Pre-Sale Due Diligence as a Part of Normal Business Operations, Part II

May 10, 2021

With the worst of the COVID-19 pandemic behind us, owners can now again hope for a healthy selling climate when the time comes in the future – whether they are ready to retire, cash out and slow down, or sell and find a new venture.  But many owners of small and mid-sized businesses may have little time to consider and plan the strategy for continued growth and transition to an exit.  Lack of preparation for transition to an exit can have a negative impact on achieving a high sales price and successful exit.  This article continues the discussion of our prior article of several years ago. https://www.peroslaw.com/news/pre-sale-due-diligence-as-a-part-of-normal-business-operations/

Many owners end up waiting until the exit is upon them to prepare for the acquisition of their business by a potential buyer.  However, many of the actions needed to prepare the business for a sale are also appropriate actions in successfully operating and growing the business.  A potential buyer will evaluate the business via its due diligence efforts.  Some issues identified by the potential buyer’s due diligence can come as a surprise to the selling owner.  Without adequate time for the selling owner to correct these issues, the potential buyer will likely negotiate a reduced purchase price and other more favorable terms for the acquisition.  Integrating pre-sale due diligence efforts into normal business operations allows the owner to take corrective actions, and allocate associated budget, over a longer period of time.

Assignment of contracts can become quite a burdensome last minute effort.  Many contracts require that the other party to the contract – for example, a customer – give written consent to assign the contract to the buyer of the business.  The seller must contact each third party to get their consent and signature on an assignment of contract.  This can involve a mountain of contracts. As part of the pre-sale due diligence, contracts that require third party consent can be identified.  In some cases, the contract can be amended when the contract is renewed or otherwise modified in some way.  The contract amendment can remove the requirement for third party consent for assignment.

Intellectual property is critical.  The value of a business can be increased by acquiring and protecting its intellectual property.  However, not all intellectual property developed by a business is related to and critical to the business being sold.  As part of the pre-sale due diligence, the owner can identify intellectual property that the owner will exclude from the deal.   This intellectual property can then be sold or licensed to other third parties that are not competitive to the business and the buyer.

Cybersecurity is important.  The potential buyer may want representations and warranties regarding sufficiency of computers, networks and equipment, and privacy and security of customer data.  Owners should consult with their information technology lead or outside advisor to assure industry standards are being followed.

Agreements with employees are also important.  While nearly all employees are likely at-will employees, some employees may have employment agreements for a term.  Other employees may have agreements to earn a commissions and bonuses at year end.  While the owner may not continue with the business, the buyer will want the key employees to make a smooth transition without any disputes over employment terms and conditions.  As part of the pre-sale due diligence, these items can be identified.

The equity ownership of the business is also critical and must be carefully documented.  A potential buyer should not discover that stock certificates and other legal documents related to equity ownership are missing or incomplete.  The owner may also want to consider buying out some of the other equity holders well before the sale.  Some equity holders may agree to a buyout a few years before the sale, allowing the remaining owners to continue to grow the business and eventually receive a larger share of the sale proceeds.

Commercial real estate leases are also important.  The buyer may desire to continue operations at the current leased location.  However, with the increase in remote work during the COVID-19 pandemic, the potential buyer may want to consolidate all employees in the buyer’s current location.  A lease with a modest initial term and options for renewal by the seller may be desirable and could be achieved with advanced planning.

In conclusion, pre-sale due diligence is critical to achieving a high sales price and favorable terms.  Pre-sale preparation and due diligence should be made a part of normal operations of a business.  Issues identified can be resolved more favorably over a period of time, thus avoiding surprises during negotiations for the sale.  The outside advisors of the business can perform many of these pre-sale diligence tasks, allowing owners to focus the majority of their time on running their business.

1 Vasilios Peros is founder and principal of Law Office of Vasilios Peros, P.C. He provides legal advisory and business advisory services to clients across various industries. His practice is focused primarily on business, technology and intellectual property law. He has been recognized as one of Greater Baltimore’s top attorneys, including SmartCEO’s 2016 Centers of Influence, 2015 CPA + ESQs, 2014 Power Players, and Legal Elite in 2011, 2010 and 2009. He can be reached at (410) 274-2053 and VPeros@PerosLaw.com.

2 This article is provided for informational purposes only and should not be construed as a legal opinion or legal advice. The reader should not rely on this article in making business, legal or other decisions on any matter without first consulting an attorney regarding any such decision or undertaking.