Selling Your Business? 3 Tips for Entrepreneurs

I've been handling sales of businesses as a corporate lawyer for 17+ years, and there are certain fundamental mistakes that I have seen entrepreneurs make over and over again. Accordingly, now that the M&A market has come back to life, I thought it would be helpful to share three basic tips in connection with selling your business. Note that these tips apply regardless of the sales price.

Tip #1: Create a Competitive Environment. There is nothing that will give an entrepreneur more leverage in connection with the sale of his or her business than a competitive bidding process (or the perception of one). Bidders can be played-off of each other and, as a result, the entrepreneur will be able to strike the best possible deal.

Often entrepreneurs will be approached by a competitor (or some other company they have a relationship with) and then begin negotiating the sales price and other material terms. This is a big mistake and creates little negotiating leverage -- particularly if the entrepreneur has executed a letter of intent (LOI) or exclusivity letter prohibiting him from shopping the company for a period of time (see #2 below).

This is why I often recommend to entrepreneurs that they retain a strong investment banker to help them sell their company. Most entrepreneurs don't have the skill set or experience to play prospective buyers off of each other; and even though investment bankers can be expensive (sometimes taking as much as 4-5% of the sales price), it's well worth it if the banker can help negotiate the best deal for the entrepreneur and otherwise add value to the process.

Tip #2: Negotiate the Material Terms of the Sale in the LOI. Entrepreneurs must understand that their strongest leverage as a seller is prior to the execution of the LOI. This is the time-frame when bidders must be played off of each other, as discussed above. Not negotiating the material terms of the deal in the LOI is the most common mistake I see from the sell-side.

Once the LOI is executed, all of the entrepreneur's leverage is gone because she generally won't be able to shop her company to any other potential buyers for a period of 60 days or longer due to what's called a "no-shop provision." So prior to executing the LOI is when the seller wants to create a competitive environment (or the perception of one) and have the prospective buyers compete on price and terms.

One buyer, for example, may offer a higher purchase price, but require that part of the sale proceeds be put into escrow to cover any claims it may have post-closing and/or require that the seller have no "cap" on liability post-closing (see #3 below); another buyer may offer a lower purchase price, but not require an escrow and only require a 10% cap. Accordingly, prior to choosing a buyer, the seller should negotiate and weigh all of the material terms of the offer, and the LOI should reflect those terms.

Tip #3: Cap Your Liability. Obviously, entrepreneurs want to sleep well after they sell their company and enjoy the fruits of their labor. Indeed, the last thing they want is to get sued by the buyer post-closing. Accordingly, it is critical that certain key provisions be inserted into the acquisition agreement to protect them. One such provision is a cap on liability, which, as noted above, should ideally be negotiated in the LOI.

A cap basically means that if something goes wrong post-closing and it turns out, for example, that the seller has breached a representation and warranty in the agreement, the buyer can only recover up to a certain amount.

Sellers should strive for a cap of 10-20% of the purchase price and should also try to minimize any buyer carve-outs. The 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).

In conclusion, selling a business can be a very difficult and emotional experience, particularly for first-time entrepreneurs; however, if you follow the three tips above, I am confident that the sales process will be a lot more productive and beneficial.