Guest post by Jeff Cassin, M&A and corporate attorney with Norris McLaughlin.
Entrepreneurs have a lot on their minds when starting a new business, from securing adequate capitalization, how to get to revenue neutral/positive, to a whole host of operational concerns, but what they’re rarely thinking about is how to sell their business. This would be a mistake. The right time to be thinking about selling a business is before you start it, because decisions you make early on can help maximize your future value and attractiveness to potential buyers. Some areas you should be thinking about are (1) entity structure, (2) operational structure, and (3) books and records.
There is a lot of debate about what is the right entity structure for a new business, and there isn’t an iron clad correct answer. Pass-through entities are tax advantageous in most circumstances but are not universally beneficial. For example, certain foreign persons owning LLCs may result in tax withholding obligations, and S-corp status may be destroyed, making it more difficult to sell to foreign persons. Certain private equity investors also prefer not to invest in LLCs for a variety of reasons.
Alternatively, C-corps are generally tax disadvantageous and when selling the equity of a C-corp the entrepreneur may suffer a hit to valuation as a result of this disadvantage. Therefore, pass-through entities can be attractive to purchasers of your entire business who also want a tax advantageous structure.
Note, it is possible to change your entity structure following your initial business organization, but there can be costs and complications when doing so. The earlier you evaluate this structure, the better you can minimize those costs and complications.
Beyond entity structure, your organizational and operational structure can impact you in a sale. For example, if you operate separate business lines and you are selling off just one of those lines, the more distinct your operations are the easier it will be to separate the businesses which can facilitate the sale. Separate branding, chain-of-command, segregated financials, and even separate business contracts should be considered if this is a potential exit.
You may also have intellectual property to protect; holding the IP in a separate entity can be beneficial for the protection of your enterprise as a whole against third party claims, and make it easier to separate business lines if you are divesting of only a portion of your business.
Books and Records
In the rush to get a business operational, entrepreneurs can start a business off with inadequate or poorly maintained books and records. It is important to document business relationships via solid contracts, and maintaining written minutes and other corporate records, all of which potential buyers of the business rely upon in evaluating your business. Unreliable records can undermine your ability to sell or diminish your valuation in a sale. In order to exit in a merger or a sale of your business to a publicly traded company, or an IPO, you will need reliable financial records that accountants can track and certify in an audit. Indeed, audited financial statements in general are considered more reliable and may even improve your valuation in a private sale.
To the extent your business relies upon intellectual property, avoiding the costs of registering copyrights, trademarks, patents, and firmly securing your confidential information and maintaining appropriate data security compliance can end up proving more costly later on.
Don’t wait. Entrepreneurs who plan ahead and act early maximize their chances of achieving their valuation goals upon an exit. Consulting with appropriate advisors early on to help you address these considerations, whether members of your board, accountants or attorneys, has consistently proven a worthwhile business strategy.
About the author: Jeff Cassin is an M&A and corporate attorney with Norris McLaughlin, who has written on a variety of topics, including startup financing options and incubators. Do you have any questions? Would you like to discuss the matter further? If so, please contact Jeffrey Cassin at 201-806-3364.