Prepare for the new year with some corporate financial housekeeping

For individuals and organizations alike, the end of the year is a time for making plans. But not just the kind that involve shopping or holiday parties. Plans for the future.
When it comes to businesses, that often involves considering strategic options. Maybe you’re seeking investors, or perhaps even selling your business in the new year.
If so, there are important legal steps to prepare for either eventuality. In fact, it’s a good idea to go through this exercise regularly, as you never know when opportunity will arise.
In any financial transaction, valuation is key. You need to have a grounded understanding of your business and what it’s worth. But valuation can depend on more than just your financial performance.
In any transaction, prospective buyers/investors will insist on performing due diligence before closing a deal.
Legal issues that are uncovered during due diligence can negatively impact valuation or put a scare into your counterparty. Even for issues that can’t be resolved before due diligence, being aware and having an answer ready is better than being caught flat-footed.
Representations and warranties
Almost every purchase or investment agreement will require the seller to make representations and warranties about its business. These are statements by the seller that certain things are true and/or have been properly disclosed.
If representations and warranties turn out after closing not to be true, the purchaser or investor can usually pursue monetary damages or other concessions. Knowing what elements you’ll have to stand behind to support your valuation can often help a transaction close faster. It can also guide you in setting terms of any deal and maximizing your valuation.
Common issues in due diligence
In my experience, and those of my colleagues at Harris Beach, certain factors routinely come into play during due diligence. Every deal is a little different, and different industries and deals will raise different types of issues.
Here are some of the most common areas for concern, along with questions you should be asking yourself:
Accuracy and documentation of capitalization tables. Purchasers or investors are entitled to know who legally owns or is entitled to the equity. Specifically ask:
• Are all the equityholders of the business properly documented?
• Has equity been repurchased or transferred? Is it documented?
• Have there been stock option or equity incentive grants, and are they documented?
• Are there oral agreements or promises to issue equity that haven’t been memorialized?
Related-party obligations. Buyers don’t know what they can’t see, and sometimes an owner may not properly document or disclose these types of arrangements. This can cause delays.
• Are there any loans or other debt payable by the company to owners or other related parties? Is there anything payable by an owner or other related party to the company? Have these arrangements been properly documented?
• Are there any intercompany arrangements (e.g., between parent and subsidiary) that are not fully documented or are not on an arm’s length basis?
• Are there intellectual property relationships (e.g., a sister company using another sister company’s intellectual property) that are not documented or not compensated?
Prior investments.
• Do they exist, and are they been properly documented?
• Have existing investors been promised anything (such as participation or board observation rights) that is not documented?
Intellectual property rights.
• Are all material patents, trademarks or copyrights properly registered and maintained?
• Are there patents or other intellectual property that were not properly assigned by the inventor to the company?
• Is the company aware of any infringement issues or potential complaints, either for or against the seller?
• Is all the material software properly licensed?
Employment issues.
• Are all of the company’s employees properly categorized (as exempt or hourly employees)?
• Are there any purportedly independent contractors who could be recharacterized as employees?
• Are there any threatened or potential discrimination or harassment claims?
• Is the company current on its Affordable Care Act filings, if applicable?
Litigation.
• Are there any outstanding litigation claims? A purchaser or investor will want reasonable detail about those claims.
• Has anyone threatened litigation? Are there facts or circumstances that could lead to litigation?
Compliance with laws.
• Is the company currently in compliance with applicable laws or regulations? Is management aware of any instances of non-compliance?
• Does the company have all necessary permits to operate? Are they up to date?
• Is the company properly registered to do business in all states where it has a presence?
Tax issues.
• Is the company current in all of its tax filings? Have any filings had to be amended?
• Has the company been audited in the recent past, or it is currently subject to audit?
• Is the company current in all sales tax obligations? This can be a particularly complicated issue in the age of a global, digital economy.
Debt and liens.
• Will the transaction leave any creditors outstanding? If so, will consent from any of these creditors be required? Are any creditors secured?
• What lien filings may be outstanding? Consider “stale” liens, precautionary lease filings, and filings against companies with similar names that may cause confusion.
• Are there any tax liens against the company?
Major contracts.
• What are the company’s major contracts (e.g., supply contracts, customer contracts, service agreements, etc.)?
• Do any of these major contracts require consent to assignment, and if so, can you get consent? More contracts are likely to prohibit assignment in an asset sale than in a stock sale, but all contracts should be reviewed.
• Are there any expired contracts that the parties are still operating under?
• Are there any outstanding disputes with major contract counterparties?
Real Property and Environmental.
• Is ownership and use of real property properly documented? (Sometimes real property will be held by a separate company but used by another, which requires at least a simple lease.)
• Are there any title defects or disputes related to any real property? If real property is being purchased, the purchaser is likely going to review the title history, and any unexpected issues can cause delays.
• Is there any risk of present or past environmental contamination on the property? Be prepared to update buyers/investors on status and remediation.
• Has the company received any notice from a governmental authority regarding contamination or potential contamination?
• Is the company in compliance with environmental permits?
Believe it or not, this is just a “short” list of some of the issues that may come up. But again, it’s the end of the year, and plans are firmly on your mind. In between sips of eggnog, take some time to start mapping out these areas so that you, rather than a tight deadline, are in control.
Partner Joshua A. Penner is a member of the corporate practice group Harris Beach PLLC. He also leads the firm’s science and technology industry team and is co-leader of its photonics industry team.