Technology March 2022
The Key Elements to Selling an E-Commerce-Based Business
The nuances of closing the deal
Written by Jim Chester
Nuances of e-Commerce Business Sales
All business acquisitions involve challenges for both buyers and sellers, but deals involving e-commerce businesses have some unique issues due to the nature of their operations and assets. Some unique challenges involved in the sale of e-commerce businesses include valuation; intellectual property, or IP; asset ownership; and key employees.
Typically, the most valuable assets of an e-commerce business are non-tangible assets such as information, data, goodwill, and know-how. Legally, these types of assets are called intellectual property and are characterized as either trade secrets, trademarks, copyrights, or patents (collectively, “IP assets”).
For an early-stage venture, the IP asset value may increase exponentially over the next few months or years, so securing a specific present value can be impossible. There is no simple, standard answer to how one should value an e-commerce business. Buyers and sellers will sometimes engage valuation specialists, actuaries, or other consultants to help calculate the estimated value of IP assets and e-commerce businesses. Ultimately, however, the value of any business is the price someone is willing to pay for it.
IP Asset Ownership
It is important for an e-commerce business to own all the IP assets used by the e-commerce business. However, for some e-commerce businesses, many of their IP assets were created by the founders and independent contractors. Unless those creators have executed written agreements with the e-commerce business to transfer their rights to the e-commerce business, those individuals—and not the e-commerce business—may own some of the IP assets. Such a situation could derail a proposed purchase of the e-commerce business.
In addition, some of the IP assets may be pledged as security for loans or lines of credit, may include third-party assets, may be subject to unfavorable licensees, or in some instances, the transfer of the e-commerce business could trigger a software escrow release. These encumbrances will affect the ownership of the IP assets, which ultimately will affect the value of the e-commerce business.
Most of the intangible assets in an e-commerce business are IP assets, but in some instances the most important assets to an e-commerce business will be a few key employees. Because of their reputation, relationships, know-how, special skills, and creativity, these key employees are extremely valuable to the e-commerce business.
As such, if those key employees leave the company at the close of a deal, the company will likely not be as valuable as it was prior to the transaction—even if the purchaser acquires all the other IP assets of the e-commerce business.
To avoid this letdown, e-commerce business purchasers will need to identify these key employees and enter into agreements with them to continue their employment after closing. These key employee agreements can be critical for a purchaser, but because they involve future employment of individuals, negotiating these agreements can present several challenges to the transaction.
Preparing for the Sale
Before an e-commerce business owner can consider selling their company, it is important for them to do some internal “housekeeping.” Typically, this involves gathering a list of assets and determining their value, reviewing company documents and records, gathering financial records, preparing an inventory of IP, and reviewing the e-commerce business’ key contracts.
Because a purchaser will want a thorough understanding of a target company’s financial situation, financial records are an important part of any proposed business sale transaction, including those involving e-commerce businesses. A purchaser will want to see records relating to the capital of the company, operating expenses, debts owed, and taxes paid. In addition, the e-commerce business seller should identify any potential liabilities or other issues and should address them prior to the sale.
Once a potential buyer and seller are identified, the parties will enter into discussions to see if a deal is possible. For these discussions to be productive, the e-commerce business and the potential buyer must share some private information such as sales, expenses, lists of vendors and contracts, and other confidential and proprietary information. As such, the e-commerce business must ensure that the parties enter into a confidentiality agreement prior to sharing such data and information.
Prior to entering any substantive negotiations with a potential purchaser, the e-commerce business seller should require the purchaser to execute a non-disclosure agreement, or NDA. An NDA will ensure that the discussions related to the deal will remain confidential. Additionally, it will allow the e-commerce business seller to share business and financial information without worrying that it will be disclosed to others.
If negotiations go well and the e-commerce business and buyer agree on the key elements of a deal, they should reduce these deal terms to a “term sheet” (sometimes called a “letter of intent,” or LOI). The term sheet will outline many of the main deal elements and will serve as a blueprint for their respective legal counsel in drafting the purchase and sale agreements. Although the LOI is designed to be merely an outline of the deal, the LOI, once signed by both parties, is a legally binding agreement. Thus, it is important that both parties clearly understand what obligations the LOI creates.
Between the time the term sheet has been signed and the closing on the transaction, the buyer will typically want to conduct a thorough investigation of the e-commerce business to ensure it is getting good value for its purchase (and that there are no unexpected liabilities or other surprises).
This process is called the “due diligence” process, and it typically begins with the purchaser sending a request for documents and other information. This usually includes corporate records, financial reports and information, material on key employees, an IP inventory, and data regarding key relationships and contracts. The buyer will also ask the e-commerce business to disclose any known liabilities, debts, or other risks.
Following the execution of the term sheet, the e-commerce business seller and buyer will need to execute a purchase agreement. Depending on the deal structure, this could be an asset purchase agreement, or a stock purchase agreement. Although the term sheet identified key deal terms that form the backbone of the purchase agreement, there will likely be additional negotiations between the parties as the purchase agreement takes shape to address the details of the transaction.
In addition to the agreements between the buyer and seller, before closing, both parties may need to obtain the consent from various parties to approve the transaction. This may be lenders, shareholders, directors, key clients, or any contracts that may be affected by the transaction, such as those requiring consent in the event of an assignment or a “change in control” of the e-commerce business.
Closing the Deal
The closing date is typically stated in the purchase agreement but very often will need to be moved at least once, so account for last minute challenges. In most instances, both the buyer and e-commerce business seller will agree to extend the closing date as needed. Once the actual closing date arrives and the buyer and e-commerce business seller are ready, the e-commerce business sale transaction will formally occur.
The purchase agreement will specify what each party is required to deliver to the other at closing. For an asset sale, the e-commerce business seller will typically deliver a bill of sale and other instruments of title to transfer the assets to the buyer. For an equity purchase, the e-commerce business seller will deliver stock certificates or other means of transferring their equity to the buyer. In addition, each party must deliver their respective consents and ancillary agreements as required by the purchase agreement.
The buyer will also need to pay the purchase price for the e-commerce business, although depending on the deal terms in the purchase agreement, only a portion may be payable in cash at closing. Failure to deliver all required documents and payments as required at closing could jeopardize the entire transaction and could expose the breaching party to legal liability.
After the closing, the buyer will have control over the assets or equity of the seller, and the deal is effectively completed. However, there are often a number of post-closing matters that need to be addressed, such as recording IP assignments, updating domains and addresses with various third parties, and other matters that could not have been accomplished prior to closing.
Although each deal will have its own elements and chronology, the above elements provide an overview of the typical steps involved in the sale of IP-based and professional services businesses. By understanding these steps, buyers and sellers can be better prepared, which should result in a smoother and more productive transaction. TBJ
This article, which was originally published on the Klemchuk blog, has been edited and reprinted with permission.
JIM CHESTER is a 25-year technology business lawyer, professor, and entrepreneur. He is a recognized authority in buying and selling technology businesses, global technology transactions, and providing strategic legal counsel for innovation-based companies. You can contact Chester at email@example.com.