In this episode Elizabeth Lee, who heads up our Commercial Law and Acquisitions Division at Aspect Legal, joins us to talk about some legal tips to prime businesses for market. With an MBA degree and decades of experience advising businesses, Liz certainly brings a wealth of experience to today's episode.
01:48 Importance of preparation
03:39 The right structure for sale
07:04 Locking in the value of your business
14:05 Getting ready for due diligence
16:26 Consequences of failing to prepare
18:04 Four key action steps
20:18 Quick recap
JOANNA: Hi, it’s Joanna Oakey here and welcome back to The Deal Room podcast!
Today, we’re discussing the legal elements in preparing for the sale of a business. This area is relevant not only to business owners and managers of businesses gearing up for exit, but also for accountants, brokers and other advisers working with businesses in this area. In getting a refresh of the legal items that need to be thought about well before a sale, so as not to slow down the sale process once it’s kicked off.
Now in upcoming episodes, we’ll be looking at other elements of preparing a business for sale and we’ll be talking to business owners and managers who’ve been through the sale process to understand what issues came up that they weren’t expecting. But for now focusing in this episode just on the legal items, we have on board our resident M&A expert Elizabeth Lee, who heads up our business sale merger and purchase division at Aspect Legal.
Liz is a commercial lawyer with an MBA degree who has advised businesses for almost two and a half decades so she certainly brings a wealth of experience to today’s episode.
LIZ: Hi Jo!
JOANNA: Thanks for joining in. Great. Ok so let’s talk first about why is it important for businesses and advisers who deal with businesses to understand why they should be preparing themselves in advance for a sale coming up.
Importance of preparation
LIZ: Well when you’re selling a business Jo, I think you want to give the business confidence that the purchaser confidence that you know as a seller you know your business inside out and not only that you’re well organized, you’re prepared and the purchaser will not come across any issues and problems after they purchased.
JOANNA: Yeah, I mean that’s the thing, isn’t it? We see this a lot when businesses enter into the sale process and get to that point of due diligence, and we’ll probably in future episodes talk specifically about due diligence as well. But get into this due diligence process if at that point they start to see holes or risks or things that they weren’t expecting at that point, it can have a major derailing impact on how the transaction flows or indeed whether the transaction continues at all.
LIZ: Yeah, that’s right. I mean it slows down the parties, there’s opportunity for the purchaser to try to renegotiate price because of concerns and so forth, you know, and really you want to try and avoid that by being prepared before you put your business on the market.
JOANNA: Absolutely. So I think it’s certainly true to say that early preparation helps with the sale price as well as reducing those issues during that due diligence process.
LIZ: That’s right. And it helps speed up the transaction too.
JOANNA: Absolutely it does. Great. Okay. All right. So there are all the reasons why we might want to prepare early. So maybe let’s now launch into what the things are the businesses should be considering in terms of getting themselves sale ready. So I guess the first area that I often think of is business structure. Is it the right structure for sale?
The right structure for sale
JOANNA: I’ve seen in the past examples of high value sales or multimillion dollar sales where the structure was inadequate and leaves business owners then in the position where they’re paying more tax, much more tax than needed to. You know, I’ve seen instances where business owners have paid millions more in tax than they need to. So I guess business structure right from the beginning is an important element for businesses to think about.
LIZ: Yes, correct because I think that there are different concessions available, tax concessions, as to whether you sell shares in a company or the business depends on the circumstances of the vendor too, as to why they’re selling. So I think consultation early with the accountants so that you know exactly what structure you want to present to the buyer in the most financially efficient manner is important.
JOANNA: Absolutely. Fabulous! Okay, so business structure is super important. And I guess also understanding the structure of the sale or the potential ways that a sale can occur. Because quite often we have as you rightly said Liz, we can be selling the assets or the shares or full business, but I guess our other way of structuring transactions is whether or not when you’re looking at selling you would be considering things like earn outs or deferred payments because all of those can be really important considerations.
LIZ: Yeah absolutely. Exactly.
JOANNA: And sometimes I find that sellers are really scared about the concept of deferred payments and earn outs, which is understandable, we sometimes spend a lot of time negotiating.
LIZ: Yes, that’s right because they’ve sold their business. They’ve given control of their business to the buyer but yet they haven’t received the full consideration.
LIZ: And not only that they’re not running the business anymore. And so to have an earn out based payment where you can’t control how the earn out occurs. That’s very risky for the seller.
JOANNA: Yeah. And then on the flip side though sometimes that can garner high value and increase a potential pool of buyers. So I guess the tricky thing is always in sort of understanding what the risks and potential benefits are in looking at some of these alternative approaches for structuring a sale.
LIZ: Yes, correct.
JOANNA: So it’s getting the advice again once again isn’t it? Speaking to your lawyers and your accountants and your brokers who are expert in this area so we can help guide you in relation to what the options are and what they mean at the end of the day.
LIZ: And to maximize your return, right. And so if you are going to go down the path of earn out be very clear to the vendor as to well what are the conditions that should apply during the period of the earn out. And so if you’re clear about that upfront you spend less time haggling and negotiating it because you’ve already agreed upfront commercially.
JOANNA: Absolutely. Okay great. So I guess then the next area that businesses can look at in preparing for sale is really considering what the value is in their business and how to lock in those elements. What are some of the areas I guess is that we see where value really sits for many of our clients in their businesses?
Locking in the value of your business
LIZ: Well it depends on the business, doesn’t it? I mean for some businesses it could be the client contracts that are really valuable. For some businesses there some key staff that’s valuable you know. Maybe that it’s the staff that’s the value in the business or it could be IP, could be location off the premises, you know, it could be any of those things.
JOANNA: So and so I guess it’s looking at each of these areas. So maybe firstly in relation to IP, it’s a good point you’re raising that, IP can be critical sometimes to a business. So the question is how has a business recognized and protected all of the IP within their business? So IP can come from brand protection so trademarks protecting the business brand which can sometimes be really important to buyers that we’ve seen?
LIZ: It could be the business name that has a lot of value out in the market.
JOANNA: And it can also be I guess other areas that might have intellectual property value to a business, so staff manual, training manual channels advertising material. So it’s all about identifying these things and ensuring number one that they’re protected when they can be say for example through trademarks, but also that the chain of title I think is established and that’s a really important one because sometimes we see businesses that have intellectual property created say for examples by suppliers or contractors and they haven’t had it in place documents that accurately or fully show their ownership that the ownership has been assigned to them from this intellectual property that’s been created by contractors and other service providers down the line.
LIZ: Yes, absolutely. Particularly in relation to perhaps any specific applications or software that a business has developed and they outsource to someone overseas to develop their software for them where’s that make sure that there is document that properly vest the IP in them.
JOANNA: And because often if it’s been created now, but you’re looking at selling your business in five years’ time and then suddenly in five years’ time you find that a buyer wants to have confirmation about the chain of title in relation to this intellectual property, it’s too late for you to go back and find the supplier and get that assignment. Or indeed they may want a high hefty price for assigning it at that point.
LIZ: Or you end up having to give indemnities that in relation to it in case any issue arises in the future which means that as the seller you take on the risk.
JOANNA: You’re bearing that risk and taking that on into the future, that’s absolutely right. Yeah. All right. So and I guess sometimes the supplier contracts you know they might sometimes be key supplier contracts that are important to lock in which is less often than like contracts but it can be the case. And I guess with these key supplier contracts one of the things that is important for you to be thinking about when you’re entering into these agreements as a business owner even if you’re not likely to sell for the next few years is the types of risk clauses that sit in these contracts because they’re the sorts of things the buyers will be interested in when they’re looking to buy a company. The risk clauses that you’ve signed up to with client and supplier agreements.
LIZ: That’s right. The extent of indemnities that you’ve given or the extent of guarantee including personal guarantees that you might have given.
JOANNA: Absolutely. And that’s an I guess on the personal guarantee side once again, businesses should be ensuring that a number one aren’t giving personal guarantees or number two recording any personal guarantees that they’ve given so that when it comes to the point of sale they are absolutely aware of which personal guarantees need to be released through that sale process.
JOANNA: All right. And I think the other areas you talked on are really relevant as well the lease. So location, locking in location, what can business owners do to lock in their location in their lease?
Locking in location for lease
LIZ: So making sure that you’ve got a secured lease essentially that there’s an appropriate term with appropriate option to renew, the lease is registered, just to make sure that you’ve actually got an ironclad tenure on the premises.
JOANNA: Absolutely. Yeah. And then and I guess staffing is also a relevant area in terms of locking in the value of the business. And obviously retention of staff is always relevant to business owners anyway, but particularly if you’re gearing up to sale. Retention of staff issues is something that’s important for business owners to think about.
LIZ: Yeah. You want to make sure that there’s appropriate provisions in your staff contract with regard to there being confidentiality clauses, some appropriate restraints and investing of IP that they’ve created throughout their period of employment. That’s all really important to make sure that they are in place because if a purchaser comes in and sees that the employment contract doesn’t quite protect the business sufficiently then there’s extra work to be done to satisfy the purchaser in due course.
JOANNA: Absolutely. I mean they’ll be really concerned to make sure that staff don’t have the ability to run off and take the client base with them.
LIZ: And also with some businesses who have a large force of contractors or casuals, as a vendor you’ve got to be very careful to ensure that you know what your legal obligations are in terms of accruing the right amount of long service leave and so forth. And yes, casual staff can have entitlement amount to long service leave. And so you’ve really got to make sure that all that is properly provisioned for, otherwise you’re going to be looking at a discounted sale price.
JOANNA: And we’ve certainly seen in the past quite a few examples of issues that have been caused when buyers take concern or potential buyers, prospective buyers take concern with organizations that have a large level of contractor-based personnel as part of their staff.
LIZ: Yes. Yes. When the arrangements with the contractor staff isn’t set up appropriately to minimize risk.
JOANNA: Great. OK. All right so I think that’s a good summation of the areas of locking in the value in the business. I guess the next area to think about is being prepared for due diligence. So what the things are that business owners can do now to be setting themselves up so that when the business is sold in the future getting ready due diligence is an easy rather than a hard process. What are the sorts of things that business owners should be thinking about with due diligence?
Getting ready for due diligence
LIZ: Well, you look at the list of the elements that have value in the business such as contract staff, employment agreement and to make sure that there’s appropriate contracts in place that are not going to present issues to you later down the track. So make sure they’re in order essentially.
JOANNA: And that you’re fully compliant with all your legal obligations, so I guess it’s just getting that house in order. Making sure the trucks are secure and you’re meeting legal obligations. I guess it’s also about putting systems in place to ensure that you’re able to access documents and contracts and financials easily. So it’s about putting in place systems to ensure not just number one that you’re compliant, number two that you have thoroughly captured value and warded against risk, but also that you can find these documents in the future right. Because that’s an issue that we see every now and again, and sometimes it’s particularly difficult for smaller businesses to actually find all of the information that we need to hand across as part of the due diligence process.
LIZ: Yes correct.
JOANNA: Particularly often I guess businesses say for example let’s take a lease as an example, businesses that have a long term in their lease may have signed this least five years ago, so haven’t looked at it for five years and if they can’t find it that’s a problem.
LIZ: Yes particularly if it’s not registered.
JOANNA: Yeah absolutely. Absolutely. Good. Okay. All right. So I think the main element then now out of everything that we’ve talked about here is making sure your business getting your business sale ready so that you can run it in a sale ready state. And I think all of the things that we’ve talked about here, locking in the elements of value in your business, having systems in place so that you’re orderly protecting your intellectual property are all sorts of things that are good for good running of a business anyway, right. It’s not just about being sale ready. This is great for businesses to do anyway, but if for some reason you have to sell your business then quickly then you’re in a state you’re able to do that.
LIZ: You’re ready.
JOANNA: That’s right. Exactly. And I guess this relate also not just to business sale, but also being ready for if you need to get finance for a business or bring partners on board or any sort of other JV arrangements that you might be looking at there.
Consequences of failing to prepare
JOANNA: So let’s talk about what if you need to sell quickly and you don’t have time for all of this preparation. I guess what can our listeners do or their advisors do? What’s the consequences? I guess the real consequence is that you might end up with a lower sale price than you originally hoped for. I guess you don’t have time for preparation that might be another.
LIZ: Yeah. When you don’t have time, you tend to rush things through and when you rush errors creep in and so forth. And it’s just not an ideal position to be in to have to sell quickly and not be prepared for your sale and it just presents poorly to the purchaser. And again has an impact on price and because you have to get out quickly.
JOANNA: Yeah, absolutely. And if any of our listeners have clients who are looking for a future sale but they aren’t told until the last minute that their clients are actually thinking of selling, so this can often happen I know to accountants or brokers, I guess the advice for you is to help your clients get the right advice from experts quickly from people who understand the area so that they can help guide your clients through what to do and get themselves ready as quickly as possible. Because these sorts of things can crop up from time to time. And it’s about making sure if that happens that you’re getting the right advice in place from people who understand the area.
LIZ: That’s right. And it’s a whole range of people, you’ve got accountants and lawyers and other financial advisers.
Four key action steps
JOANNA: Yeah, yeah. Absolutely. Okay. All right. So I think probably the action steps then for our listeners from the things we’ve talked today are first, well number one, check out our website which is thedealroompodcast.com to get a transcript of today’s discussion and also an e-book which we’ve prepared here at Aspect Legal that helps businesses get ready for sale. And we also have a number of checklists there. But let’s run through I guess the four key action steps for our listeners or any business in relation to preparing for a sale. What’s the first one do you think?
LIZ: Well, it’s just to  make sure that your business structure is appropriate to sale.
JOANNA: Absolutely. Yeah, I think that’s a good first step. And I guess that second step then is probably  thinking about the key areas of value and locking them in.
LIZ: Yes. And make sure that your contracts are all in in order and in place to maximize the value of your business.
JOANNA: Absolutely. So we’re locking in intellectual property, I guess client contracts as you just mentioned, key staff, lease.
LIZ: The property lease, yeah.
JOANNA: Yeah, absolutely. And I guess supplier contracts as well. And so then the third area to look at is  establishing systems for reducing risk. So I guess that would be making sure your agreements are up today. As I said before being careful about indemnity clauses and liability exclusion clauses, and buyers hate you know broad indemnity clauses and liability exclusion clauses.
LIZ: And also to make sure that those contracts don’t have prohibitive clauses regarding assignment or change in control. That’s a very key clause in your contracts with customers and suppliers.
LIZ: Just so that they can’t get out of the contract just because you’re selling a business.
JOANNA: Yeah absolutely. And I guess fourth finally is  run the business sale ready because it’s good for your business and it’s good for you if you need to sell the business on a quick or urgent basis.
JOANNA: Great. Okay. Well that’s all. Thank you so much for joining in Liz.
LIZ: You’re welcome.
JOANNA: Just a quick recap for our listeners in this episode, we talked about the legal elements in preparing for the sale of the business for owners and managers of businesses gearing up for exit, but also for accountants brokers and other advisers who work with businesses who might possibly be gearing up for a sale in the next five years.
Thanks for listening in if you’d like more information about this topic head over to our website at thedealroompodcast.com. If you’re looking to buy or sell in the near future you can organise a free consultation with us or if you have clients who are looking to buy or sell we can also organise a free consultation for them. We also have a number of free checklists available for you or if you have clients this can be co-branded also with your business.
Throughout our website on thedealroompodcast.com, you’ll also be able to download a transcript of this podcast episode if you’d like to read it in more details. And you’ll also find details there of how to contact our lawyers at Aspect Legal if you’d like help with any of the items that we covered today. And finally if you enjoyed what you heard today please pop over to iTunes and leave us a review.
You’ve been listening to Joanna Oakey and Liz Lee from Aspect Legal on The Deal Room Podcast. See you next time!
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