Six FAQs to Prepare Your Closely Held Company for Sale or Transfer

Getting a closely held company ready for sale or transfer can be a daunting task, but preparation can help the process go smoothly. Whether you’re planning to change ownership soon or years down the road, these answers to common questions offer concrete steps to structure a deal that works best for you and your business.

1. What do you need to do now to prepare your company for a sale?

The answer is the same whether you’re selling your business in a year or in 10 years, and whether you are transferring the company to your children or selling it to another company.

The first step is to set up the company so that it doesn’t need you on a day-to-day basis. Eliminate yourself as a key man. It’s important to buyers and your eventual successor that your company can run without you. Then, make sure you have clear and sound corporate governance, including documentation, tax planning and financial statements.

Also, it’s important to understand and overcome the emotional factor of not being in control anymore. In addition to potentially working for the buyer for at least a transition period, if not longer, you’re trading a highly illiquid asset that you have control over for liquid assets that are subject to market risk.

2. Who are the key players on your advisory team when you’re considering a sale?

An advisory team can often include:

• • Corporate counsel to structure the deal
  • Investment bankers to help attract suitors and manage the overall process
  • Depending on the size of the business, a good CFO
  • A CPA to advise the seller on personal finances
  • A financial advisor to run through different scenarios, check your finances and set up a realistic post-sale budget

3. Who should be on your legal team to help you navigate a sale?

Sales have a lot of moving parts, and it’s important to account for all of them. These are the most common people you’ll need on your legal team:

• • Corporate lawyer to oversee the process
  • Employee benefits lawyer to advise on the transition of your employees to the buyer
  • Executive compensation lawyer to properly handle change in control agreements and avoid adverse tax consequences
  • Tax lawyer to navigate complex tax issues and potentially increase the bottom line
  • Environmental lawyer if the business involves real estate or certain environmental issues
  • Real estate lawyer if you own real estate that is being transferred to the buyer
  • IP lawyer to advise on IP transfers and licensing to the buyer
  • Regulatory lawyer if the business is in a highly regulated industry

4. What do you need to know about valuation?

The common jargon is multiples of “earnings before interest, taxes, depreciation and amortization” (EBITDA), which measures a company’s overall financial performance. People often think they can look at announced deals in an industry to get a sense of what multiple they should be around. But only about 5% of announced deals disclose any information. And when they do release it, it should be taken with a grain of salt, because it might not accurately reflect the deal’s actual economics.

The buyer is looking at the future. To give an estimate of what a seller can get in the market, first adjust the EBITDA. To get to a more accurate representation of the cash flow that the company’s operations can produce, remove non-recurring or non-operational expenses that a buyer is unlikely to continue.

Timing is a huge factor. The mergers and acquisitions market has stayed strong going on 10 years now, though there is a little bit of softening in multiples.

There is also timing from a market perspective. If you can, pick the perfect sweet spot to sell. This is when the company is coming off of two to three years of growth with more to come. Don’t wait until the company hits a growth ceiling. Sell while there is still something left for the buyer to benefit from without a lot of effort. That being said, there can be significant risk to trying to time the market. If the market is good, waiting for another year or two of growth presents the risk that the market may soften. If multiples drop from 5x to 4x, or 20%, the company’s EBITDA would need to grow by 25% to remain at the same valuation. Here’s an example:

	2019	2020
Adjusted EBITDA	$1,000,000	$1,250,000
Required EBITDA Growth		25%
EBITDA Multiple	5.0x	4.0x
EBITDA Multiple Decline		-20%
Enterprise Value	$5,000,000	$5,000,000

5. How does the structure of the deal change the tax consequence, and how will the price be realized as capital gains versus income?

If you’re going to sell the company’s stock, that will usually be subject to capital gains tax. Selling assets of a business will have certain components. Some of these will be taxed at capital gains rates and some will be taxed at ordinary income tax rates. The entity type and tax regime (i.e. c-corporation, s-corporation, limited liability company taxed as a partnership) may also affect the manner in which the transaction will be taxed.

At the beginning of the transaction, look at the best way to structure the deal and whether reorganization is needed.

Think about what the buyer wants. Can a better deal be reached by compromising on some things? If an issue is tax neutral to you but benefits the buyer, you may be able to trade that benefit for something.

6. What is a transaction data room and what documents do you need to include in it?

Data rooms provide a cohesive vehicle to transmit all materials related to a company in connection with a process to sell the company. You should include everything in the data room, even the maintenance contract on the printer. You also want to make sure everyone who intends to submit an indication of interest has the right information.

Data rooms are also interesting because you can see what buyers are looking at, how many times they opened it and what is important to them.

Please contact Mark Fullmer, Will Bishop or any member of Phelps’ Business team if you have questions or need compliance advice and guidance.

These questions and answers were discussed during a panel with Phelps lawyers Mark Fullmer and Will Bishop, along with Legacy Capital founder Marianne Van Meter and Gulf Point Advisors partner Chris Kenny. Maverick Claims owner Greg Pellegrini moderated the panel. Thank you to our panelists and moderator for their time and their invaluable insights!