Many of the most successful businesses are the product of the investment of its founder’s time, energy and money. Often, this investment may be the most significant source of their retirement income or personal wealth.  Yet at some point, whether due to political or market conditions, or more personal reasons, it may become time to sell the business and unlock the value of this investment.

Here are some important considerations for selling a closely held business, especially for those founders who have never been through a sales process, to achieve a successful exit.

  1. Know the value of your business – and how a buyer might value it. There is not one standard metric used to value a business, and a valuation may take a variety of factors specific to the business or its industry into consideration. Often, buyers will be willing to pay a multiple of earnings or revenue, though the specific multiple will vary based on industry, size, growth potential, as well as other factors. Sellers, who at times tend to overvalue their company, could benefit by engaging a professional valuation firm for an independent perspective. Also, having multiple years of financial statements that have been audited by a reputable CPA firm will enhance the reliability of any buyer price proposal and reduce the likelihood of the buyer lowering its initial offer once it gets “under the hood.”
  2. Anticipate likely transaction structures and acceptable forms of consideration. Buyers typically will propose deals on a “cash-free, debt-free” basis and insist on sellers delivering a pre-determined level of working capital. Buyers may offer all cash or some combination of cash, promissory notes and/or equity in buyer. Equity can be a useful mechanism for aligning the parties’ interests and incentivizing the founder post-closing, typically when the founder is asked to remain with the business. Buyers might propose an “earn-out” arrangement, whereby a portion of the purchase price will get paid only upon the attainment of pre-determined financial or operational milestones. These arrangements are typically more palatable to founders who are staying with the business post-closing and thus have some ability to impact the achievement of those milestones.
  3. Identify factors that can undermine value, and work to clean them up. Especially if valuation is based on an earnings multiple, eliminating or reducing a several hundred thousand dollar expense can result in a multi-million dollar increase in purchase price. Similarly, buyers may seek “dollar for dollar” indemnification (i.e., without any deductibles) for certain matters, such as pending or likely litigation. Sellers often try to resolve these issues before a sale to reduce the likelihood of an indemnity claim post-closing. To the extent such issues cannot be resolved, founders should be forthright about them with the prospective buyer.
  4. Identify third-party approvals – including that of your board. In many deals, a consent or approval from a third party is required before the transaction can close. These can take the form of consents required by contract with a private party, government approvals, or even board approval of the seller. Obtaining these consents or approvals can be time-consuming and expensive, even when founders have enjoyed harmonious relationships with their customers, vendors, lenders, and regulators. Often, consent in a sale transaction requires separate legal review by these parties, which could result in delays. Sometimes other equity holders have a right of first refusal (ROFR) giving them the opportunity for a defined period of time to buy the business on the terms offered by a third party. When a ROFR exists, an eventual sale to a third party could be delayed to allow for the ROFR period to lapse or to obtain a waiver of the ROFR from the holder. Identifying required third party approvals as soon as possible will better enable sellers to realize a timely closing. And, aside from being good corporate practice, to facilitate a smooth and timely board approval process, founders should keep their boards of directors involved and informed as to the sales process at every stage.
  5. Consider your next move (personally); know that restrictions could be imposed. Many founders envision riding off into the proverbial sunset without looking back. Others are already planning their next venture. Others wish to remain in place to see their life’s work flourish post-closing. Of course, buyers may have something else in mind altogether. Buyers may require founders to stay on with the business for a period of months or years and, in any event, will often insist on non-compete and non-solicitation agreements from founders for a number of years post-closing. Founders may also be able to negotiate exceptions to these restrictions that are acceptable to buyers.
  6. Tax matters (very much!). Different transaction structures – for example, asset sales vs. stock (or membership interest) sales, or the inclusion of accounts receivable in the deal – may result in vastly different tax effects to the seller. Founders may avoid “seller’s remorse” by understanding the after-tax value of the deal consideration, especially in light of their anticipated post-closing financial needs. Sellers are well-served to seek the advice of tax and accounting specialists as early as possible to identify a tax-advantageous deal structure.
  7. Take steps to maintain the value of the business. To preserve the value of the business prior to the transaction’s signing and closing, and to facilitate a smooth sales process, sellers may offer retention bonuses to key employees. Variations of these arrangements could entail employees receiving a percentage of the transaction consideration, aligning their interests and those of the founders. Especially where earn-outs are utilized, these arrangements can be tailored to provide for bonuses post-closing, benefiting the business and the founder for years.
  8. Remember to keep your toys! Exit transactions, regardless of structure, do not automatically involve the transfer to the buyer of every last item on the seller’s premises. Often, certain items are actually owned by the founder outright and not the business. Personal effects such as sports memorabilia, artwork, family heirlooms (such as antique furniture located at the business), and similar items should not be overlooked, and the founder will want the definitive agreement to expressly provide that these items will remain with the founder in the sale of the business.

A founder’s decision to sell will surely be momentous both for the business and for the founder. Hopefully that decision can be easier knowing in advance some key considerations for a successful exit transaction.

Robot Hand Investing on LaptopAs with most aspects of the workplace, employee benefits are going digital.  From online enrollments and administration for all types of benefits, to electronic educational tools, employers are increasingly seeking ways to use new technologies to enhance their benefits programs, increase efficiencies and employee engagement.  Among these innovations is the proliferation of computer-driven, digitally-based investment advisers, or so-called “robo advisers.”  The market for robo-advisers is growing fast with many new companies entering the space with increasing frequency.  Well-established companies are also developing and offering their own automated investment services which can be available to assist individual investors or participants in an employer-sponsored savings plan. Plan sponsors will increasingly be presented with robo-adviser services for their participant-directed retirement plans, and they must be prudently selected.

Robo-advisers are not without their critics.  There is an ongoing debate whether robo-advisers can meet the fiduciary standards of a trained professional who provides investment advice to investors in their best interest.   For example:

  • On March 15, 2016, the Financial Industry Regulatory Authority (FINRA) released a report regarding digital investment advice which raised questions concerning the standard of care that applies to broker-dealers and investment advisers under federal securities laws with regard to investment advice that they provide and the application of same to digital services used either in conjunction with a financial professional or on its own.   The FINRA report recognizes that digital investment advice tools will play a significant role in wealth management and that investor protections must be paramount and should include a foundation for understanding customer needs, with sound methodological groundings and recognition of the tools’ limitations.
  • On April 1, 2016, the Massachusetts Securities Division issued a policy statement and declared that robo-advisers may be inherently unable to act as fiduciaries and perform the functions of a state-registered investment adviser without the necessary due diligence and personalization to act in the best interest of their clients.
  • On April 6, 2016, The Department of Labor also released its final rule regarding investment advice fiduciaries (the “Rule”). The Rule itself continues to come under attack and on June 1, 2016, eight industry and trade groups filed a lawsuit in Texas federal court challenging the Rule and asserting that the DOL overstepped its authority in issuing the Rule, the Rule will increase costs and litigation, and that the Rule will not help investors. (See Chamber of Commerce of the United States of America et al. v. Thomas E. Perez et al., case number 3:16-cv-01476, in the U.S. District Court for the Northern District of Dallas.)  Whether the Rule survives pending challenges remains to be seen.  In the meantime,  robo-advisers that make investment recommendations are fiduciaries under the Rule which provides that fiduciary communications such as recommendations can be initiated by a computer software program.

It is also important to note that while the DOL also released a Best Interest Contract (BIC) exemption from its prohibited transaction rules to allow investment advisers to continue to provide advice and earn compensation such as commissions, sales loads, 12b-1 fees and revenue sharing payments without running afoul of conflicts of interest standards so long as certain requirements are met, this BIC exemption does not apply to the provision of investment advice solely through digital means unless the robo-adviser charges level-fees and is a “level-fee fiduciary.”  It appears that the pre-existing rules for “eligible investment advice arrangements” under Section 408(g) of ERISA provide an alternative path for robo-advisers to follow in order to avoid running afoul of the prohibited transaction rules.

For plan sponsors that desire to incorporate digital investment advice services into their retirement program in the near future, several issues, at a minimum, should be considered, including:

  • Assess the need for investment advice services versus provision of non-fiduciary educational tools, or determine an approach that incorporates both services
  • Ensure that the plan fiduciaries follow an objective process to elicit information necessary to assess the robo-adviser’s qualifications and credentials, quality of services offered and reasonableness of fees and costs charged for the services
  • Evaluate the robo-adviser’s investment approach embodied in the design of the tool
  • Assess whether the digital investment advice tool is paired with access to a human investment professional who is able to assess the plan participant’s needs in a manner that goes beyond the limitations of the digital tool, and, who is trained to utilize the tool effectively
  • Review any conflicts of interests
  • Determine if the robo-adviser charges level fees and meets the requirements of the BIC exemption  or whether it meets the requirements of an “eligible investment advice arrangement” under ERISA which either charges level-fees or uses a compliant computer-model
  • Review service agreements including fiduciary, indemnification, audit, record retention and data privacy and security provisions
  • Confirm that the robo-adviser acknowledges fiduciary status and that the participants are provided with any required disclosures
  • Establish a procedure for prudent ongoing monitoring of the robo-adviser service

For plan sponsors who already offer robo-adviser services to their plan participants, now is the time to review the arrangement under the evolving guidance and implement prudent changes.

In this environment, the fate of the Rule, and the standards for robo-advisers, will continue to evolve and new developments must be monitored.  Whether the robots know best is a question yet to be answered.