For some, starting a business becomes a lifelong endeavor that gets passed down to the next generation. For others, creating a business is only a temporary venture with a shorter-term hope of having it acquired by a more established corporation. What are some considerations for those whose company is in the process of acquisition?
Considerations Before Acquisition: Financials
Whether a company is looking to be acquired or is approached by company with an acquisition offer, there are some recommendations concerning the company's financials. Buyers are often concerned with the last 36 months of financial statements, on a quarterly and annual basis, including any reviews of the financial statements by an independent auditor.
Other concerns buyers often have might include what present and potential liabilities exist, such as lawsuits or product warranty claims, and how those will be resolved in the future. This can also include debt obligations' terms and guarantees and how those will be addressed with regard to repayment.
Proprietary & IP Concerns
Acquirers will also want to look at what types of intellectual property the company owns. This could include what patents a company possesses and how it protects its patents through non-disclosure agreements with employees. It also may include how the company deals with ownership of intellectual property created by independent contractors through contract clauses addressing confidentiality and copyright ownership. Depending on how services performed are negotiated and documented with an independent contractor, questions may arise as to whether a work is under license or considered a "work made for hire." This can and does impact authorship and usage for the acquiring party.
Another important consideration for a seller is if a non-compete is part of an acquisition package and how the terms will be addressed by both parties. Along with negotiating a non-compete agreement with a reasonable timeframe, another important consideration is where the seller may not engage in commerce geographically, subject to the contract's agreed upon definition of what commercial activities are prohibited. As more and more businesses develop e-commerce operations, ones that provide services only may be subject to wider geographical restrictions compared to operations that manufacture and ship their products because it's more logistically prohibitive.
When a business is subject to acquisition, buyers often request an indemnification claim to ensure reasonable compensation for losses they may suffer from a seller’s misrepresentation or error. Examples of when a buyer may be able to make an indemnification claim during an acquisition include issues with the seller’s improper accounting practices or when the seller is subject to a breach of contract lawsuit from a client or supplier. These issues can occur during a financial audit of the seller’s financial statements or if regulators notify the acquiring company of a seller’s potential legal violations.
Sellers are able to negotiate with the buyer on their legal responsibility for indemnification through the so-called Baskets and Caps concept. Under the Caps concept, there’s a ceiling on the amount the seller is responsible to indemnify the buyer. Depending on how it is structured, there are different levels of financial responsibility for the seller.
- If a “tipping basket” is set up, when total losses exceed the agreed upon threshold the seller is responsible for all losses.
- If a “deductible basket” is set up, the seller is responsible for all losses in excess of the agreed upon deductible threshold.
Whether you’re thinking about selling your business or you’ve been approached to sell, knowledge is power.