“The bad things you can see with one eye closed. But keep both eyes wide open for the little things. Little things mark the great dividing line between success and failure.”
Jacob Braude, Author and Humorist (1896-1970)

By Sean Brown[1] and Ladd Hirsch

In business, an eyes wide open approach is essential to the successful purchase of a private company. When the purchaser of a private company enters into a letter of intent (“LOI”) or reaches a handshake deal to buy a private business, the little things often have not yet been fully disclosed and it therefore remains to be seen whether the transaction will fail or succeed. This post reviews focuses on little things that a private company buyer should make sure to address to achieve an optimal outcome, including steps to be taken after the parties have signed the LOI.

Little Thing No. 1: Conduct Adequate Due Diligence

Due diligence, in the context of mergers and acquisitions, is commonly referred to as the process by which the buyer gathers information about the business or the assets for sale. It is crucial for a buyer to conduct sufficient due diligence to establish the following information, a minimum, before closing on the purchase:

Confirm the seller has the authority to sell the stock or assets of the target company;

  • Identify and investigate potential liabilities or risks;
  • Identify necessary steps to integrate the target business into existing business; and
  • Identify any obstacles to closing the transaction, such as shareholder consents, third-party consents, or prohibitions on transfer.

Establishing this information requires the buyer to review the seller’s organizational documents, such as formation documents, bylaws or operating agreements, benefit plans, vendor contracts, supply contracts, and customer contracts. Some of the common issues the buyer will need to focus on are: (i) ownership of the target company, (ii) existing management of the company, and (iii) necessary consents from third-parties in connection with key contracts. Continue Reading Buyer Beware: Purchase a Private Company With Both Eyes Wide Open

By Ladd Hirsch and Trip Dyer[1]

“There is no such thing as a free lunch.”  It is a common expression with a clear meaning— don’t expect to receive something for nothing.  But there is an important corollary expressed less often: it is possible to receive something that will have value in the future, but without having to pay for it now.  Like seeds waiting to sprout, the concept of a private company profits interest fits this description of an asset with no current worth, but which may become quite valuable over time.  The profits interest therefore has an important role to play in the private company context, but what exactly is a profits interest and how does it work?

Defining a Profits Interest

In brief, a profits interest is a creative way for private company business owners to provide their employees with a significant financial incentive—an ownership stake in the company—but without saddling them with a tax burden when they receive this interest.  A profits interest can serve a purpose that is similar to a stock option by granting an equity interest in the company to the employee, but unlike some stock options, the employee does not recognize income or pay taxes on the grant of a profits interest because the profits interest has no value when it is granted.

The absence of value is because a profits interest is forward-looking; it provides the employee with a share in: (i) the company’s future profits and (ii) the appreciated value of the company.  If the company was liquidated on the day that the profits interest was granted, the employee would receive no proceeds from the liquidation.  The employee receives financial benefits only when the company’s assets are sold for a higher value than the date the profits interest was issued or when the company makes distributions with respect to future profits.  Further, the employee is not required to contribute any capital and is awarded a profits interest based on the services that the employee has provided or will provide to the company. Continue Reading The Equity Profits Interest: Giving Seeds Time to Sprout, Incentivizing Key Employees, and Keeping the Tax Collector at Bay

The statistics are grim on relationships remaining intact between business partners.  This month’s edition of Inc. magazine cites Noam Wasserman, entrepreneurship professor at USC’s Marshall School of Business, reporting that 10% of co-founders end their business relationship in less than one year and 45% break-up within four years.  While these statistics are focused on two-person owned companies, break-ups are at least as common among businesses with multiple owners.  Faced with these distressing figures, this post focuses on concrete actions that business partners can take at the outset when their company is formed or when an investment is made, which our experience teaches will improve their prospects for maintaining long-term business relationships.

Operational issues and the vision for the company can definitely lead to disputes, but in many (if not most) cases, the crux of the conflict between business partners comes down to a disagreement over money—how the financial pie will be split.   Our suggestions therefore key on how the company’s finances are handled.  The starting place is to put an exit plan in place at the outset of the relationship —a Buy-Sell agreement that governs any future Business Divorce.  This “corporate pre-nup” will help avoid litigation and a huge distraction for the company when a partner departs.  We have written extensively on this topic in previous posts (see links below), and adopting a partner exit plan is essential.

But the Buy-Sell Agreement only comes into play when business partners are separating.  There are three specific steps that partners can take when their relationship begins, which will help limit their conflicts and, perhaps, avoid the need for a Business Divorce in the future. These steps are: (1) adopt a dividend/distribution plan, (2) implement an executive compensation plan or formula and require annual valuations of the company prepared by an independent business valuation firm.  Each of these actions is discussed below. Continue Reading Can We Keep the Band Together: Seeking Long-Term Harmony Among Business Partners

By Brad Monk and Ladd Hirsch

People change, and not always for the better. Which leads to the question:  what is the best course of action when a trusted business partner turns out to be a rotten egg?  The answer is not easy, but usually the best course of action is to promptly remove an untrustworthy partner from ownership in the business and also from participation in the company’s management.

Removal Provisions Need to be in the Governance Documents

The process of removing a bad business partner is often unpleasant and difficult, but it is likely unavoidable.  To prepare for this type of risk, diligent majority owners will want to include “removal rights” in the company’s governing documents (the LLC agreement, the partnership agreement, or corporate bylaws) that provide for the removal of business partners who go off the rails.  By the same token, minority investors will want to closely review all “bad boy” provisions to insist on changing these terms if they give the majority owner unbridled power that could be used abusively to harm the minority investor. Continue Reading Be Careful With the Rotten Egg: Removing a Bad Business Partner From the Company is Difficult

By: Mark G. Johnson and Ladd Hirsch

Recognized by Texas Bar Today’s Top 10 Blog Posts

In Edgar Allan Poe’s short story, the Purloined Letter, his fictional sleuth, C. Auguste Dupin, successfully located a stolen letter the thief had cleverly concealed by hiding it in plain sight.  In the legal world, letters of intent (LOIs) are used to form partnerships, raise funds, and add investors, among other things, but the common use and non-binding character of LOIs does not mean they are problem free.  This post takes a look at LOIs and focuses on issues that may be overlooked, but which can create significant legal problems in the use of LOIs.

Letters of intent are referred to by many different names, including memoranda of understanding, term sheets, agreement in principles.  Whatever it may be called, an LOI is simply a summary description of the essential terms of a business transaction.  In most cases, the parties intend that the LOI will be non-binding and will not establish an enforceable agreement between them except as to one or two provisions, such as confidentiality and exclusivity.  Due to the non-binding nature of LOIs, and the fact they “have no teeth,” business owners and investors may conclude there is no need for or value in retaining legal counsel to negotiate and draft LOIs.    This common sense assessment, however, actually reflects a risky business strategy.  Whether the proposed transaction involves the start up of a new company or the investment in an existing business, hiring an experienced business lawyer to assist is a wise, cost-effective decision. Continue Reading Hiding in Plain Sight: Often Overlooked Problems with Letters of Intent

By Ryan Bruderer and Ladd Hirsch

Recognized by Texas Bar Today’s Top 10 Blog Posts

Just as an excessively lavish desert can ruin a fine dinner, including an overly broad indemnity provision in a private company agreement can prove to be too much of a good thing for the company.  The point of indemnity provisions is to protect company executives (e.g., officers, directors, managers) from claims made against them in the good faith performance of their duties.  To ensure the net is broad enough to include all types of claims made against executives, however, these clauses are often drafted quite broadly.  But when the provisions are so inclusive they exceed their intended scope, another truism may apply—the cure may be worse than the disease.  This post discusses the effective use of indemnity provisions in private company governance documents and reviews potential drawbacks that can result when these provisions are drafted without appropriate limits.

Continue Reading Too Much of a Good Thing: Avoiding Unwelcome Results From (Too) Broadly Drafted Indemnity Provisions in Private Company Governance Documents

July 2018

A search for the perfect buy-sell provision for use by private company owners and investors may be akin to hunting for a unicorn, because the business objectives of majority owners, on one side, and minority investors in the business, on the other, are rarely, if ever, fully aligned.  But, if this search is limited to focusing solely on the terms of a buy-sell provision that addresses the critical business concerns of both majority owners and minority investors, that task is not beyond the rainbow.   What is clear is that majority owners and minority investors share an interest in putting a buy-sell agreement in place at the start of their business relationship.  This post therefore covers the essential terms that owners and investors will both want to consider in a provision that strikes a balance in a mutually acceptable buy-sell agreement.

Continue Reading The Perfect Buy-Sell Provision: Is it a Unicorn, or is There a One-Size-Fits-All for Every Company

By Liz Monteleone and Ladd Hirsch

It is rare to find a business partner who is selfless. If you are lucky, it happens once in a lifetime.

Michael Eisner, Chairman and CEO of the Walt Disney Company from 1984 to 2005

Starting a company with a best friend or family member may sound like a great plan, because these new partners share a high level of trust and a close personal relationship, as well as excitement over launching a new business.  These co-founders foresee no problem in forming the company as a 50-50 split in which they expect to share equally in the company’s ownership, management and control.  In this heady state of forming a new company, akin to the bloom of a new romance, it may seem off-putting to consider and address a potential future ownership break-up in which one of the partners leaves the business.

But as former Disney CEO Michael Eisner notes, finding a selfless business partner is exceedingly rare, and the more likely result is that a serious rift will arise in the partners’ business relationship in the future.  It may be caused by a divorce, an unexpected illness or a change in business priorities that develops over time.  But realistically, the question is not “if,” but “when” a disagreement will arise, and how the business partners will handle this conflict and the potential need for them to participate in a business divorce.  The failure to acknowledge this risk at the outset and then address how to manage a deadlock or to structure the company to enable an amicable separation can result in significant cost to the partners and the business. Continue Reading Half a Loaf is Better Than None—Except in Private Company Investing: The Potential Pitfalls of a 50% Ownership Stake in a Privately-Held Company

The number of businesses that fold due to bad partnerships is staggering.  In some cases, they are charlatans, in others inept business people, and others find themselves unable to scale with any growth.

Michael E. Gerber, World’s No. 1 Small Business Guru according to Inc. Magazine.

For all the success stories of start-up businesses that made it big, they are far outnumbered by the many companies that failed to achieve lasting success.   According to the U.S. Bureau of Labor Statistics, approximately 50% of new companies are out of business within five years, and only one-third of new businesses last for a full 10 years.  The causes of these failures are many, but one of the biggest challenges that new, jointly-owned businesses face are conflicts between the company’s owners—it is difficult for any business to survive a bad partnership.

While the importance of finding a good business partner is well-known, what is less understood are the characteristics of a good business partner.  Our views on this important issue are based on experience.  In our Business Divorce practice, we have worked with both owners and investors in  hundreds of private companies, and this vantage point has allowed us to observe first-hand both remarkable business successes, as well as epic company failures.  From our position in the trenches advising owners and investors, we have concluded that the best business partners are: accountable, adaptable and accessible.  This post takes a look at these three traits in more depth. Continue Reading With Friends Like These, Enemies Aren’t Needed: Character Traits of Great Business Partners

Peace is not the absence of conflict, but the ability to cope with conflict by peaceful means.

— President Ronald Reagan, Commencement Address at Eureka College in Illinois, May 9, 1982.

The business relationship between private company majority owners and minority investors does not have to be a zero sum game—there are positives available for both sides in their business dealings.  But, a win-win approach for majority owners and minority investors needs to begin at the outset when they negotiate and adopt a buy-sell agreement at the time the investment is made in the company, which provides terms that will govern the eventual exit of the minority investor from the business.

A buy-sell agreement will not eliminate all conflicts between company owners and investors, but signing off on a “corporate pre-nup,” which carefully balances the rights of both parties should help lessen the potentially contentious nature of the investor’s ultimate departure from the company.  This blog post therefore reviews some of the critical terms that majority owners and minority investors will want to include in their buy-sell agreement to provide for a more peaceful future Business Divorce between them.  Those terms are listed and discussed below: Continue Reading Threading the Needle:  A Win-Win Buy-Sell Agreement for Private Company Majority Owners and Minority Investors