enter into the transaction, or the price the buyer is willing to pay.

  8. Are Your Business Contracts Assignable? As part of a buyer’s due diligence review, the buyer will want to know which contracts are not assignable, or are assignable only with the consent of the other party. Sellers should be mindful of this issue before a transaction is before them. In general, most contracts are assignable, unless they provide that they are not assignable. Most contracts, such as leases, have provisions against assignment. When negotiating a contract, therefore, the seller may want to ask the other party to agree in the assignment provision to accept assignment to a successor to the business, or for provisions to make getting consents to the assignment easier. Since the buyer will often look to the seller to provide the third party consents to assignment, laying the groundwork to get those consents may save the seller time and money in completing the transaction.

  9. Does the Business have Multiple Owners? If So, Will They Be On Board With a Sale? Even with a controlling interest, a majority owner may not be able to force minority owners to go along with a sale of the company. It may even be possible for a minority owner whose approval is required to make the sale to extract concessions from a majority owner as a condition to approving the sale. To avoid this problem, it is common in shareholder or operating agreements to have provisions which require a minority owner to “tag along” with the majority owner in a sale transaction. There may also be provisions which permit a majority owner to buy out the interests of an uncooperative minority owner. It is important that such agreements be in place prior to the time a potential buyer comes into the picture.

  10. What About Tax and Regulatory Compliance? As part of a buyer’s due diligence, the financial and tax records of the business will be examined. An important step in planning for a future sale is to make sure that the business has complied with its tax obligations. It may be advisable to engage tax advisors to review the company’s income tax, payroll tax , sales tax and other filings and procedures to identify and address any potential issues. Issues that frequently come up include employee/independent contractor classifications, the tax status of the company’s employee benefit and retirement plans, and the company’s sales and use tax compliance. In addition to tax issues, it is important to confirm that the business maintains appropriate employee records, including records of its confirmation of work eligibility of it employees. Manufacturing operations or businesses that store potentially hazardous materials may find it advisable to have an environmental consultant review the company’s operations and permits. In any regulated business (such as healthcare, insurance or banking) it may be valuable to have a consultant review the business’s licenses and permits in the context of its operations to confirm that appropriate licenses are in place and active.

In business, anticipating problems and opportunities is a key ingredient of success. In the sale of a business, anticipating the problems that may arise in the sales process and coming up with plans to resolve them is a key ingredient to a successful transaction. Many of these steps have the greatest benefit when taken early in the life of a business. Others may be taken just prior to starting the sales process. As with other aspects of business life, careful preparation with the right tools can increase the chances for a successful transaction. This is no less true in the most important transaction a small business owner may have – the sale of his business.