The Exit Ready Series · Post R.6
View the full series →Getting Your Legal House in Order
The first question the buyer asks is "who owns what?" If you can't answer it cleanly, you've already lost your first deduction.
Ed Kowalski spent a Saturday in his garage looking for his stock certificates.
His M&A attorney had asked for them on a Monday, the way a doctor asks about your last physical. Ed said he had them somewhere. He did not, it turned out, have them somewhere findable. By Saturday he was pulling down banker's boxes from 1998. The certificates eventually turned up in an expandable file behind an old tax return.
The attorney had also asked for the annual corporate minutes. The actual answer was that Meridian Climate Systems had not held a formal board meeting since approximately 2004.
This is how buyers learn what your corporate structure really looks like. Not from a schedule you produce. From the things you cannot produce.
What the Buyer Is Actually Asking
The buyer's first legal question is never about valuation. It is about ownership. Who owns what, how is it structured, and is any of it documented in a way a court would recognize.
Your corporate structure is the thing the buyer is actually buying. The product — the services, the customers, the equipment — is wrapped inside a legal entity with specific form, specific ownership, and specific obligations. If the wrapper is unclear, the contents are unclear. The buyer either prices the uncertainty in or walks away.
The founders who tend to get in the most trouble are the ones who built something simple at the start and added complexity over the years without documenting it. An equity gift to a spouse for tax reasons. A profits interest to a key employee that was supposed to vest. A buy-sell agreement signed in 2007 that nobody has looked at since.
Each 1 is fine in isolation. The problem is that the buyer's attorney is the first person in 15 years to look at all of them together.
Entity Type Determines Deal Type
The structure you chose at formation determines the deal you can make at exit. S-corps, C-corps, LLCs, and partnerships each constrain what the buyer can offer and how the proceeds are taxed.
The practical lesson: your entity structure determines whether the deal is an asset sale or a stock sale, which determines the net tax to you, which determines the price you can accept. For a deal of Ed's size, the gap between those 2 outcomes can be $2–3M of net-to-seller.
The buyer will push for an asset sale. You will want a stock sale. Who wins depends on leverage — and 1 of the biggest sources of leverage is how clean your corporate structure is. A buyer looking at unclear ownership history will insist on an asset sale to insulate themselves. A buyer looking at clean records may agree to a stock sale.
The cleanup is the leverage.
The Cap Table Question
The second buyer question is who owns the equity, and is every interest documented and enforceable.
Ed owns 70% of Meridian. His wife Linda owns 30%. The split was done in 2007 because Ed's accountant had a tax-planning theory about income splitting. Linda does not attend board meetings. She does not sign corporate documents. Ed has never treated the 30% as real.
The 30% is real. Legally. In the eyes of any court, the IRS, and the buyer.
When Ed sells, Linda is a selling shareholder. She has to sign every closing document. She has personal reps-and-warranties exposure. Any prior informal handling — distributions misallocated, decisions undocumented — becomes a diligence issue.
What Ready Looks Like
A founder ready for the legal-house review can put 4 things in front of the buyer's attorney within 24 hours of the request.
A current cap table reconciled against a complete stock-issuance history. Every share ever issued, to whom, when, for what consideration. Every transfer documented. Every spousal interest acknowledged in writing.
A minute book maintained continuously since formation. Annual meetings held. Resolutions for every material decision. Not a perfect record — a real one.
A buy-sell agreement updated within the last 5 years. Current valuation methodology, current trigger events, current named parties. Reviewed by counsel before any conversation about a sale starts.
Documented equity grants. Every profits interest, option, phantom equity arrangement, and informal ownership promise either papered into a binding agreement or formally extinguished — with a written record showing the current status of each.
For Meridian, none of these were true.
The Ed Moment
Ed sat across from his M&A attorney with the latest invoice in front of him. The cleanup had cost $70K in legal fees and was still not finished.
The attorney told him the $70K was the cheap part. The expensive part was already in the LOI. Seeing the state of the corporate records, the buyer's legal team had insisted on a broader indemnity package and a $135K purchase price reduction for corporate cleanup provisions.
Ed asked what would have changed it.
"Three weekends, 12 years ago, with a binder."
What this cost Ed: $135K.
The cap table and minute book were undocumented. Stock certificates that took a Saturday to find. Minutes not held since 2004. The buy-sell agreement had not been updated since 2007. Verbal equity grants had to be settled or papered before close. Some cost cash. Some cost concessions.
The buyer's legal team treated the corporate records as unreliable and required broader indemnity and a $135K reduction. Another cut.
Don't be Ed.