The many years of hard work and long days at the office may be about to pay off—you have just received an offer from a potential buyer to acquire your business. Just as you developed and followed a detailed business plan to build your business, now you need to develop a well-thought out plan covering the sale of your business, paying proper attention to the due diligence process.
There are many traps for an unwary seller in connection with a buyer’s due diligence investigation of a seller’s business. In this context it is critical that the seller’s professional advisors carry out due diligence on the seller’s business before the buyer conducts that same exercise. In this regard, the seller’s lawyers and accountants will need to do the following:
- Carefully review all documentation, reports, financial statements, tax returns, corporate records (including shareholder minute books, stock ledgers, organizational documents, and shareholder agreements), and material records and agreements for the business (collectively, the “Material Business Documentation”) to (i) identify and correct any issues or problems relating to the seller’s business and (ii) ensure that the seller will not be providing to the buyer certain confidential information that should only be provided when it is more clear that the transaction is very likely to be completed;
- Cause all of the Material Business Documentation to be assembled in a data room where they will be reviewed by the buyer;
- Engage a third party to provide a valuation of the business;
- Assemble and prepare a team of key managers of the business who will be responsible for meeting with the buyer and its representatives for purposes of addressing the many issues, questions, and requests they will have; and
- Assist the seller with each step during the process of completing the transaction, including the preparation and execution of a confidentiality agreement, a letter of intent, employment agreements and a purchase agreement.
While due diligence is often associated with a potential buyer’s analysis of the corporate records and material agreements of the business it is seeking to acquire (commonly known as the “target company”), due diligence is not a one-sided process. It is very important that a seller and its professional advisors invest a great deal of time analyzing all facets of the seller’s business before a potential buyer conducts its due diligence.
Problems that arise in the buyer’s due diligence investigation can affect the timing and the amount of the purchase price to be paid to the seller, and even the viability of the transaction itself. A careful review of the seller’s Material Business Documentation will enable the seller’s professional advisors to identify and resolve any problems that may exist before the buyer uncovers those problems during its own due diligence review. By conducting internal due diligence, the target company will be able to develop a complete picture of its business and resolve any problems that may exist and thereby minimize the length, risks and costs associated with the buyer’s due diligence review of the target company.
The buyer’s formal due diligence process generally begins after the parties have signed both a letter of intent (which describes the structure and material terms of a potential transaction) and a confidentiality agreement (which requires each party to keep confidential any information obtained from the other party in regard to the potential transaction), and it often continues until the transaction has been completed.
Many think of due diligence as a process where a team of lawyers very closely scrutinize all of the Material Business Documentation. However, legal due diligence is only one piece of the overall due diligence process.
In addition to engaging a law firm, typically the buyer will seek the assistance of accountants, financial advisors and environmental consultants. As the due diligence investigation can be a very time consuming, risky and expensive process for the target company, it is critical that the letter of intent place restrictions on the scope and duration of the buyer’s due diligence investigation.
While the parties negotiate the terms of a purchase agreement, the target company will be providing a large volume of documentation to the potential buyer and its professional advisors so that they may fully assess the state of the target company’s business.
The buyer typically gets access to these documents by conducting an on-site review in a physical data room that the buyer has set up in an office, or by reviewing electronic copies of the documents that the buyer has set up in a virtual data room that is accessible by computer. The type of data room used for the due diligence process generally will depend on the amount of documentation that needs to be reviewed, the amount of time available to conduct the due diligence review and the amount of money the parties are willing to spend on the transaction.
In the early stages of a potential transaction, the target company should assemble a team of managers who are the most knowledgeable about the inner workings of the company’s business. These individuals will work with the company’s professional advisors, as well as the buyer and its professional advisors, in responding to questions and document requests concerning the target company. The target company’s legal team will field and review due diligence requests and determine whether and when the company should provide certain information to the buyer and its counsel. 
Before the target company provides any documents to the buyer, the company should provide the documents to its legal team so they can review their terms and take inventory of all the documents being delivered to the buyer.
The target company’s legal team will prepare a due diligence checklist, which categorizes and summarizes of all of the Material Business Documentation that the target company has provided to the buyer. This checklist will assist the target company’s key managers and employees in determining whether the company has fully disclosed its Material Business Documentation to the buyer. The due diligence checklist will also assist the target company and its legal counsel in preparing disclosure schedules to the purchase agreement where the target company identifies certain information and documentation that was not provided to the buyer in the due diligence process.
The process of selling a company may seem daunting for an entrepreneur who has invested so many years focused solely on the growth of the company. Entrepreneurs often get so caught up in the business aspects of their companies that they forget about the regulatory and legal aspects of their businesses. As such, once you begin to give consideration to selling your business it is very important to engage a legal team to carefully evaluate and organize your Material Business Documentation and guide your company through the whirlwind known as due diligence.
Background: Buying a company’s Assets that is a customer list that produces revenue and some purchase agreements exist.
Questions:
1. What is the responsibility of the seller?
2. What happens if not all customers agree to go with the new owner for whatever reason?
3.Is the seller responsible to ensure all customers transition? If so, can the buyer sue the seller because some customers did not transition?
Basically, I’m trying to understand the risks and liabilities as a seller.
Thanks,
The answer to your questions should be handled in the relevant agreements. Our 9-step No Remorse process ensures that our seller/buyers see around the corners.
Hi Mike,
You ask some great questions about the very important element of customer retention in the transfer of ownership of a business. As a business broker, here is how I have often addressed this issue in a business sale representing either the buyer or seller.
The seller should include in a transfer of ownership plan with recommended steps that should be taken to minimize the possibility of customer loss. This often includes a plan for the seller to introduce their key clients to the new owner in person. In some cases, a seller will agree to introduce the buyer to some key customers prior to the close of the sale.
In some sale agreements, the structure is such that the seller will receive a percentage of the sale price at some later date after closing based on how many customers are retained or future financial performance. As an example, I represented a seller in which 50% of their revenue came from one account. The sale agreement was structured such that a large percentage of the total sale price was paid one year after closing. The amount to be paid by the buyer was based on total revenue received from that one account over one year. This type of approach, if necessary, could be applied to one or a few major customers, or the entire customer base.
If the seller’s personal relationship with customers, expertise and/or experience have been major factors in keeping the customers, it may be necessary for the seller to stay with the business for a long period after the closing to ease customers’ concerns about a new owner. The seller and buyer can determine a gradual transition strategy that will show customers that there will be no drop off in quality of service or product they receive from the business.
In your due diligence, you should investigate the customer retention rate for the business, terms of customer contracts, how many customers are responsible for the bulk of the total revenue and how many new customers are secured each year. Are there long term contracts with customers? If not, could customers be incented to sign a long term contract prior to or after closing? Are there any customer relationship problems? What can the seller and/or buyer do to solidify customer relationships? As the new owner, could you offer customers new benefits, services, incentives etc. that would make the ownership transfer a positive for the customers.
It is rare that a business owner can guarantee there will be no customer loss. However, the seller should work with you to implement a detailed plan to minimize customer loss and win new customers. If there are issues that suggest customer loss could be a significant problem, the sale agreement terms should protect the buyer in case customer loss is significant. And, if the seller helps you retain the customer base and grow the business in terms of revenue and/or new accounts, the seller should probably receive some type of bonus for this success.
I hope this helps.
Greg Younts
1) Seller agrees to retain the Broker as Seller’s sole and exclusive representative in connection with the sale of the business, its assets, and any related transactions. Seller’s obligations during the term of this Agreement include the following:
a. Cooperation and reasonable support to Broker to permit Broker to perform its obligations pursuant to this Agreement;
b. Provide timely and accurate information and files related to the Business and its assets as may be reasonably requested by the Broker from time to time;
c. provide appropriate technical support to assist Broker in evaluating target buyers and markets to which the Business may be attractive;
d. Make available such company personnel as are necessary to carry out any of the foregoing responsibilities,
e. Provide Broker with a list, contact information and other relevant information of any party that has previously contacted Seller to the express any interest in purchasing the Business or its assets; or, contacts Seller at any time during the term of this Agreement to express such an interest; and,
f. Maintain the Business and the underlying assets in good and saleable condition, continue to operate the business with its customary business practices and promptly notify Broker of any event or occurrence after the execution of this Agreement that may alter the value of the Business or its assets.
g. Broker has the right to rely upon said representations and warranties of Seller, which said warranties shall survive the closing of the sale of the Business.
h. Any financial statements or other facts or figures provided to Broker in the course of this engagement represent a fair and accurate depiction of the operation of the Business, and as such rely on the Seller’s accurate representation of such facts or figures.
i. Maintain the Business and the underlying assets in good and saleable condition, continue to operate the business with its customary business practices and promptly notify Broker of any event or occurrence after the execution of this Agreement that may alter the value of the Business or its assets.
2) The broker should make both parties aware that in any transaction there may be some customers fall out. The seller should make every effort to inform and promote the benefits of the new owners/buyers. The deal structure may have built-in contingencies into the deal to protect the buyer such as holdbacks, earnouts, or sales levels.
3) The buyer may have some legal remedies if the seller customer list as presented to the buyer was not as stated, document, or presented. The buyer does have responsibility during the due diligence process to evaluate the customer list.