By Harvey Koning
This primer was written to help newspaper managers and owners pursuing a sale of their business. We touch on the basics of the sale process with a focus on the legal aspects and documents.
The transaction will involve some unfamiliar procedures and terms for those who have not had prior experience buying or selling a company. Your lawyer, accountant and business broker are there to advise you. The better you understand the key concepts, the better equipped you will be to make good decisions and reach a good result.
The timeline for your deal will likely include:
Letter of Intent
The buyer you select will produce a written proposal letter or letter of intent naming the price, transaction structure and key terms. It will be “nonbinding,” meaning that everything remains subject to negotiating and signing a more detailed definitive purchase agreement. The letter of intent will often include a binding agreement to negotiate exclusively with the buyer for a period of time.
The buyer will do a thorough review of your business. This will include a review of the financial statements, contracts, employee compensation and benefits, real estate and other key aspects. You may be frustrated by the amount of information the buyer requests and the time it takes to respond. If a particular request is especially burdensome, do speak up. However, it is almost always better to produce the information when possible rather than argue about whether the buyer really needs to see it.
Review of Governing Documents
Early in the process, the selling corporation should review its articles of incorporation, bylaws and any shareholder (buy-sell) agreements. Look for anything that might affect the transaction, such as rights of first refusal or super-majority vote requirements. Your attorney can help you with this.
Structure – Sale of Assets
Most purchases of newspaper companies are structured as asset purchases. The corporation selling the business transfers all the business assets to a corporation controlled by the buyer. Sometimes the buyer forms a new corporation to purchase the assets and sometimes it uses an existing entity. The seller keeps its corporate entity and dissolves it sometime after the closing. Buyers do this to avoid any known or unknown liabilities that your corporation may have.
Transferred assets include owned real estate, equipment, furniture, accounts receivable, prepaid assets, the “goodwill” of the business, the name of the paper, all website addresses, etc. In most cases, cash is retained by the selling corporation.
Some working capital liabilities may also be transferred to the buyer, such as accounts payable. Bank debt and other long term liabilities are typically not assumed by the buyer. Liabilities not assumed by the buyer remain an obligation of the selling corporation.
Larger media companies purchasing smaller newspapers typically pay all cash. Some of the purchase price (often 5% to 15%) will be placed in an escrow account with a bank for an agreed-upon period of time (more on that below).
The purchase price is for the “enterprise value” of the business without regard to bank debt and other long term liabilities. You will need to pay off any bank debt or other long term liabilities out of the purchase price. Other liabilities may include deferred compensation payments and any severance obligations.
The purchase price will often include a “net working capital adjustment.” Net working capital is current assets (excluding cash) minus current liabilities. Net working capital varies daily as revenues are received, expenses are paid and liabilities and prepaid assets are accrued.
When a business is sold, the buyer and seller will often agree on a “net working capital target.” The target is intended to be a normal amount of working capital that should be there as of the closing. If the actual net working capital at the time of closing exceeds or is less than the target amount, then the purchase price is increased or reduced dollar for dollar.
You will want to be very careful about selecting the net working capital target because any shortfall at closing will reduce the purchase price. Newspapers have a large liability for subscriptions that have been paid for but not yet delivered. Accounting rules treat this as a liability. It is so significant that a newspaper’s net working capital is often a negative number.
Asset Purchase Agreement
The buyer will prepare a detailed Asset Purchase Agreement (APA) that may run 30 to 50 pages or more. The APA will list what assets are being purchased and the purchase price.
The APA will include a large number of “representations and warranties” that the seller makes to the buyer. Typical representations include:
If the representations are not true at the time of the closing, the buyer is not required to complete the transaction.
If after the closing the buyer discovers that a representation is not true, the buyer may have a claim against the seller. For example, if the seller represents that the equipment is free and clear of liens and it turns out there is a lien, then the seller would be responsible to pay off the lien. The purchase agreement will include a number of limits and procedures related to how and when the buyer can make a claim against the seller.
How do you protect yourself? By providing the buyer with “Disclosure Schedules” disclosing any problems or facts contrary to the representations. For example, the agreement may say, “Except as disclosed on Disclosure Schedule 3, there is no pollution contamination in the real estate.” If you know of contamination, list it on the schedule. If you disclose it before the closing, the buyer cannot make a claim after the closing. This is where the due diligence review helps you too.
The APA will include a list of “covenants” – legalese for promises. The seller will promise to operate its business “in the ordinary course” between signing and closing. The seller will also agree to “negative covenants,” promising not to do certain major actions between signing and closing, such as entering into a large new contract or making a large dividend.
Board of Directors and Shareholder Approval
The board of directors should review and approve the definitive Asset Purchase Agreement before it is signed. If a board of directors decides that a sale of the company is the best decision, the directors have fiduciary duties to get the best deal for the shareholders and make an informed decision. Hiring a business broker and soliciting multiple bids for the business is considered the gold standard for a good process designed to get the best possible price. The directors should carefully review the deal terms and transaction documents. Directors should include their lawyer in the board meeting and ask the lawyer to walk through the key terms of the legal agreements. Your attorney can help you prepare board minutes that document the process you followed and your reasons for doing the transaction.
The APA must also be approved by the corporation’s shareholders (by a majority of the outstanding shares unless there is a super-majority vote requirement). The shareholder meeting takes place sometime between when the APA is signed and when the business is transferred at the closing. It is essential to have a valid shareholder approval so care should be taken to give proper notice of the meeting and to follow good corporate procedures consistent with the company’s bylaws.
In addition to approving the sale of all the assets, the shareholders will often also vote to dissolve the corporate entity after the closing. During the dissolution process, the corporation turns its assets into cash, pays its liabilities and then distributes the net proceeds to shareholders. More on this wind-down process appears later in this primer.
Most every state has a corporations statute that includes something called “dissenters’ rights.” Early in the process, your attorney should review the corporations statute and advise you about whether the transaction is exempt from the dissenters’ rights provisions. In most states, dissenters’ rights do not apply when assets are sold for cash and the proceeds are distributed to shareholders within one year. If dissenters’ rights apply and the transaction is not exempt, a dissenting shareholder has certain rights to go through a process designed to determine the fair value of his/her shares.
If the seller leases real estate, the lease must be carefully reviewed. Often it will be necessary to get the landlord’s consent before transferring the lease to the buyer. If the seller owns the real estate, then the real estate will most often be transferred at the closing.
Title insurance will be obtained to confirm that the seller owns the real estate and to identify any mortgages, easements or other lines or encumbrances on the property. The buyer will expect all mortgages to be paid at closing so that it gets clean title to the property.
Often the buyer will get a survey of the property to show the precise property boundaries and to show the building’s exact location on the property.
The buyer will also often hire an environmental consulting firm to examine the real estate for any contamination or asbestos. A “Phase I” assessment involves a tour of the property, a look at the history of the property and a determination of whether there are any “recognized environmental conditions” that may require further investigation. If it looks like there may be serious issues, the buyer may proceed to a “Phase II” assessment which involves taking soil borings and testing them for contamination.
The buyer may also get a building inspection to inspect the structure, HVAC systems, roof, etc.
Net Proceeds to the Seller
The corporation selling the business closes the transaction and receives the cash purchase price. Out of the purchase price, the seller must pay off its bank loans and other long term debt. It must also pay its transaction expenses, which include the business broker fee, attorney fees, accountant’s fees, real estate title insurance, etc. Any net working capital adjustment will also affect the net proceeds to the shareholders of the selling corporation.
Early in the process, your CFO and outside accountant should prepare an estimate of what the net proceeds to the owners will be after payment of all expenses and taxes.
The buyer will often hold back part of the purchase price, often 5% to 15% of the total. That money will be put in an escrow account for a period of time. If the seller has misrepresented the business to the buyer, the buyer will take from escrow money to make itself whole. If the buyer does not have any legitimate claims, the money will be distributed to the seller at an agreed upon date, often 12 to 18 months after the closing.
For sellers, one tactic is to negotiate a staged release of the escrow funds. For example, 50% to be released to the seller six months after the closing with the remaining 50% to be distributed to the seller 12 months after the closing.
Employee Transition to Buyer
In an asset sale, the employees are the seller’s employees before the closing and the buyer’s employees after the closing. The buyer will typically do the same new employee intake paperwork that it would do for any new employee. Employees may be required to fill out an employment application, a form I-9 to verify employment eligibility, etc. Employees will enroll in the buyer’s benefit plans. If the seller has a 401(k), then arrangements will be made to transfer balances to the buyer’s 401(k) or to individual employee IRAs. This process can begin well before the closing.
A buyer is not required to hire all of the seller’s employees. Sellers should ask buyers about their intentions as part of the negotiation process. Sellers should consider severance obligations and policies for any employees not hired by buyer.
At the closing, the final documents are delivered, the buyer pays the purchase price and the business is transferred. Often it is a “virtual closing” that does not require people to be physically present in the same room. The lawyers arrange to get documents signed and delivered where they need to be. When everything is set, the parties and/or their lawyers will get on a conference call, agree that everything is done and direct the buyer to transfer the purchase price.
After the Sale
At the closing, the seller transfers substantially all of its assets and receives the purchase price. The selling corporation then enters a wind-down period that may take three to 12 months. The corporation must pay all its creditors. A final tax return must be filed. The net remaining cash is distributed to shareholders. The cash distribution sometimes is done in stages with an initial distribution made early on and the remainder distributed after all expenses have been paid.
The seller will need to determine who will do the wind-down work after the buyer has hired the employees. Outside accountants are often involved. Sometimes the buyer will let one of the employees “moonlight” for the seller for a while to assist with this transition.
This primer was prepared by Harvey Koning, an attorney with the Varnum LLP law firm in Grand Rapids, Michigan. It includes general information and does not constitute legal advice. You are encouraged to work closely with your attorney, accountant and business broker. All agreements should be carefully reviewed in light of your particular situation.
Harvey can be reached at email@example.com, 616-336-6588 (office), or 616-822-5269 (cell).