7 Things an Entrepreneur Should Consider Before a Sale

At Next Coast, we’ve been fortunate enough to have some portfolio companies that recently exited via acquisition and it’s given us a birds-eye view on just how important it is for entrepreneurs to prepare for such a big moment. The sale process is chaotic, unpredictable and stressful and must be managed alongside the day-to-day operations of a scaling a startup. So we reached out to the legal experts over at DLA Piper to give us the nitty-gritty details on what entrepreneurs should expect during this process – and how they can prepare for it. It’s detailed, but that’s exactly what you’d expect from a great legal team helping you cross your t’s and dot your i’s during the roller coaster of the sale process.

By Sam Zabaneh and Brent Bernell, DLA Piper

We see it every day: An entrepreneur builds an amazing business, navigates the perils of raising capital and reaches that transformational moment – the liquidity event – only to be confronted with the enormity of the process. While nothing can truly prepare an entrepreneur for their first sale of a company, we hear time and again from our clients about steps they wish they had taken earlier to make the process run more smoothly. Here are seven pieces of practical advice to help an entrepreneur prepare for this exciting moment:

1. Get organized

Entrepreneurs wear many hats, and bouncing between being head of product, vice president of sales, director of business development and chief people officer, they can sometimes forget how important it is to keep the legal side of their business in order. Entrepreneurs tell us that selling their companies made them wish that they had gotten organized sooner, and for one simple reason: due diligence. In a sale process, buyer due diligence can be a significant burden, particularly when coupled with negotiating the substantive deal points and running a business. Entrepreneurs can ease the burden by getting organized early and staying current. Entrepreneurs should create a contract log and organize all contracts, preferably into an electronic data room. This allows them to be more responsive with minimal effort when a buyer requests contracts for significant customers and vendors.

2. Understand your contracts

Entrepreneurs often tell us that they wish they had taken more time to understand the various contracts that they have already entered into as they built their businesses. As part of the sale process, the buyer and its attorneys will look through significant contracts to identify potential red flags. These can include terms that limit the company’s ability to expand its business (such as non-competition provisions), lock the company into always giving a customer its best pricing (often referred to as a “most-favored-nation” clause) or expose the company to significant potential liability (often through unlimited indemnification obligations). While the main goal should be to avoid these types of provisions, new companies must agree to them from time-to-time in order to close a big sale or secure an important relationship. Sophisticated buyers may find these red flags and make them a significant deal point that results in adjustments to the purchase price or requires special indemnities by the company in favor of the buyer. By understanding existing contracts and putting in place an organized and disciplined contracting approach (including signing authority), entrepreneurs can get ahead of these potential issues – and possibly avoid them altogether.

3. Don’t forget IP assignment agreements

Entrepreneurs are often diligent about the need for trademarks, copyrights and patents, but they often forget how important it is to make sure that the company’s intellectual property, or IP, is secured. During the sale process, a company’s intellectual property history, and how well the company has protected its assets, will be closely scrutinized by the buyer. A company will almost certainly have to prove that all employees and contractors (or at least all individuals that have generated IP) have signed an agreement to protect proprietary information and assign any intellectual property to the company.

Determining whether every employee and contractor has signed an agreement can be a burdensome task, and having gaps in the documentation can make a buyer nervous. Entrepreneurs need to be disciplined in having every employee or contractor sign an agreement and organize them in a central location. This will help entrepreneurs lock up their IP, give comfort to prospective buyers and minimize the risk that an entrepreneur has to concede value to a buyer or chase down current or former employees for IP assignments on the eve of a transaction. We provide our entrepreneurs forms of these agreements, often referred to as PIIAs or EPIAs for employees, and consulting agreements or MSAs for contractors.

4. Run your liquidation waterfall scenarios

As a company evolves, it may develop a complicated capitalization structure with different classes of stock and other convertible instruments (like warrants) that will need to be paid out in a sale transaction. The willingness of these different groups to consent to a deal will depend in large measure on what level of return they are receiving. Understanding how the money will be allocated in a sale transaction can be very complicated and can vary significantly depending on the valuation.

Building out a liquidation waterfall model and updating it for each financing round will make it easier to assess different opportunities and understand where the economic interests of their different stakeholders diverge. Although all companies will need to go through this exercise as part of the sale process, entrepreneurs that do this early will be better prepared to enter into negotiations, evaluate different proposals and manage their stakeholders to a successful closing.

5. Know your approvals

One thing that can come as a surprise to entrepreneurs is how many of their stockholders are required to consent to a sale of the company. Over the course of raising financing rounds, different classes of stock may negotiate for the right to block a sale of the company. Even if the stockholders from that class are no longer the most senior holders or actively engaged with the business, they could still hold those rights. Knowing what approvals are required in advance will help an entrepreneur manage outreach to the most important stakeholders and avoid any last-minute delays or surprises. Understanding the impact of these provisions can also allow entrepreneurs to hold the line during financing negotiations to avoid overly-complex approval processes.

6. Talk to your employees about equity

Employee equity is one of a company’s most important retention tools, and while most companies will discuss it briefly when giving out awards, they rarely provide education to employees about the awards and their terms. Entrepreneurs tell us that they wish they had been more proactive in discussing equity awards with their employees, including what happens upon a sale and how different scenarios can impact tax burdens. By doing so, they could have gotten ahead of the inevitable questions that pop up in the sale process and helped their employees maximize the value of their equity awards.

7. Build a deal team – before there is a deal

A sale opportunity can come out of the blue or it can be the result of a deliberative process, but both scenarios require entrepreneurs to have a team of trusted advisors to assist them during the process. While entrepreneurs will naturally look to their senior management team and board of directors to help them in the process – which they should – having skilled lawyers, bankers and accountants is equally important.

A company can always retain advisors after an offer comes in, BUT having someone you trust, who understands your business and can give you advice in advance of the offer, can be invaluable. Entrepreneurs often tell us that they would not have been comfortable relying on advice from even the most experienced advisors without that level of pre-existing trust.

While some of these items seem like common sense, we regularly hear from entrepreneurs that these seemingly simple actions are often overlooked as they keep their focus on building their businesses – leading to issues when sale negotiations are in the home stretch. By being proactive and planning ahead, entrepreneurs can better position themselves to get the most out of their sale transaction.

About Sam and Brent

Sam Zabaneh is a partner at DLA Piper LLP (US) in Austin, Texas and chair of DLA Piper’s Texas Corporate & Securities practice. Brent Bernell is a corporate associate in the Austin office. Together with the rest of the DLA Piper corporate team in Austin and across the globe, they help guide entrepreneurs and technology companies throughout their life cycle, from idea to public company or liquidity. You can find out more about how Sam, Brent and DLA Piper help entrepreneurs grow their businesses here.

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