Exit Strategies: A Hunt for Hidden Treasure
If you are like many entrepreneurs, your business plan may focus on growth, marketing or product development -- or perhaps just day-to-day survival.
Increasingly, however, clients are asking us what they can do now to plan for an eventual acquisition or other business succession event. Here are 10 steps to consider:
1. Begin assembling your Exit Strategy Team. Now is the time to put in place the right outside advisors to help plan a long-term exit strategy. This includes a good CPA, transactional attorney, M&A advisors and perhaps a valuation professional. Ask your CPA to begin preparing audited or reviewed financial statements and to put in place rigorous systems for financial reporting and fraud reduction. To the extent you feel comfortable, begin bringing your internal management team into the loop as well (e.g., your CFO, HR Director, etc.).
2. Whether or not you have a formal board of directors, it may be advisable to initiate an informal advisory board. This is typically a non-fiduciary, non-governing committee of industry peers and professional advisors.
3. Begin identifying and appropriately documenting valuable intangible assets, including intellectual property (patents, copyrights, trademarks and trade secrets), employment agreements, non-disclosure agreements and restrictive covenants. Start viewing contracts, leases and technology licenses as valuable assets. For example, do your best to make sure your lease has renewal and expansion options and would be freely transferable in an acquisition. Also, make sure that agreements address ownership and transferability of copyrightable work product.
4. Work toward customer and employee retention. Purchasers increasingly seek assurances that customer and employee relationships will continue uninterrupted after the closing.
5. Make sure that stock ledgers and transfer records are complete and up-to-date and that shares have been properly authorized by board action and paid for. You should be able to demonstrate a clean "chain of title" for your company's equity.
6. Consult with your insurance professionals as to whether or not optimal insurance is in place (including liability, business interruption, errors and omissions insurance).
7. Work with an HR professional and employment law counsel to ensure compliance with employment laws, including ERISA, OSHA and equal employment opportunity compliance. Put in place effective employment policies, and do your best to have discharged employees sign termination agreements releasing your company from any claims.
8. Consider spinning off company division into separate legal entities. This may increase total value, diversify risk, cause more accurate financial reporting and allow you the opportunity to retain part of the business.
9. Consult with your tax advisors as to whether your company is the optimal form of legal entity for an acquisition. For example, a C Corporation may not be the best choice of entity if you expect to be acquired. The double taxation associated with an asset sale may limit the options for structuring the acquisition. It may be time to convert to a pass-through entity, such as an S corporation or LLC.
10. Consider having a formal business valuation prepared. A valuation will consider various elements of business value, including operational, intellectual property, organizational/management structure, nature of contracts and outside factors (e.g., competition, regulations, market trends, etc.). This can identify strengths and weaknesses in a business which you can begin addressing now.
11. Review a customary set of representations and warranties you would expect to find in a purchase Agreement, and see how your company would measure up. Investors are increasingly risk-averse. You will eventually have to step up to the plate by making strong representations and warranties in a Purchase Agreement. This can be like walking through a minefield in snowshoes if you are unprepared. You should be prepared to disclose everything about the business, "warts and all".
12. Finally, ask your M&A advisor or attorney for a standard acquisition Due Diligence Checklist. You will be presented with such a checklist by your eventual buyer. This can provide a useful guide in outlining your exit strategy now. Common "warts" that turn off investors include:
(a) Current Litigation or history of Litigation
(b) Employee and Labor Disputes
(c) Government Investigations
(d) Poor Financial Statements or Financial Reporting
(e) Incomplete or Inaccurate Corporate & Stock Records
(f) Tax Audits and Tax Controversies
(g) Securities Violations or Investigations
(h) Intellectual Property Infringement by
(or against) the Company
(i) Insufficient Documentation of Intellectual Property
(j) Benefit Plans not in Compliance with ERISA
(j) Inconsistent Cash Flow; Aging Receivables
(k) Non-Assignable Contracts & Leases
(l) Environmental Issues
(m) Insider Transactions; Conflicts of Interest
(n) High Employee Turnover
(o) High Customer Turnover
Above all, view the exit strategy planning process as a worthwhile and even an enjoyable exercise. You may be surprised at the hidden treasures you unearth.