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.

In the latest HR headline from the start-up world, the offending executive doesn’t fit the typical mold, but the lesson remains the same: don’t ignore human resources.

Miki Agrawal, the self-proclaimed “SHE-eo” of THINX, and her “boundary pushing” workplace demeanor are the focus of a New York City Commission on Human Rights complaint by the former head of public relations, Chelsea Leibow. Leibow alleges that Agrawal created a hostile work environment through her constant discussion of sex, nudity around employees, and inappropriate touching of employees’ breasts.

THINX, the “period underwear” company that seeks to disrupt the menstrual products world, intentionally pushes boundaries with its marketing strategies. In her role, Leibow was responsible for PR emails, which were the subject of media attention highlighting the emails’ casual, “millennial-speak.” According to Leibow in an interview with New York Magazine, the company also pushed internal boundaries of professionalism.  Leibow alleges that, just a few months after she joined THINX Agrawal, “helped herself” to Leibow’s breasts and engaged in a variety of other sexualized conduct.  Leibow asserts that Agrawal drove a casual culture, and that many employees engaged in more casual (and often sexually-inappropriate) conversations out of fear of losing their jobs.

Leibow alleges that she made multiple internal complaints, including to the CFO and CCO, about Agrawal’s behavior, but those complaints were ignored. Rather than establish a formal HR function, Agrawal introduced “Culture Queens” to manage internal disputes. Neither of these individuals had HR experience, and the reporting line brought all complaints back to Agrawal – even those complaints about her. In fact, Leibow alleged that it was ingrained into the culture that the employees and the executive team “operated on different planes.”

In response to Leibow’s complaint and subsequent publicity, Agrawal published a blog acknowledging that THINX failed to appropriately establish a human resources function early enough in the formation of the company. Like many start-ups, when THINX had only 15 employees, Agrawal did not make hiring an HR professional a priority.  She acknowledges that the failure to address human resources was a “problem area,” but “to sit down and get an HR person and think about [health insurance, vacation days, benefits, and maternity leave] were left to the bottom of the pile of things to get done.” THINX has commissioned an employment law firm to investigate these claims, along with several other allegations being anonymously reported to various news outlets.

Following the complaint, Agrawal has stepped down as CEO, and THINX is hiring a new CEO and a HR manager. Our attorneys have seen a continuing pattern of successful start-up companies ignoring human resources functions in favor other responsibilities to launch the business.  But as this example teaches, start-ups and other small businesses should not leave HR-planning to the end. Although managing the HR function early on seems less important than getting the business off the ground, failing to establish basic workplace rules, including a harassment complaint procedure, can lead to major problems.

On August 31, 2016, the U.S. Department of Homeland Security (DHS) issued a proposed rule which, if adopted in its present form, would ease the ability of foreign national (FN) entrepreneurs to temporarily enter the United States to invest in and grow start-up businesses.  At the present time, there is no temporary visa classification that permits FNs to make significant investments in new or growing businesses and then remain here to manage them.  In announcing this proposed rule, DHS indicated that it was intended to spur business growth and job creation at a time when the U.S. economy is posed to attract this type of capital.

To qualify under the proposed rule, a FN entrepreneur would need to establish that his or her admission to this country would provide a significant public benefit because he or she has created a new start up entity here within the past three years in which the FN has a “substantial” ownership interest and which has a significant potential for rapid growth and job creation.  Each application would be assessed on a case by case basis.  Under the proposed rule, a FN with at least a 15% ownership interest in the start-up entity would be deemed to have a substantial ownership interest.  Any start-up which had received at least $345,000 within the past year from qualified U.S. investor(s), or at least $100,000 in qualified government grant(s) or award(s) would be considered a qualified investment.

Under the proposed rule, qualified FN entrepreneurs would receive an initial stay of two years, and this could be extended for up to another three years if the startup continued to provide a significant public benefit, as demonstrated by an increase in investment capital and/or job creation.  Comments on the proposed rule are due by October 13, 2016.

By Dustin E. Stark

Do start-up tech companies need an HR professional or employment counsel from the start?  A recent highly publicized incident involving a former GitHub Inc. employee suggests the answer is yes. 

Earlier this month, a GitHub employee quit her job and immediately took to Twitter, tweeting multiple complaints accusing the company of illegal gender-based discrimination.  News outlets picked up on these tweets, and the story spread quickly.  The former employee also gave an interview with TechCrunch, the information technology website, further outlining her complaints of gender discrimination.  In response to the rapidly developing public scrutiny, GitHub was forced to place one of its co-founders on leave while it investigates the allegations.

The type of damage control GitHub is being forced to engage in is expensive.  It ties up resources that a young, developing company would prefer to channel towards growth.  Although GitHub launched in 2008, the company lacked an experienced human resources leader until January 2014.  It is often harder, and more costly, to remedy employment discrimination problems after they take place, rather than putting measures in place to prevent their occurrence. 

Companies similar to GitHub can reduce exposure to potential lawsuits or government agency investigations by instituting appropriate written policies and employee training from inception.  Start-ups focus on getting their business off the ground, and unfortunately legal compliance or human resources issues can fall through the cracks.  Guidance from appropriate legal counsel, and having a dedicated human resources professional working with your company, can help develop the required employment law safeguards to guide and protect your company as it grows.  Oftentimes, start-ups focusing on growth and capital campaigns can lose sight of the important role of an HR professional in managing its human capital.  The HR professional is more likely to be employee number 50 than employee number 5, which can create exposure and undercut the substantive value that the start-up is working to create in the market.

Some small start-ups may falsely believe that federal, state, and city laws and regulations do not apply to them, due to their small number of employees.  However, even if your company is not as large as GitHub, the threshold number of employees required to be subject to federal, state, and city employment laws is often very low (sometimes as few as one employee).  Also, as your company grows and expands, it may be subject to an increased number of laws and regulations, which can increase exposure to legal liability.  The best practice is to have the appropriate policies and training in place before this becomes an issue.  As demonstrated by the former GitHub employee, start-ups employ tech savvy individuals that know how to use social-media to spread complaints when things go wrong.  Having the proper policies and training in place can help prevent these incidents, and limit the amount of damage control that needs to be done if they occur.

The goal of any start-up is successful and sustained growth.  By building a solid foundation of written policies and implementing appropriate employee training guided either by an in-house HR professional, in-house employment counsel, or through external counsel serving in a quasi-in-house role (a service EBG offers to clients), a small amount of caution on the front end can avoid distractions from this goal, and prevent exposure to large legal liability and costs on the back end.  In this regard, an ounce of prevention can be worth a pound of cure.