Notwithstanding the slower economy and weak venture capital and stock markets, Nevada is loaded with highly successful family-owned businesses approaching critical decision points. These decision points may arise from shifts in management or ownership to the next generation, retirement, need for capital to expand or remain competitive, or desire to diversify the family assets by cashing in all or part of the ownership, among numerous other possibilities. Many of these business owners have worked with legal and tax advisers to plan their estates. While this is important, far fewer seem to have taken steps to prepare their businesses for a possible corporate transaction – whether a sale, merger, private financing, initial public offering, or even a major debt financing. Even if these possibilities seem remote today, a few steps today can save much time and money in the future.
Whatever your business, an astute buyer or financing source will be looking at many of the same items. While the emphasis will change depending on the nature of your business, much will be the same. While a buyer of a computer software company will be looking at intellectual property and a buyer of an apartment complex will be looking at real property, they both usually will want to be sure who really owns the asset and how much it has earned the owners in the past. With this in mind, the following is short list of topics for business owners to think about, with the importance varying depending on the particular business.
Who owns the company?
This is not a trick question. Most businesses are held by a legal entity, be it a corporation, limited liability company, partnership or other. How are the ownership records? This is generally an area in which perfection or near-perfection typically is required. Buyers, underwriters, or other financing sources are willing to take risks, but rarely on who owns what they are buying. There should be a clear and concise ledger of all owners and the number of shares or other units of their equity, who they acquired the shares from, and records of the circumstances of sales or other transfers. Is it clearly documented that the transactions were exempt from registration under both federal and state securities laws as a private placement or otherwise? Were all required filings made?
There are also more subtle issues which can arise. If there are agreements or even letters or other proof that shares were offered to anybody, this can cause a problem. A large corporate transaction can attract people even from the distant past who may make a claim to part-ownership if they see there is a chance at getting part of the money. Stock options or other employee stock plans need to be well documented. Careful records of grants, exercises, terminations and other transactions need to be maintained. Even if a former employee or former partner has only a very marginal claim, under the pressure of trying to complete a transaction, many business owners will pay at least a nuisance-value settlement to avoid risking the deal. What may be cheap or even free to fix today, may be costly when you are trying to do your once-in-a-lifetime corporate deal.
Does the company own its assets?
Again, not a trick question. Many issues can arise which can spook a buyer or investor. As noted above, buyers of software or other information- technology companies are typically very interested in whether they can commercially exploit the intellectual property free of risk of infringing rights held by others. Similarly, they will want to know whether they can stop others from using the rights they are looking to acquire.
A detailed analysis of the comparative efficacies of trade secrets, copyrights, patents and other devices to document and secure ownership of information technology is beyond the scope of this article, but the question to ponder is whether you have thought about it. If intellectual property is a key component of the value of your business, this is a topic you should address with an expert. Even if you developed all your intellectual property without assistance, do you have the records to confirm that? If your products or services incorporate or use computer software or other intellectual property of other persons, do you have adequate licenses that cover both the scope and level of your use, and are the licenses current and paid up?
Recurring issues involve the rights of employees or consultants who develop intellectual property. They should enter carefully prepared work-for-hire, confidentiality, and related agreements to ensure they have no rights to the intellectual property. If they are paid for their services, then you do not want to have to pay them again to sign the right papers in order to get your corporate deal done.
Even if your company is not intellectual-property intensive, you may have names that are valuable to your business. Have you made the appropriate tradename, trademark and servicemark filings with the appropriate federal and state agencies?
Hard assets, whether personal property or real property, may involve less intellectually challenging issues, but may nonetheless raise problems which could affect your ability to do your corporate deal. If equipment is a key component of the value of your deal, do you have the papers to establish ownership, such as a bill of sale? If you acquired the equipment under a lease with an option to buy for a dollar at the end of the term, did you remember to send in the dollar to receive the bill of sale? If you bought the equipment with financing that is paid off, did you receive a release, cancelled note, etc. and were the appropriate UCC termination statements filed in the appropriate state offices?
Real property can raise similar ownership issues but these are often, but not always, discovered during the process of obtaining title insurance. If real property is a key component of the value of your business, an experienced real estate lawyer should review the exceptions to title when you bought the property to advise you on what may cause problems to a subsequent buyer.
Does the company exist?
A fundamental but often overlooked point is whether your company exists. Even if you filed all of the right papers when you organized the company, there are annual fees and filings to maintain its existence. Also, there should be at least annual minutes, elections and other corporate formalities maintained to ensure your entity and the limited liability it affords the owners will be recognized. Corporate directors or the equivalent should approve significant matters, and the company’s bank accounts and other assets should not be commingled with those of the owners. Buyers will generally review the minute books and other corporate records for serious problems. Unlike other areas, some of this can be fixed retroactively, so long as a problem does not arise beforehand. However, it is safest and most efficient to maintain good corporate records and formalities.
Are you permitted to sell?
Even if you fulfill the above requirements, there may be other legal impediments to doing your corporate deal. Private and governmental parties may have the right to veto your deal or may be in a position to exact a toll charge for you to complete your voyage to financial security.
Loan agreements, commercial leases, major intellectual property or similar license agreements, and other significant agreements often have restrictions against transferring to third parties. This is more of a concern with a sale of a business than with a private or public financing in which the same owners retain control of the business. However, even in the case of a financing, “change of control” provisions may prohibit the sale of more than a very small percentage of the total ownership. If a possible corporate transaction is in your future and you have any bargaining power on these agreements, try to eliminate or minimize these restrictive provisions. Even if you lack the bargaining power to do that, at least try to include a provision that approval to a transfer will not be unreasonably withheld. Also, it is important to be in compliance with the terms of your key agreements, because you do not want to be surprised with allegations of default when you start to talk to your landlord, lender, or licensor about your corporate transaction.
Also, if your business is subject to any government regulation at the federal, state, county or city level, you may need permission to transfer the business or the licenses that are required to operate the business. This can require background checks of the buyers and their owners and managers, as well as filing fees and waiting periods. Do you have all the necessary licenses? Are they paid up and is the information supplied to the regulators up to date? In Nevada, many businesses are either regulated directly under gaming laws or affected by such laws indirectly because of their dealings with regulated companies.
Even if your business is not in a heavily regulated industry, the nature of your corporate transaction may require filings, filing fees and governmental approvals. If you are selling a business for more than $50 million, you and the buyer may need to make Hart Scott Rodino filings with the Federal Trade Commission and the Justice Department. This is a pre-clearance process to detect antitrust problems which may arise from the transaction. Of course, if the government believes your deal results in too much concentration of market power, it can challenge the transaction and seek to enjoin it. Even in the absence of a problem, if the filings are required, they are cumbersome and there is a significant filing fee.
If you are contemplating an initial public offering, an extensive document called a registration statement must be filed with the Securities and Exchange Commission (SEC) along with the required filing fees. The key part of the registration statement is the form of prospectus that must be given to potential investors. The staff of the SEC reviews and comments on the registration statement, which must be amended to meet the staff’s comments before it clears the registration statement and the shares can be sold.
Can you show that your business is making money?
Even if all of the legal issues fall into place, buyers or investors often want to be sure your business is profitable. Good financial records are essential. If you want to go public, annual audits and unaudited quarterly financial statements are necessary. In addition, you are required to have records and a system of accounting and corporate controls suitable to produce financial statements in accordance with generally accepted financial statements. Such financial statements will also be required if you are being acquired by a public company and the acquisition is financially significant to the public company under SEC rules.
Even if your deal is completely private, the buyer typically will want to thoroughly review financial records. While annual audits by a reputable accounting firm tend to inspire the most confidence (notwithstanding some well-known auditing busts), annual reviews can also be helpful. There is no substitute, however, for clear, complete and accurate records and systems that ensure high quality recordkeeping. Unless the buyer is simply interested in acquiring certain of your assets to fit into its existing business, the profitability of your ongoing business will be of keen interest to a buyer. It will pay less or walk away from the corporate transaction if earnings, cash flow and other entries on the financial scorecard cannot be established with sufficient confidence.
Tax is another area to be addressed regularly. While there is nothing wrong with minimizing taxes with legitimate tax planning, if you are planning to sell or finance your business one day, overly aggressive tax maneuvers can create tax risk to a buyer that can limit your flexibility in structuring a sale or even jeopardize the corporate deal.
What about the employees?
Don’t forget the employees. Many buyers and investors will also have interest in this area. Do you have employment agreements locking up key employees? Even if you do not think such agreements are necessary or feasible, have you considered at least a non-compete agreement covering a modest period after termination? Are there contractual severance arrangements that should be reviewed? Are there any implied or oral commitments that could surface if a buyer wants to make a change? If there are employee-benefit plans such as pension, 401(k) or even health or dental coverage, have appropriate filings been made under ERISA? Have all the terms of the plans been complied with? Collective bargaining agreements can also raise a host of compliance issues and concerns upon a corporate transaction, such as gaining possible union approval. Finally, note that mass layoffs or facilities closing may require prior notice to employees under the WARN Act.
Do you have international operations?
Even the transfer of modest foreign operations can raise a host of issues in the foreign jurisdiction, ranging from competition law filings and approvals, employee notices and approvals, foreign exchange approvals, dealer or distributor protection laws and various other governmental approvals. You should confirm that all your foreign registrations and licenses are up to date and any foreign subsidiaries remain in existence. These issues must be approached on a jurisdiction-by-jurisdiction basis.
These are just a few of the topics you should begin thinking about if you contemplate a corporate transaction, even one fairly far into the future. This is a not a comprehensive list and – as noted above – each business will have its own special areas of concern. However, you can save time, money, effort and worry by addressing some mundane details today before they become potential deal-killers tomorrow.
