This post is the first in a series that highlights various important yet often overlooked topics when management decides to sell the business. These considerations help the business evaluate and address key areas early in the process. This in turn helps lead to more effective and efficient decisions on structuring, negotiating and ultimately documenting and closing a sale transaction.
This first installment focuses on contracts. Each business has its own particular needs depending upon a range of factors such as size, industry, market and competitors. While no two enterprises are the same, here are four questions that management of any business should consider about their contracts when preparing for a potential sale:
1. What contracts does the business have? This question seems very basic, yet if pressed many businesses would struggle to identify all their contracts. To prepare for a sale, management should at a minimum locate and create a list of all contracts if an accurate one does not already exist. Having a spreadsheet of all contracts listing key terms and other information will provide even greater benefit and is typically essential for larger transactions. Besides helping to get ready for a buyer’s due diligence process, an early focus on contracts helps to identify potential problem areas. This process may reveal lost or illegible documents, missing signatures or verbal understandings that were never put in writing. Management may then have time to resolve any identified issues and avoid a potential delay or other extra problems.
2. What is the duration of each contract? Contracts typically have a defined duration or “term” during which they are in effect. To a potential buyer, a key vendor contract with strongly favorable terms, for example, may actually be of limited value if it is going to expire soon. A potential trap is assuming that each contract has only a single relevant time period. In more complex agreements, there can be multiple periods to consider. For example, a contract may have an overall “expiration date” along with an extended period when certain restrictions or other obligations will continue. Sometimes contracts will not have any defined term, which can lead to different results depending on the type of contract and other factors. Early focus on these issues may allow time to negotiate an extension or other changes to enhance the value of key contracts.
3. Are the contracts transferable? Many contracts allow the seller to transfer its rights to a buyer without the need for any consent from the other parties. Oftentimes, however, contracts require consent unless there’s a specific exception such as a transfer as part of a sale of all or substantially all of the business. Others may allow transfer only in other limited circumstances, which may not be clearly defined. Contracts silent on transfer are often freely transferable without needing consent, but that is not always the case and the opposite may be true. Government agencies or other third parties may also need to consent in certain situations. Early focus on transfer may be crucial in determining sale structure and helping to avoid last minute scrambling for needed consents.
4. What are possible contingent liabilities? Many contracts have less obvious but nonetheless important sections that expose the seller (and its potential buyer) to contingent liability. For example, contracts often contain various representations and warranties that last for an extended period of time. Many contracts have strong indemnification protections, allowing a party to recover damages in the event of third party litigation or other covered circumstances. As the range of possible contingent obligations can be extremely broad, careful review up front can be essential to identify unusual contingent exposures that may trouble a potential buyer or even derail a sale transaction if not properly evaluated and addressed.
The tips above highlight just a few of the important questions to consider regarding contracts when preparing for a sale. Businesses do even better when they focus on these points before entering into each contract. Stay tuned for these other topics to come in this series: Employee Obligations, Litigation/Compliance and Post-Closing Obligations.
Ian Platt and other attorneys at Freed Howard LLC regularly advise small businesses and larger companies that are entering into new contracts, reviewing their contracts as part of a potential business sale or working on other business transactions. If you would like to discuss selling your business or other transaction, please contact me at email@example.com or 470-839-9300.