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.

By Michelle Capezza

The New Jersey Technology Council (NJTC) is a not-for-profit, trade association which focuses on connecting decision-makers and thought-leaders from technology and technology support companies through access to financing opportunities, networking, and business support. Through its programs, the NJTC provides timely business information to help its members grow and succeed and provides forums for member companies to work together to advance New Jersey’s, and the region’s, status as a leading technology center.

At NJTC’s Annual Meeting held in July at The Palace in Somerset, NJ, the NJTC furthered its mission by hosting a series of discussions on topics of import to today’s technology companies. The meeting was abuzz with various conversations and idea exchanges on such issues as early stage/angel investments, energy efficiency, representation and warranties insurance for transactions, IT support issues, co-working spaces and The Affordable Care Act.  The goal of each discussion was to identify top priorities and brainstorm regarding solutions to achieve these goals.  My partner Gretchen Harders and I had the privilege of leading the discussion at the annual meeting on The Affordable Care Act and explored several top priorities with NJTC members as a result of the Act including: (i) importance of self-audits of health plan compliance efforts to date and establishment of a compliance plan going forward, (ii) attention to plan documentation, recordkeeping, reporting and disclosure requirements, and (iii) attention to fiduciary responsibilities with respect to company health programs.  As technology companies continue to grapple with the requirements of the Act, as well as the business opportunities that present itself in the health care industry, we at Epstein Becker Green are well positioned to assist.  As an NJTC Ambassador, I am also inspired by the strides being made in the region’s technology community.

Highlights of the various discussions are found on pages 14 and 15 of the August 2013 issue of TechNews.

Katherine LofftFrom our colleague at Epstein Becker Green Katherine R. Lofft, on the TechHealth Perspectives blog:

There are myriad opportunities right now for new businesses and talented entrepreneurs targeting healthcare, particularly in the IT sector. It’s an exciting time for people and companies looking to harness the promise of innovation and the power of technology to improve health care delivery, empower patients and lower costs.

However, even the best ideas usually require money to get off the ground. Sometimes they require more capital than the founders or management, or their family and friends, have available. While there are many individuals and institutions around the country with money to invest, it can be hard for the average start-up or emerging business to identify and appeal to them, or to distinguish itself from competing investment opportunities.

In view of existing prohibitions on the use of general solicitation and advertising in private offerings of equity, many entrepreneurs, founders and early-stage business leaders turn to so-called “finders” (sometimes called “brokers” or “promoters”) to access capital. Finders are typically individuals, often with no other relationship to the company, who commit to leverage their network of contacts and connections to help a company identify investors and/or secure funding. The consideration under these arrangements often involves payment of a fee or commission based on a percentage of the funds invested.

Now, you might be asking, what’s the problem with this kind of arrangement? Only this: If an individual is involved in the purchase or sale or securities and receives or expects to receive a commission (whether payable in cash or other consideration, such as stock) as a result of the transaction, the individual must be properly licensed under federal, and often under state, law. The use of unlicensed “finders” or brokers can result in serious consequences not only for the individual finder or broker, but also for the company/issuer.

Read the full post on the TechHealth Perspectives blog

VC firms have been funding, and M&A transactions should continue to increase in the health information technology (HIT) sector

“We are gearing up!”  I heard this statement and other similar statements from many VC firms when I recently attended “The World Congress Annual Leadership Summit on Mergers & Acquisitions in the Health Care” in Orlando, Florida.  Consistently, panelists and attendees at the conference noted that VC firms are funding for M&A transactional opportunities within the heath information technology (or HIT) sector.  According to many managing directors who spoke at the conference, there will be many such transactions because many hospitals and health systems throughout the country may need to update their older systems to keep up with emerging technologies that allow for better care for patients.  During 2012, many VC firms have been involved in numerous HIT deals.  For the remainder of 2012 and beyond, those firms are forecasting a wave of new technology, which should include, in addition to a complete overhaul of computer systems, an expansion of new applications to run on those computer systems in order to better help providers and patients within the healthcare sector.  Strong M&A activity within the healthcare provider IT market should continue as a result of solid demand for quick, efficient technologies and lower healthcare costs.

According to Mercom Capital Group, LLC, a global communications and consulting firm:

  • VC funding in the HIT area in Q1 2012 was $184 million in 27 deals (the highest number of deals ever recorded since Mercom started collecting data in Q1 2010).
  • A total of 46 different VCs invested in Q1. 
  • In Q1 2012, M&A activity in the HIT sector was strong with 34 M&A transactions.

The increase in M&A activity could lead to more technologies “merging” to build better systems for information, storage and transporting health care data, and communication for decision making.  In addition to better utilization, the increase in the implementation of HIT may lead to:

  • Lower health care costs
  • Increased access to affordable care
  • Fewer mistakes
  • Improved care quality
  • Improved organizational efficiencies
  • Reduced administrative burdens

Healthcare Growth Partners, an investment banking and strategic advisory firm, has concluded recently that “the HIT surge shows no signs of subsiding”, and overall, there is a lot of optimism around the opportunity within the market…private equity interest is high and valuations are often equal to or above strategic estimations.

It appears that the M&A market in the HIT sector has been hot since Q1 2012 with new technologies and opportunities in health care available.  VC firms appear to be concentrating on technologies that help lower costs and improve the quality of care.  The conference was a chance to hear firsthand from VC firms who have been carefully planning their strategies with regards to HIT.  Now appears to be the time that these firms are stepping up to the plate; hoping that they won’t swing and miss.


Our colleague, Hylan Fenster, shares his thoughts on source code escrow agreements:

Despite the burst of the bubble, many companies, notably small and mid-sized businesses, continue to rely on licensed software to perform their critical business operations. Source code escrow can provide the business with some protection if the software provider faces bankruptcy or stops maintenance or support for the licensed software.

Software License and Escrow Agreements

Licensees should ensure that their contracts with software providers contain provisions protecting source code rights. Source code is programming language written by a programmer that can be translated to machine language, which a computer would understand.  Unless a licensee has access to the source code, they cannot read or modify the program being licensed.  Licensees typically request source code escrow, which is the deposit of the source code of the software with a third party escrow agent.  Source code escrow is generally negotiated as a part of the initial software license agreement.  This request is made to ensure that the licensee will have continuing access to the software even if the licensor becomes defunct.   Pursuant to the specific terms of the contract, the escrow agent is authorized to release the source code to the licensee upon the occurrence of certain triggering events.

The licensor and licensee must agree not only whether to enter into a source code escrow agreement but also who should bear the expense.  Typically, a source code escrow agreement is entered into among the licensor, the business licensee and an unrelated third party escrow agent.

In addition, bankruptcy laws should be reviewed when drafting a source code escrow agreement as such laws may disallow the release of the source code escrow to the licensee, and the licensor’s creditors may be entitled to seize the licensor’s assets, which may include the escrowed source code.

Source code escrow agreements should provide for the following:

(i)               subject of the escrow,

(ii)              release events,

(iii)             duty of licensor to provide updates to the source code to the escrow agent,

(iv)             fees associated with the escrow agent’s services,

(v)              licensee’s rights upon release of the source code, and

(vi)             ongoing obligations of the escrow agent, if any.

The licensor will often resist entering into a source code escrow agreement due to the proprietary nature of the source code.  However, the licensee should be afforded some protection in the event the licensor is no longer complying with its obligations under the software license agreement.   A source code escrow provision in the license agreement protects the licensee and his business from potential events that may render the licensor unable to provide service or support.

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act or JOBS Act.  In light of the sharp decline in the number of companies entering the U.S. capital markets through IPOs over the last ten years, Congress recognized a need for this legislation since small companies are critical to economic growth and job creation.  To promote growth and assist small companies in gaining access to capital, the JOBS Act amends the securities laws in several ways, which include the following:

(i)                  Establishes a new category of issuers known as “Emerging Growth Companies” (EGCs) which are issuers that have total annual gross revenues of less than $1 billion (after December 8, 2011).  EGCs  are exempt from certain regulatory requirements until the earliest of the date (a) five years from the date of their IPO, (b) they have $1 billion in annual gross revenue or (c) they become a large accelerated filer (i.e. a company with worldwide public float of $700 million or more);

(ii)                While EGCs must comply with SEC-mandated quarterly and annual disclosures, they would be exempt from Section 404(b) Sarbanes-Oxley requirements regarding auditor attestations of management’s assessment of its internal controls, for a transition period of up to 5 years.  EGC management would still need to establish and maintain internal controls over financial reporting and its CEO and CFO would still need to certify the company financial statements;

(iii)               Allows EGCs to provide audited financial statements for the two years prior to registration rather than three years.  Within a year of an IPO, the EGC would report three years’ worth of financial statements;

(iv)              Provides exceptions to rules on mandatory audit firm rotation;

(v)                Exempts EGCs from certain requirements under Dodd-Frank legislation such as the say on pay requirements and disclosure of median compensation ratios of all employees compared to the CEO.  EGCs would still comply with corporate governance and listing requirements including board member independence rules;

(vi)              Provides for more communications and information flow to investors and special provisions for providing draft registration statements for non-public review.  On April 10, 2012, the SEC Division of Corporate Finance issued FAQs addressing questions relating to the confidential submission of registration statements;

(vii)             Provides special exemptions in connection with solicitation and advertising to accredited investors;

(viii)           Establishes new thresholds for registration; and

(ix)              Sets forth special rules for a “Crowdfunding” exemption-Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure. This allows for aggregate sales to all investors up to $1 million using web-based platforms (up to the greater of $2000 or 5% of the annual income/net worth of such investor (with additional requirements)).

Start-ups and emerging growth companies should take the time to explore the JOBS Act and the related guidance being issued.  The new law may address a particular hurdle previously faced which would allow certain companies to move forward and grow.