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May It Please The Internet

May it Please the Internet: Getting Your Business Ready to Sell

By John DiGiacomo

Getting Your Business Ready to Sell

John Di Giacomo and Eric Misterovich open the Revision Legal Podcast: May It Please The Internet series with a discussion about getting your business ready for sale. They dive into eCommerce, economies of scale and large roll-up funds.
Show Outline:
a. Take a hard look at your business, what is sloppy?
b. Getting books in order
i. Knowing your landed costs of inventory without question

  1. Including any customs fees
    ii. Document and organize loan documents, get a personal contact with the
    lender if possible
    iii. Clean up internal house – operating agreement, who owns your
    business, who needs to approve the sale, etc
    c. Independent contractor agreements
    d. Supplier contracts
    e. Registering and chronicling IP
    i. Make sure right entity owns it

John: Hello, everyone. This is the Revision Legal podcast, may it please the internet. And today we are talking about getting your eCommerce business ready for sale. And I have my partner here, Eric Misterovich. Hello, Eric.

Eric: Hi, John.

John: That was very sharp.

Eric: We’re here. We’re sharp. We’re ready to business, ready to sell some online businesses.

John: Well, today we’re talking about online businesses and getting your business ready for sale. And this is a huge market right now, and we’ve been lucky enough to represent a number of these large roll-up funds. And Eric, explain what these roll-up funds are. What do they do? And why are they such an important thing for eCommerce?

Eric: Yeah, it’s been an explosion of them. We can probably dig up some of the articles. There’s a New York Times article from a year or so back explaining kind of what’s going on in this space. And it is these privately funded entities and funds that are buying up eCommerce businesses with the idea that if their economies of scale and their resources can take a business that was maybe a million dollar business and grow it into a $10 million business, and that when they have supply chain systems and things worked out, then they can combine forces and make this big monolith of brands that is making a lot more money than when they bought them.

John: Yeah. And these roll up funds are really making millionaires out of people who are just selling on Amazon as a mom and pop business or as a single seller, and it’s changing the way that the world is working at this platform. So, when they go to sell these businesses, a lot of times we have to take a hard look at them. What do you see the first time you look at a business that somebody wants to sell to one of these roll-up funds?

Eric: That’s a good question. Before that, though, when you talked about making millionaires out of people, that is something that I really don’t think should be overlooked, and it’s one of the parts of our job that I really love is when we work with sellers and you help someone sell a four or five million Amazon business that they started from scratch. It’s life changing to that person. They were making a lot of money before, but when escrow clears and you that four and a half million bucks for some product you sourced, designed, handled all the supply chain, your family’s life is different forever. And being an attorney has a lot of difficult, stressful aspects to it, but that one is a fun part of the job.

John: You know, I always find too that you ask them, “What are you going to do with this money?” And you expect them to say, “I’m never going to work again,” or, “I’m going to vacation in Tahiti.” And oftentimes they say, “Well, I’m just going to go start another business.” So they get the taste of what it feels like to sell a multimillion dollar business and they go right back at it, which is also kind of cool. It’s building an ecosystem that otherwise didn’t exist

Eric: Almost every time they already have another idea. And usually we’re talking about the non-compete provision and they are telling me what their next idea is and we’re making sure it flies with the non-compete that they’re going to have to agree to. So, yeah, I think once you learn how to do it and you’re successful at it, you’ve probably made a lot of mistakes to get there, these are not overnight successes, even though they can grow quickly, and you’ve learned and you’re ready to go and do another one. So it is fun. I love that part of the job.

John: Yeah. So going back to my original question, when I look at these things, these businesses, and we get a hold of a seller for the first time, it’s often a mess. Wouldn’t you agree with that?

Eric: Yeah. The sellers, a lot of times, they’re very small businesses, one owner, maybe with a couple independent contractors, or a few owners of the business, but one person’s primarily running it. And from the legal part of stuff, things are not in order very often.

John: I often talk to a seller about valuation and they get upset because they have to roll out their Tesla. It’s not a part of the valuation of the assets. Or they have to stop taking the vacations. And it’s a realization that some of the benefits of owning a business are going away, and they also factor against the valuation that they ultimately get on the business itself. And it’s hard to get those books in order, but I think it’s really important to get it done. And why do you think that is? You represented buyers and sellers. Why is it so important to get those books in order?

Eric: The due diligence process and the legal purchase agreement process is so taxing and difficult, time consuming and stressful, and it’s the only thing on your mind. Well, it’s going to be a lot easier if things are in order. Things are going to move faster. And ultimately, what you’re trying to do is sell this business and you’re going to have a better chance of doing that when a buyer is able to conduct some initial due diligence and see things that make sense. You’re going to be more attractive because it’s probably going to be an easier process for them to complete their diligence.

John: Yeah, I agree entirely. And I often think about the opposite side where you are in the APA, you’re building out the asset purchase agreement, and you’re close to the end, or you’re during migration, and the buyer takes hold of the asset and then takes a closer look at how sales are happening or how expenses were booked to the business, and they realize that things didn’t actually happen the way that you described them. And so I think getting those books in order is important also for that reason, because it creates these settled expectations and it reduces litigation later on in the asset purchase process. And it’s just great to be able to close quickly. These roll-up funds want to close within one week, two weeks, as you and I both know because they’re yelling at us to get deals done in that short period of time. So it just makes life easier for everyone involved.

Eric: Yeah. We represent buyers and sellers, and when we are doing the initial round of legal due diligence, we have our own items to handle. Typically, bigger buyers are going to handle the financial and supply chain diligence on their own. We’ll be brought in when there’s issues that come up. But you can tell right away when there’s going to be problems. Things don’t match up, things don’t make sense. You’re not sure who is who, who owns what. And it just really can cause problems. Then if the business is good enough, buyers are going to push through. But if there’s a lot of problems early, it may prevent a real commitment to closing the deal.

John: A good example is we handled recently a situation where there was an issue over customs fees, where one party’s customs broker is saying customs fees per unit are a dollar, where the other party’s customs broker is saying, no, I think they’re more like $7. And that becomes a big sticking point, and it becomes difficult to close a deal when you don’t have an agreement on what those expenses actually are. So, yeah, I agree. I think it’s an important part of the process. What else is important?

Eric: The custom fees are an area that can really cause problems because it may be an expense that sellers are intentionally reducing by maybe not declaring the actual value of the custom fees. And when you do that, it’s not just that it’s a problem that is going to be uncovered, that’s a problem that can impact purchase price because your fees and your expenses are actually a lot higher than what you portray them to be. And that’s an area that can really cause some problems. And sellers know they’re doing it. It’s not a surprise. So that’s one where if you’re selling your business, it’s hard to have a true valuation if there’s a big discrepancy in those kinds of custom fees.

John: What else do you think a party that is getting ready to sell should be looking at? When I think about this stuff, the next area that I go to is really contracts and kind of making sure that I have my head around what contracts exist, what contracts need to be assigned, what contracts cause potential liabilities that have to be addressed in the asset purchase agreement. What do you look at in that area?

Eric: I think that’s what a buyer is going to ask, you’re exactly right, where are the contracts? Let me see them. What can I get? What’s a problem? The reality is most sellers say, “What contracts? I don’t have any.” There’s none exist. And that’s not necessarily a problem. A lot of sellers of very successful businesses have few, if any, contracts. But there’s some that are more important than others. And one of those areas goes around if you’re a big enough seller where you’re taken on debt to kind of leverage your business is your loan documents, understanding who has taken out the loans, what assets are secured by the loans. And a lot of times, having a contact with that lender, because what happens is you’re not going to be able to fully be paid out until that loan’s paid off, and if you’re working with the SBA or some other large lender and you don’t have a personal contact, it’s a real pain in the ass to get confirmation that the loan has been paid off and that you have the appropriate UCC filings, which can slow up when you get paid. So getting those loan documents in order, trying to get a real personal contact at that lender is really helpful.

Eric: But then on the same time, your own internal agreements, who owns the business, where is your operating agreement? How do you prove to the buyer you have the authority to sell this business? It’s something that’s really easily overlooked, easily solvable, but may not be readily apparent to sellers when they’re getting ready to sell.

John: One of the big things that I see with due diligence and one thing that holds it up significantly, is when you have, for example, Chinese sellers, and they have multiple accounts under multiple names, which is often the case with those particular sellers, particularly because they have different business names, they have spellings that are different between the translation of Cantonese or Mandarin or whatever it might be into different Roman character representations. And that becomes really difficult to do due diligence on because you’re searching for keywords that don’t make sense within the English language to us. And it becomes very difficult to do lien searches and determine where an organization is organized so you can see whether or not they’re in good standing. I find it to be really important, particularly in foreign transactions, to get that stuff in order at the outset so that you really know who’s selling what and it doesn’t become a dispute later.

John: And again, like you said, getting ownership contracts in place, things like who made that logo for you 10 years ago? Well, there’s going to need to be a contract that assigns that logo to you because without it, you don’t own it and you can’t sell it. You have to tie up those loose ends, and it’s a pain, and it’s a lot easier to do either at the time that you are creating the logo, for example, or your software developer is creating your custom software than it is to do just before sale. Although it can be done just before sale, but it’s easier to do it at the outset.

Eric: This is surprisingly an issue that comes up pretty late in the process way too many times, which is who owns what, especially when it comes to intellectual property. So if we’re talking about primarily Amazon eCommerce businesses, unless you own a patent, then we’re primarily talking about copyright. So who took the photos for all the product listings? Who took the videos? Who wrote all the copy? Who was in charge of social media? And majority of time, there’s at least some portion of photos or images or video or text that was outsourced to someone else and no one really remembers who that was and it was a long time ago. But you’re not really making the buyer real comfortable and the risk. So from the buyer’s perspective, not having full title to all of the copyright rights is a major problem because copyright infringement is strict liability. It doesn’t matter that it was a mistake. It doesn’t matter that the buyer wasn’t really the one that was involved. If they continue using an image that’s infringing, they’re liable. So it’s not just like cleanup, it has real impact. And so understanding and documenting what pictures you own, what pictures you don’t own, you have to do it. And if you do it at the outset, it’s just going to make things go faster.

John: I think it’s important to stress that that liability isn’t temporary, it’s liability that extends for multiple years. And in any APA, any asset purchase agreement, where a buyer is buying your business, there is going to be an indemnification clause that says that you will indemnify us against any IP infringement claims that arose prior to the closing of the sale. And that means that any images that you didn’t track down and get contracts for are potentially going to pop up three to five years later and you can get sued for it. And we’ve represented a number of buyers who got sued, and then the buyer has to turn around and seek indemnification from the seller for that lawsuit years later. And everyone’s upset about it because no one wants to be in a lawsuit. And then particularly the seller is upset about it because they thought they could spend all that money or go do something else and they had no risk or liability when all this stuff hadn’t been cleaned up at the beginning. So it becomes a huge problem for everyone involved.

Eric: And it’s a classic example of where the cover up is probably worse than the crime. If you know you don’t have the rights to images, tell the buyer, tell the buyer upfront, put it in the asset purchase agreement. Because the easy fix here is the buyer gets new photos. This isn’t that complicated of a problem to solve. The buyer just doesn’t use those photos or at least understands the risk if it continues to use those photos. If you just say, “Yeah, I own everything,” and you don’t, that’s when you have a problem. And being upfront, honest, disclose those things, it’s going to work out better because there’s usually a business solution on these items. Even if it’s a relatively major problem in terms of IP, most of the time it’s solvable. There are ways to make this not nearly as scary as it may sound.

John: Another area where I see a lot of the hangups or the difficulties in due diligence, or even after the closing of a sale like this, is supplier contracts. And with supplier contracts, the risk is always that one, they aren’t exclusive, so there is another party, for example, selling on Amazon that could sell exactly the same product under a different brand; or two, that because there is no written agreement between the seller and the supplier, that immediately when the buyer takes over, the supplier raises the prices. And so we often see that not having those contracts with fixed prices in place that can be assigned becomes a problem for buyers.

Eric: Yeah. Perfect world, you have all these contracts, they’re all buttoned up and signed in blood and they can never be broken. But the supplier contracts ones, it’s tough because a lot of the times, sellers don’t have these. And the buyers, they can be pretty reasonable about what exists and what doesn’t, but if you have those agreements, even if you just have a course of history saved in writing, that kind of evidence is the terms on which everything is working, that is better than nothing. But those supplier contracts, if you can get them and you can get something that says have exclusive rights and lock in some terms, then you’re going to be a lot better off.

Eric: But the supplier issue, too, is when I’m helping a seller and we’re in the middle of negotiating a purchase agreement, I always tell those sellers, “Listen, talk to your suppliers basically as little as possible. Do not strike up a conversation with them. Don’t try to shoot the with them. And do not talk about a potential sale.” Because it could result in a scenario where they talk about raising the price. And that’s a problem because any purchase agreement you sign, you’re going to have to make a promise that you don’t have any knowledge of pending price increase. And I had a deal specifically day before closing, seller kind of started cracking some jokes, and next thing you know, the supplier’s talking about raising prices and it caused a major problem. We resolved it and the price didn’t change, but that took some trust on the part of the buyer and a lot of communication with the supplier and probably some sleepless nights for the seller. So dealing with those suppliers right before selling is a very sensitive topic.

John: Yeah, I agree entirely. And I think another area of concern with suppliers is a lot of times we don’t know whether or not what the supplier is producing is covered by a patent or not. So we’ve had cases where the supplier actually owns the patent and a buyer comes in as it bought the business, and the supplier says, “Well, I don’t think I’m going to license you that patent anymore.” And that obviously causes a problem. Or the supplier is using substandard materials. For example, in California, there’s this proposition 65 that requires disclosure of cancer causing materials. And you’ll see it on everything, California says this may cause cancer. Well, it’s a real concern because there’s a lot of entrepreneurial or enterprising attorneys that look for people who are selling things that fall in those categories and they sue you for it. So if you’re not looking at what is this product made of, what potential product liability claims arise out of it, and thinking about those things during due diligence, then it’s a mistake because you could face some potential liability further down the road.

Eric: Yeah. You’re going to get all these questions. Buyers are asking these questions. And if you don’t know the answer or how to get those answers, or you wonder the same thing, you should figure those out before you make the decision of trying to sell, because these aren’t hypothetical questions that are being asked. These are questions the buyers will ask.

John: So, that brings me to my favorite part of the due diligence process, which is chronicling IP. A lot of our clients are terrible at this. When we don’t do due diligence for them, they get upset with us because they soon realize that there are trademarks in foreign jurisdictions that were not assigned, or there are trademarks that are owned by other sellers who are trying to take advantage of the brand registry that Amazon provides, which allows you to register your trademark with Amazon and own the space. And so it becomes incredibly important to keep a updated list of all of your intellectual property. Who owns it? Where is it registered? What is the status of the registration? And what needs to be done to get it assigned during this process?

Eric: Yeah. What we’re doing is we are saving sellers money right now. That’s what we’re doing. Because if a buyer opens up your IP and you’ve got six trademarks registered to six different entities, it’s going to be a problem. You’re going to have to spend time working with your attorney. They’re going to work with their attorney. It’s going to slow things down. You’re going to have a bunch of expenses to clean that up and get it right. It’s not that hard. Make sure your trademarks are registered by the correct entity. And this happens all the time. Sometimes it’s a seller registers it in their personal name. They didn’t hire an attorney. They file it, they filed it in their own name. Well, that is a problem. It’s not you that owns that trademark. It should be your business that owns that trademark. And so this one’s low hanging fruit for sellers to make sure they know what’s going on, mainly with trademarks. Patents can fall into this issue too if they’re in the wrong name, but trademarks are much more common. You can have all these international marks and you can get kind of mixed up with them if you’re not paying attention.

John: Yeah. I had one recently where the seller said the trademark was registered in his friend’s name and he no longer has contact with the friend. I’m just like, “Well, this is a red flag. Maybe we should rethink this deal.” And you get a lot of that. Amazon’s the wild west, and a lot of people become very negligent in the way that they deal with their IP, even though it’s the key part of selling on Amazon. So yeah, you should take it very seriously and make sure you get all of your ducks in order. Well, thanks,

Eric, this has been helpful, I think, and been good information. So I appreciate the time. And again, this is the Revision Legal podcast, may it please the internet, and we thank you for listening.

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