“Ask the Attorney” – Selling a Venture

by Scott Edward Walker on May 12th, 2010

Introduction

This post is part of my “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”  Below is a longer, more-comprehensive version of the VentureBeat post, which provides seven tips to entrepreneurs contemplating selling their venture.

Question

I liked your posts on VentureBeat a few weeks ago about what to watch-out for as a buyer of a business.  What about if I’m a seller?  I’m the founder of a web-based music business, and I’m ready to sell and move onto my next venture.  Any advice would be appreciated.

Answer 

Thanks, below are seven quick tips in connection with selling your company.

1)  Be Careful with Private Equity Buyers.  Private equity firms are in the business of buying and selling companies.  Accordingly, they are extremely sophisticated and savvy and are often represented by large, aggressive law firms.  Indeed, I used to represent private equity firms when I worked at two major law firms in New York City, and I understand very well how they operate.

Deals with private equity buyers are generally more complex than those done with strategic buyers due to, among other things, the level(s) of debt added to the target and/or financial engineering.  Moreover, unlike most strategic buyers, private equity buyers usually require the selling entrepreneur to rollover part of his/her equity into the acquirer (i.e., to maintain skin in the game) and may include a financing condition in the acquisition agreement – which obviously adds a level of uncertainty to closure.

2)  Negotiate the Material Terms in the Letter of Intent.  As I have previously discussed, your strongest leverage as a seller is prior to the execution of the letter of intent (the “LOI”).  This is the time when a solid investment banker will create a competitive environment (or the perception of same), and prospective buyers will be required to compete on price and terms.  One buyer, for example, may offer a higher purchase price, but require a “cap” (as discussed below) equal to such price; another buyer may offer less, but only require a 10% cap.  Accordingly, prior to choosing a buyer, you should negotiate and weigh all of the material terms of the offer, and the LOI should reflect such terms.

3)  Sell Stock (Equity) Not Assets.  As a general rule, you should sell stock, not assets, for three significant reasons: (i) potential tax savings if your company is a “C” corporation (i.e., there will not be “double-taxation”); (ii) to pass the company’s undisclosed liabilities onto the buyer (subject, of course, to the indemnification provisions); and (iii) because it generally requires less documentation and less time to close (which means less legal fees).  Obviously, every deal must be structured with the assistance of competent counsel, including tax counsel; however, as a seller, you should be thinking about selling stock, not assets.

4)  Cap Your Potential Liability.  Obviously, you want to sleep well after you sell your venture (and enjoy the fruits of your labor).  Accordingly, it is critical that certain key provisions be inserted into the acquisition agreement to protect you post-closing.  One such provision is a cap on liability, which, as noted above, should ideally be negotiated in the LOI.  You should strive for a cap of 10% of the purchase price and should also try to minimize any buyer carve-outs.  Your message to the buyer is simple: inherent in any business are certain ongoing risks; thus, once the business is sold, the buyer should only be able to recover a limited amount of the sale proceeds (absent fraud).

5)  Insert a Non-Reliance Provision in the Acquisition Agreement.  Another important seller protection that should be inserted into the acquisition agreement is a so-called “non-reliance” provision, which requires the buyer, in effect, to acknowledge that it is buying the business based solely on the seller’s representations and warranties in the acquisition agreement.  Indeed, such a provision is intended to prevent the buyer from suing the seller based on any oral statements, writings, projections, etc. outside the four corners of the agreement.

6)  Retain a Strong, Experienced Corporate Attorney to Watch Your Back.  This is obviously a bit self-serving, but you, as the seller, need a strong, experienced attorney to watch your back.  There is just too much at stake for you to be (i) utilizing an inexperienced lawyer (such as the guy or gal who formed the company or negotiated the office lease) or (ii) retaining the cheapest lawyer to save money.  Moreover, as the Madoff affair and other recent high-profile cases demonstrate, there are a lot of unscrupulous characters out there trying to take advantage of unsophisticated entrepreneurs.

The bottom line is that a strong, experienced corporate lawyer will sober you and lay-out all of the significant legal risks; he will then push hard to negotiate reasonable protections.  If the sale sours post-closing and lawsuits are filed, well-drafted documents with appropriate protections become a kind of insurance policy.

7)  Get the Buyer to Pay a Termination Fee.  Finally, you should try to require the buyer to pay a termination fee if the acquisition agreement is terminated through no fault of your own.  This is sometimes referred to as a “reverse break-up fee,” which can be as high as 10% of the purchase price or as low as the total amount of the seller’s transaction expenses.  This is an issue that is often not addressed by middle-market sellers, but should be.

Conclusion

I hope the foregoing is helpful.  I currently have two sales of businesses on my plate and, I can assure you, that I am working hard with my colleagues to protect the sellers and make sure that nothing comes back to bite them.  If you have any questions, please shoot them to me through the comments section or via email at .  Many thanks, Scott

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