General Business Information

There are numerous reasons you might consider selling your business – it could be that retirement beckons, your business has reached its growth limit under current management or financial constraints, or an exit opportunity knocks.  Whichever the case may be, before moving forward with a sale, it is important that you understand what your business is worth and consider the most effective way to market the business for sale.

If you are seriously considering a sale, a prudent first step is to dispassionately determine the value of your business.  There a several ways to do this.  You can rely on your specific industry experience along with the financial history of your business, take into account an offer received from a third party or a competitor, or engage an appraiser to prepare a report based on market conditions.

There are many guidelines and rules-of-thumb for valuing a business (although few absolute rules).  You can use multiples of revenues or earnings, or a combination of the two.  Do not expect an absolute uncontestable answer. Do proceed with caution as these are approximations and useful only to suggest what the market will bear.  Additionally, do not overlook the value of intangible assets such as intellectual property, business methodologies and the goodwill that goes along with an established brand.  In the end, arriving at a realistic price is key to drawing prospective buyers.

When it comes to marketing the business for sale, there are some important things to keep in mind.  Doing the marketing yourself can be hazardous.  It can disrupt ongoing client relationships should your clients learn that you are looking to exit the business.  It can also create uncertainty for employees who, in turn, may seek other employment opportunities.

For these reasons, having your business marketed on a confidential basis by a broker or investment banker is usually the preferred method.  It is recommended that you speak with an attorney prior to engaging a broker or investment banker.  Why?  Your first negotiation will likely be the terms of the agreement to market your business as set out in an engagement letter.  Such letter will set forth the terms of your engagement, including whether the broker/banker will be your exclusive marketing agent, whether you will be charged a monthly fee, and what fee you will pay upon a successful sale.  It is important to note that in many cases a fee will be requested upon sale even if the purchaser was not identified by your broker/banker.  Remember, agreements are always negotiable.  Talk over your goals and expectations with your attorney to ensure you are not surprised by the “small print” as you transact a sale.

There is likely to be no one more passionate about your business than you and no one who knows more about running that business than you.  Yet, at such an important time, when you are ready to move on to your next venture, research, preparation and a qualified team working for you can speed and smooth the process.

Contractors, advisers, and employees (collectively, “Service Providers”) who receive property that is non-transferrable or subject to a substantial risk of forfeiture must generally defer their income recognition until those conditions no longer apply. However, due to the potential appreciation in the property (for example, in value of start-up equity) the ordinary income ultimately recognized could be significantly greater than the initial value. The Service Provider may be able to significantly reduce their taxes, and the employer may create a significant compensation incentive, if the Service Providers make the election under Internal Revenue Code Section 83(b) to recognize the income currently, notwithstanding the forfeiture risks. Timing of this election is critical as it must be made within 30 days after the property is transferred to the Service Provider.

Under Internal Revenue Code 83(a), Service Providers who receive property (including equity interests) for their services that are non-transferrable or subject to a substantial risk of forfeiture are required to pay, at the date the interests vest, income tax on the excess of the fair market value of the property over the amount paid for the property. If the fair market value of the property increases between the grant and vesting of the interests, Service Providers will pay an income tax on the greater value, and possibly at a higher marginal rate too. A Section 83(b) election may be the perfect tool for Service Providers to convert immediate ordinary income into deferred long term capital gains.

The downside of the election is that the income is recognized even though the risk of forfeiture still exists. If the risk materializes and the property goes down in value, or becomes worthless, there is no deduction to the Service Provider. They are stuck with paying income tax on property that is potentially worthless.

These risk/reward tradeoffs highlight the advantage of using this election for compensating employees of start-up ventures, typically with equity subject to vesting. In this case, the current value of the equity is limited, so there is little or no income to report (and pay tax on) currently. If the equity goes down in value, or is forfeited, the employee has not wasted tax payments. However, if the equity increases in value, as the parties hope, then the employee will be able to report this value at the more favorable capital gains rates instead of ordinary rates. The Section 83(b) election can make a start-up equity grant a much more effective inducement to attract new employees, by putting more money into the pocket of the employee.

But remember, taking advantage of the Section 83(b) elections requires a filing by the Service Provider within 30 days after the grant of property. The law does not want to allow the Service Provider to see which way the value is moving. The election, and the commitment to property must be made up front.

Service Providers should contact an attorney or other tax professional when deciding whether or not to make a Section 83(b) election. Additionally, issuers and companies should contact Cole Schotz P.C. before granting equity or other compensation.

Delaware General Corporate Law § 226 (the “Custodian Statute”) bestows the Delaware Court of Chancery with the power to appoint a custodian for solvent companies and receivers for insolvent companies in certain circumstances. See 8 Del. C. § 226. Specifically, a custodian may be appointed where, inter alia, a company’s “stockholders are so divided that they have failed to elect successors to directors whose terms have expired”, and where the business is suffering or threatened with “irreparable injury because the directors are so divided respecting the management of affairs that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division.” 8 Del. C. § 226(a)(1), (2). Although a custodian appointed under § 226 shall “continue the business of the corporation and not . . . liquidate its affairs and distribute its assets,” the Chancery Court has wide discretion in how it addresses a deadlock, and may even authorize a custodian to sell a company. See id. The scope of the Chancery Court’s broad discretionary authority to address deadlocks under § 226 was addressed in a recent decision of the Delaware Supreme Court. See Shawe v. Elting, No. 423, 2016, 2017 WL 563963, at *1 (Del. Feb. 13, 2017). Some read that decision as expanding the power of the courts to order the sale of a solvent company’s stock over the objection of the company’s shareholders.

In response to the decision, legislation has been proposed that would restrict the Chancery Court’s ability to dissolve or sell a solvent company by requiring that “alternative remedies prove insufficient after three years”, or the “necessary parties stipulate to such a sale.” Proposed Delaware Senate Bill No. 53.  The purpose of the proposed legislation is to “ensure the continued fair and equitable treatment of corporations in Delaware” by addressing “deficien[cies] in providing fair and equitable remedies in specific regards to deadlock situations.”  Id.  The Delaware Corporate Law Section plans to oppose the bill. The full text of the case, Shawe v. Elting, can be accessed here.

 

In a recent decision of the Delaware Court of Chancery, the Court struck down a corporate bylaw provision of NutriSystem, Inc., a Delaware corporation (the “Company”), ruling the provision to be inconsistent with the Delaware General Corporation Law.  See Fretcher v. Zier, No. CV 12038-VCG, 2017 WL 345142 (Del. Ch. Jan. 24, 2017).  The Company’s bylaw provision, which had recently been adopted as an amendment to the Company’s bylaws, stated that the stockholders of the Company may remove directors, but only upon the vote of “not less than 66 and two-thirds percent…of the voting power of all outstanding shares” of Company stock.  Id. at *1.  This bylaw provision is in contravention of 8 Del. C. § 141(k) under which directors may be removed by a majority vote of corporate shares.

Plaintiff, a shareholder of the Company, brought a class action suit on behalf of the shareholders of the Company against Defendants, who were comprised of the Company and the Board of Directors of the Company.  Id.  Prior to the adoption of the subject bylaw amendment, the relevant bylaw allowed Company stockholders to remove directors only for cause and upon the affirmative vote of two-thirds of all outstanding shares of Company stock (the “Removal Provision”).  Id.  On January 7, 2016, the Company filed a Form 8-K with the Securities and Exchange Commission announcing that the Board had approved an amendment to the Company’s bylaws which removed the “for cause” requirement from the Removal Provision.  Id.

The Plaintiff filed his Verified Class Action Complaint on February 24, 2016 (the “Complaint”) pleading two counts.  Id. at *2.  In Count I, the Plaintiff alleged a breach of fiduciary duty against the Defendants, contending that the directors breached the duty of loyalty by enacting an unlawful bylaw to entrench themselves in office.  Id.  In Count II, the Plaintiff sought a declaratory judgment that the Removal Provision violates Section 141(k).  Id.  The Defendants moved to dismiss the Complaint on May 27, 2016 and the Plaintiff moved for partial summary judgment on Count II on August 9, 2016.

The Defendants defense was centered on two legal issues.  First, the Defendants focused their argument on 8 Del. C. § 216, which permits corporations to adopt bylaws specifying the required vote for the transaction of the business of the corporation, subject to other voting requirements necessary to take specific actions.  Id. at *3.  The Defendants conceded that the specific provisions of Section 141(k), addressing removal of directors, supersede this general permissive language, but argued that Section 141(k) “does not dictate a contrary result” because the Section “sets the rules only for the circumstances under which stockholders may remove directors without cause, and does not address the percentage of the vote that is required to remove directors.”  Id.  Second, the Defendants argued that the majority vote portion of Section 141(k) is a permissive provision, noting that Section 141(k) provides only that a majority of stockholders may remove directors, “thereby leaving the bylaws free to require a minority, a supermajority or even unanimity as a requisite for director removal.”  Id.

The Court disposed of Defendant’s arguments using a plain language reading of the statute, ruling that “[Section 141(k)] provides that holders of a majority of stock may—not must—remove directors; that is, if they so choose, the section confers that power.”  Id. at *4.  Stated otherwise, the permissive portion of Section 141(k) is whether a director is removed — not the required vote for such removal.

The Court denied Defendant’s Motion to Dismiss and granted Plaintiff’s Motion for Summary Judgment with respect to Count II.  Count I was withdrawn.  Id.

This decision is a stark reminder that corporations should be mindful of statutory rules when drafting and adopting bylaws.  While corporate statutes serve as guidelines in some circumstances, careful attention must be given to those provisions of a state’s corporate law that are to be literally, not figuratively, construed.

Updates and speculation regarding the forthcoming merger between AT&T and Time Warner have dominated the recent news cycle. Many pundits and business professionals have debated whether a vertical merger of such magnitude will survive regulatory scrutiny. The transaction will be reviewed by the Federal Trade Commission (“FTC”) and the Antitrust Division of the Department of Justice (“DOJ”) as per the Hart-Scott-Rodino (“HSR”) Antitrust Improvements Act of 1976 (the “Act”).

The Act requires that parties who are planning to complete certain mergers, acquisitions, and transfers of assets or securities make a comprehensive filing with the FTC and the DOJ. The parties may not finalize the transaction until a determination is made by the agencies as to whether the transaction will negatively influence United States commerce in violation of antitrust laws. Parties may complete due diligence and make plans for post-transaction activities during the agencies’ review.

Effective as of September 1, 2016, the FTC, with the concurrence of the DOJ, adopted new standards concerning HSR filings which are meant to make the process easier and more efficient for filers.

With the new changes, the FTC has authorized filers to make HSR filings by submitting a DVD containing the filing. Filers will retain the option to submit a paper filing, but may not file on any other format, including CDs, flash drives, or SD cards. The filer should submit two DVDs to the FTC and two DVDs to the DOJ for review. If the DVD contains a virus or is either encrypted or password-protected, the submission will be rejected. Any errors with the DVD or the files on the DVD will require a replacement DVD. The DVD filing must include paper copies of the cover letters, original affidavits, and certification pages. All other documentation must be submitted on the DVD if the filer wishes to file by DVD, as there is not an option to file a combination DVD/paper filing.

Additionally, the FTC updated the instructions that apply to the HSR form. While some of the updates relate to filing by DVD, most were implemented in order to streamline the instructions and make them less complicated for filers. The form itself is not affected by these amendments.

The FTC vote to publish the Federal Register Notice was unanimous at 3-0. The Federal Register Notice and the new instructions to the form may be viewed at the following link.

To expedite review, the FTC encourages filers to follow the recommendations located on the “Style Sheet.”