Happy New Year!
If you’re like me and countless others, the New Year is a time to reflect on where you are and where you want to go in the coming year. Just as 2018 offers a fresh start to achieve your personal resolutions, the same holds true for your business goals and aspirations.
In the business context, a proverb (often attributed to Benjamin Franklin) I like to embrace is “[a]n ounce of prevention is worth a pound of cure.” I use this saying to guide my thoughts on minimizing potential legal liability. To this end, as your company gets started in the New Year, I strongly encourage you to include a legal checkup as part of its first quarter 2018 ‘housekeeping.’
Think of the legal checkup as being similar to one that you would have with your personal physician. Basically, it’s taking stock of where your business’s legal and strategic matters are currently and to identify areas for improvement/updates. Once you’ve identified these areas, you can address them deliberately at your own pace before they turn into potentially expensive time-consuming problems (the ‘ounce of prevention’).
With a legal checkup, you’re conducting a top-level review of your business’s legal records. Examples of matters that may need to be addressed include: i) updating internal agreements such as shareholder agreements if one or more key shareholders have sold their interests in the prior year; ii) updating/modifying existing customer agreements to reflect most current terms of service (or frequently negotiated provisions); and iii) preparing for anticipated M&A activity.
The remainder of this legal checkup blog will explore the example of a prospective purchaser (“Buyer”) interested in buying your business. Specifically, there are certain basic items the Buyer will ask to review during their research on your business (note: this process is often referred to as “due diligence”). The Buyer conducts due diligence to understand “what” they are buying – both in the way of liabilities and customer driven income. Following is an overview of key items and areas of your business a Buyer will likely ask to review (note: all should be included as part of your business’s legal checkup):
I. Corporate Organization:
- Type of Entity;
B. Articles of Incorporation (or if not a corporation, other organizational filing)
- Action by Majority Written Consent;
- Board of Directors and Officers (Indemnification);
C. Bylaws and amendments (or similar internal org. doc such as an operating agreement for a limited liability company)
D. Director and Shareholder Meetings/Actions
- Note missing meetings/minutes;
- List and history of officers and directors;
- Voting requirements/action by written consent.
II. Capitalization and Records
A. List of Owners (including each related company and subsidiary)
B. Unit of ownership
- Record of units issued (transfer ledger)
C. Shareholder Rights
D. Shareholder Agreements
E. Voting Agreements
F. Equity Financing
- Common Units;
- Preferred Units (preferences).
G. Debt Financing (e.g. line of credit, term loan, etc.)
III. Material Contracts: Third Party and Customer Matters (check material terms, any breach of terms and barriers to transfer)
A. Service Agreements
B. Purchase Order Agreements
C. Consulting Agreements
D. Sales Agreements.
From my experience representing buyers and sellers of businesses, due diligence review of the items listed above is almost universal. An important objective for your legal checkup is to have all of your legal records in a format where they are easily accessible by you and your professional advisors. Having those materials current will benefit and expedite any due diligence process, one of the reasons why an annual legal checkup can be so helpful for your business. When companies do not have their records readily available and current, it can lead to reservations on the Buyer’s part with regard to the health and management of the company and may very well negatively impact the sales price.
Why is a legal checkup important today (even if you’re not actively selling your business)?
- Your business may find agreements that need to be updated or modified (remember the example of the shareholders and customer agreements noted above);
- Searching for missing/incomplete records in the future can be time consuming and wasteful of your resources; and
- Complete corporate and sales records are ‘good housekeeping’ for all of your future endeavors.
Ready to get your ‘legal house’ in order for 2018? Please call me and let’s discuss how we can help you do so. The ‘ounce of prevention’ approach will save your business time and money.
LAWYERLY DISCLAIMER: none of the foregoing items from the list should be deemed exhaustive, nor should this post be construed as legal advice.