Seller Beware: Don’t Market Your Staffing Firm Without Doing a Presale Legal Audit

Selling a staffing firm involves significant risk and is something that most owners do only once in their lifetime. And there are no do-overs. The seller must do it right the first time to avoid pitfalls that can result in a reduced number of interested buyers, a reduced sale price, unfavorable payment terms, a large at-risk escrow amount — or even a deal that does not close. In the case of the latter, substantial management time is likely to have been spent, tens of thousands or hundreds of thousands of dollars in professional fees are likely to have been incurred, confidential information about the seller’s business will have been disclosed, and employees may leave.

Operations. Business consultants often advise potential sellers of staffing firms to have an operational audit done before going to market. Operational audits analyze the seller’s business operations from the perspective of what is important to a buyer and suggest improvements to maximize the desirability of the business and its sale value. Such audits typically address market focus, customer diversification, margins, growth rates, profitability, accounts receivable turnover, the existence of modern operating systems and electronic information systems, the quality of financial reporting, and the existence of experienced management who will remain with the business after closing.

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Earnings. Meanwhile, sell-side investment bankers and business brokers often recommend that potential sellers of staffing firms have a “Quality of Earnings” report done by an independent highly-regarded accounting or financial advisory firm before going to market, and generally require a potential seller to obtain a Q of E report on its business if the seller’s EBITDA exceeds $5 million — particularly if the potential buyers will include private equity firms. The primary objective of the Q of E report is to assess the accuracy and sustainability of historical earnings of the seller’s business, as well as the achievability of future projections, and to give the buyer a more comprehensive and credible understanding of the potential value of the business.

What is equally important and often overlooked by sellers of staffing firms is the importance of doing a presale legal audit of their businesses.

Legal Audit

A presale legal audit is, in our view, a necessity because every buyer and its professional advisors will conduct a due diligence review of the seller’s business from both an operational and a legal perspective.

We have seen more than one transaction in which a buyer refused to proceed with the deal, significantly lowered the purchase price, or insisted on significantly less favorable payment terms (including large at-risk escrow amounts), when the buyer discovered during its due diligence that legal problems existed in the seller’s business which the buyer (and even the seller) was not aware of when a Term Sheet or Letter of Intent was signed. This notably disadvantageous position could largely have been avoided if the seller did a proper legal audit of its business before going to market.

A seller’s legal audit prior to going to market identifies legal problems and vulnerabilities that may exist in its business and becomes a roadmap to fix those problems and reduce those vulnerabilities in advance of sale. This allows the seller to present a legally clean (or at least cleaner) business to a potential buyer, disclose to the buyer legal issues it has learned about (note: full disclosure by the seller is essential), and avoid surprises when the buyer conducts due diligence of the seller’s business.

A comprehensive legal audit should review a number of elements. Over my next two posts, I will list 21 that should not be overlooked.

Paul Pincus

Paul Pincus
Paul H. Pincus is an M&A attorney and a partner with Ortoli | Rosenstadt LLP, where he concentrates on mergers & acquisitions, corporate law, contracts, and employment law for the staffing industry. He can be reached at php (at) orllp (dot) legal.

Paul Pincus

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