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Increasing Business Value
We live in an era of rapidly increasing
business value for information, know-how, and intangible property.
This increase in value has nothing to do with the internet.
All entrepreneurs, regardless of their business, should be
alert for the opportunity to create intangible property –
in the form of contracts evidencing key business relationships
– to help enhance the value of their business.
• Basic Philosophy. Even
if you have no present intention to sell your business, you
should always run your business as if you do. Properly positioning
a business for sale increases – sometimes dramatically
— the exit value you realize. We’ve seen many instances
where an entrepreneur received an attractive unsolicited offer.
Many times, the entrepreneur is then faced with explaining
why the “true profits” are higher, or why the buyer
will continue to benefit from key business relationships after
the transaction closes and the entrepreneur leaves.
• Example. Many times, a
business’ key relationships – relationships that
are very valuable – are informal. They might be based
upon the personal relationships of the entrepreneur or the
entrepreneur’s key employees with critical customers
or suppliers.
For example, suppose a key vendor has
been supplying goods for very favorable prices and terms in
recognition of the volume of business given to the vendor
and the vendor’s relationship with the entrepreneur.
If the entrepreneur remains involved in the business, the
advantages and added value provided by this relationship may
continue indefinitely. However, if the entrepreneur wishes
to sell the business, the buyer will be concerned about the
evaporation of that relationship. From the buyer’s standpoint,
due to this risk, there is less value to the business.
The solution is to look for opportunities
to document valuable business relationships in a simple contract.
Even a letter agreement will do. The important point is to
have the agreement document a definite term during which the
agreement will be in effect. The entrepreneur can point to
the agreement to show that, for example, the vendor is committed
to providing goods on the same favorable terms for at least
several years following the sale.
• Other Examples. Another
example involves key employees. Many businesses operate with
loyal, long-standing key employees who work without a formal
employment contract. However, if those key employees are needed
to maintain the company’s profits, most sophisticated
buyers will require employment agreements with them as a prerequisite
to a purchase.
We have been involved in many situations
where an absentee owner who sells a business has great relationships
with key employees, but as the business sale approaches, the
key employees recognize that it’s a “new game.”
They may ask for salaries, benefits, etc. from the new buyer
that they would never dream of asking from the old owner.
Even worse, the ownership change may cause them to seek other
opportunities.
Most lawyers advise their clients to
avoid legal liability by using written employment contracts,
including “at will” provisions in appropriate cases.
However, a significant benefit of written employment contracts
– giving permanence to valuable relationships –
is often overlooked. If the entrepreneur wants to take advantage
of a sale opportunity that materializes, the employees have
the assurance of knowing they have some job security, and
the entrepreneur does not have to worry about shoring up key
relationships at a critical time.
Simple distribution agreements provide
another opportunity. For example, assume a business starts
selling a new product which the entrepreneur feels has potential.
In order to realize that potential, the business must incur
additional expenses and take other steps to develop the business.
Since these steps must be taken anyway, why not, as a condition
of carrying the product, enter into an exclusive distribution
agreement with the manufacturer for exclusive distribution
rights, for a certain period of time, in a certain area? Such
agreements can add enormous value to a company in a sale.
• What’s involved.
By training, lawyers habitually try to consider every possible
scenario in drafting a contract. However, for most of the
relationships referred to in this article, attempting to get
the other side to sign a 20-page contract can result in delays
and even spook the other party. Many times, because the business
relationships are already in effect, a simple agreement or
written memorialization covering all of the key points is
an easily accomplished first step. (Caveat: you can and should
consult counsel to make sure each essential point is addressed.)
Once an agreement has been in effect and operating smoothly
for a certain period of time, you can always go back and suggest
that the arrangement be “formalized.”
• Conclusion. We have seen
numerous instances where two-page letter agreements have added
substantial value to businesses. The lack of a longer, more
comprehensive agreement may still make the buyer nervous.
However, having something in place evidencing valuable relationships
and the terms on which they can be maintained in the future
is better than having nothing, or attempting to document something
when the other side knows a sale is pending. In cases where
one or two key relationships affect the entire value of the
business, that simple piece of paper may make all the difference
in the world in determining whether you have something of
value to sell or not.
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