Steps to Success: Preparing for a Sale of Your Manufacturing Business

2024 has seen two major acquisitions of Connecticut manufacturers by private equity firms—part of a trend of robust investment in the manufacturing sector over the last several years.

Selling a business—whether to a private equity investor or otherwise—is an exciting opportunity, but it can be a long, complex, and challenging process.

Here are some steps you can take to set your business up for a smooth and successful sale.

Taking adequate time to get your business acquisition-ready will help you find a buyer that aligns with your goals, shorten the time to close once a deal is in place and, in all likelihood, get you a higher price.

1. Identify Your Goals

Type of Sale. The two general types of sale are stock sales and asset sales.

A stock sale involves the sale of equity interests (i.e., stock, membership interests, or units) of the business, which will continue to operate post-transaction.

An asset sale involves the sale of assets of the business, like inventory, equipment, intellectual property, and goodwill.

The type of sale has consequences that you will want to evaluate with your professional advisers. You should also think about whether you would be willing to “take back paper” in the form of a promissory note or to receive an earnout.

Type of Buyer. Different types of buyers have different competencies and objectives. For example, another manufacturer may want to remove your business as a competitor and may be willing to pay a premium to buy your company and have you walk away.

On the other hand, a private equity buyer may see an opportunity for growth and may want to bring you on as an employee or consultant to continue supporting the business during the transition period.

Rollover Equity. Rollover equity refers to a deal structure where equity holders of the seller opt to receive equity interests in the buyer instead of either taking the purchase price all in cash, taking back paper, or receiving an earnout.

The prospect of receiving equity and future payments in the event of a subsequent sale of the buyer can be an attractive option, especially when selling to a private equity buyer that is “rolling up” multiple other businesses to achieve operational or market efficiencies.

However, it is important to consider whether you want to walk away from the business or remain involved, and whether you believe in the buyer’s plan for the business.

2. Preparing for Due Diligence

Contracts and Leases. Among the most important assets that the buyer will be looking to assume in any sale is your relationships with customers, vendors, and other third parties.

A buyer will request to review all contracts, including customer and vendor contracts and leases, as part of the due diligence process.

Collecting contracts is often a substantial time investment, and beginning the process after a deal is underway can slow the transaction down. Get ahead of the curve by ensuring that you have executed copies of all contracts in hand.

Additionally, familiarize yourself with any restrictive provisions in your contracts, such as non-competition, exclusivity, and most favored nations clauses.

Special attention should be given to clauses restricting assignment or requiring notice or consent to assign.

Liens and Loans. Buyers want to be sure that they are buying a business free from encumbrances and other liabilities.

Liens can stem from bank financing, such as lines of credit, equipment rentals, or unpaid liabilities such as taxes.

If your business is subject to any liens, have a plan in place for having them lifted prior to or upon closing a sale. Prepare to pay off loans and close out lines of credit either at or before closing.

Licenses. Ensure that all licenses and permits needed to operate the business are effective and up to date. Collect documentation of all licenses.

Familiarize yourself with the requirements to transfer your business’ licenses and permits and the timing on the process, cutting down on surprise delays that may arise if a permit or license may take significant time to assign or has a compliance process in the event of a change of control.

Tax Returns and Financial Statements. Financial health of the business is of paramount concern to potential buyers.

Buyers will typically request financial statements and tax returns for at least the last three years. They do not necessarily have to be audited.

Governance. Corporate governance is often low on the list of business owners’ priorities, but potential buyers will want to be comfortable that business decisions have been properly authorized in accordance with the seller’s governing documents.

Make sure you have copies of your business’ governing documents, including an operating agreement if your business is a limited liability company or bylaws if your business is a corporation, and copies of minutes of meetings or actions by written consent of the board, managers, members, or stockholders, as applicable.

If you do not have governing documents or documentation of business actions in place, consult with your attorney to prepare necessary documents, and operate in accordance with them moving forward.

Appearing organized gives potential buyers confidence, while appearing disorganized is often a red flag which results in more inquiries and typically a lower price.

Compliance. Ensure that your business complies with all relevant regulations, including labor, safety, and environmental laws.

Non-compliance can be a significant red flag for buyers, as it could lead to legal complications and potential liabilities post-closing and, at a minimum, can extend the diligence process.

It is common for buyers to request special indemnities or purchase price adjustments for material compliance issues.

Address any outstanding compliance issues and keep documentation of your efforts.

Intellectual Property. Intellectual property consists of a business’ patents, trademarks and trade names, copyrights, web domains, trade secrets, and other intangible assets such as know-how and software.

When preparing for a sale, be sure to inventory your business’ intellectual property. After taking inventory, work with your counsel to assess whether the business holds sufficient rights in the intellectual property as are necessary to operate and whether the business will be able to transfer its rights to use any intellectual property that it licenses from third parties (e.g., software).

Environmental. The nature of your business and its premises will impact the scope of environmental due diligence.

Businesses that handle hazardous materials will face more scrutiny in due diligence because buyers can be held liable for the clean-up and remediation of pre-existing environmental issues in certain situations.

As such, you should collect and organize documents relating to any ongoing remediation projects, underground storage tanks, special licenses or permits for the handling or disposal of materials, and documentation relating to any prior release of hazardous substances on the premises.

Benefit Plans. Ensure that you have copies of all active benefit plan documents, including written plan summaries, recent annual reports, and associated tax forms (e.g., Form 5500s) for the previous three years.

3. Engage Professional Advisers

Investment Banker. An investment banker (or a business broker in the case of smaller businesses) will help you evaluate the financial and business health of your company, connect with and screen potential buyers, formulate an optimal financial structure for the sale, solicit and evaluate proposals, and assist in negotiations with potential buyers.

After a letter of intent has been signed, your investment banker will help you review the business terms of transaction legal documents, assist with due diligence, and work with you to resolve differences that may arise during the closing process.

You will be charged a fee, but it is typically money well spent.

Accountant. An accountant will help you prepare financial statements, evaluate the financial health of your business, and advise you on tax considerations related to a potential sale.

Attorney. Once you have decided to pursue a sale transaction, an experienced mergers and acquisitions attorney will help you navigate the deal process, including reviewing engagement letters with investment bankers, negotiating the letter of intent, drafting and negotiating the primary sale agreement and other ancillary contracts, performing due diligence, and analyzing potential risks.

Preparing for a sale may seem daunting, but by thinking strategically about your personal and business objectives, spending time collecting documentation and doing operational, financial, and legal due diligence, and working with experienced advisers, you can set yourself and your business up for a successful transaction.

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About the authors: About the author: James Schulwolf is a partner in Shipman & Goodwin’s Business and Corporate practice group. He focuses his practice on advising clients in financing, investment, acquisition, and restructuring transactions. Saman Azimi and Michael Paciorek are both associate in Shipman’s Business and Corporate practice group.

For more information about Shipman’s manufacturing practice, please contact Alfredo Fernández (860.251.5353).