This article consists of two parts. Part I describes preliminary matters a seller should consider before beginning negotiations to sell its staffing business. Part II is an overview of the acquisition process.

PART I – WHAT A SELLER SHOULD KNOW BEFORE IT STARTS NEGOTIATING

Having built a successful staffing firm, it is time to sell. The eventual buyer of the business is likely to be experienced in acquiring staffing firms and may be a competitor; however, this is the seller’s first sale.What should aseller do to help level the playing field?

Before beginning any discussions with a potential buyer, a seller should assemble and confer with an acquisition team consisting of its broker, accountant and acquisition lawyer to understand the value of its business; the business, tax and legal issues involved in the proposed transaction; and any alternative structures or solutions that may exist. After assessing its bargaining position, a “game plan” for the negotiations should be prepared. Since neither party usually
gets everything it wants when negotiating, prioritizing the seller’s goals will enhance the likelihood of getting what is most important to it.

Preliminary Considerations

The first considerations in preparing for negotiations are (1) what are the seller’s needs and goals, and (2) what is the seller’s bargaining position. For example, although obtaining the maximum price at closing for the business is always a priority, is it the seller’s highest priority? Are the seller’s owners prepared to stay on with the business after the sale is completed? Is the seller willing to accept a large earnout, or significant deferred payments that
although “guaranteed” (not contingent on operation of the business after closing) may not be secured? Are the seller’s owners willing or desirous to retain an ownership interest in the business, or obtain an ownership interest in the buyer, after closing. Is the seller willing to accept additional contingencies to the buyer’s obligation to close, such as the buyer obtaining financing for the purchase on specified terms and conditions, signing employment contracts with
certain key employees, obtaining consents from customers and other parties for the assignment of all written contracts that require such consent, or obtaining assurances of a continued level of business?

An analysis of the seller’s bargaining position is also an important preliminary consideration. Is the seller in a desirable niche market or does it otherwise have an attractive business mix, has it been experiencing rapid growth, does it have above average margins, is it sufficiently large (companies with EBITDA in excess of $5 million are most attractive to larger buyers), does it have a sufficiently broad customer base (few or no dominant customers), does it
have a high percentage of customers with whom it has direct relationships (vs. VMS/MSP relationships), does it have stable experienced management that will remain with the businessafter the sale is completed, in the IT space is its use of corp-to-corp contractors a modest percentage of its overall consultant workforce, is it in an attractive (high growth) geographic area? A seller’s failure to properly assess its bargaining position can result in not receiving full value for its business, accepting terms that will increase the risk of the sale not being completed, or accepting terms that will increase the risk of not getting paid.

Principal Issues

What are the principal issues a seller should address?

1. Purchase Price. A seller needs to understand not only the dollar amount of the purchase price, but what the purchase price includes. Acquisitions are typically done on a “cash-free, debt- free” basis. This means a seller is expected to deliver its business free of all debt at closing, and gets paid for (or retains) all cash and accounts receivable above a normalized level ofworking capital it typically is required to leave in the business or transfer to the buyer at closing. The agreed-upon working capital amount will have a dollar-for-dollar impact on the proceeds the seller receives.
2. Payment Terms. Terms include the length of time for any deferred payments, whether they are “guaranteed” (usually in the form of seller notes) or subject to an earn-out (contingent on performance of the business after closing),and any security for the deferred payments. Deferred payments are frequently for 1 – 2 years after the closing.
3. Financing Requirements. One of the first things a seller or its representatives needs to determine is whether the prospective buyer is financially “qualified” – does it have the current ability to pay for the deal from available cash funds, existing borrowing facilities, or authorized shares of stock (if the buyer will pay for all or part of the purchase with its stock).
   If financing must be obtained by the buyer, a seller needs to assess the likelihood of the buyer being successful in obtaining the financing, the time delay that may be entailed, whether it is worth proceeding in light of the risk that the buyer may not be successful, and, if so, what conditions should be requested.
4. Structure. Staffing acquisitions generally involve either the purchase of stock (or membership interests in the case of an LLC) or assets of the seller. The structure to be used is usually determined (at least initially) by the buyer,depending largely on tax and liability concerns (in a stock or membership interest purchase, the buyer receives all of the assets and inherits all of the liabilities of the seller’s business). Despite the additional risks involved, buyers frequently purchase stock or membership interests when acquiring larger staffing firms, since fewer consents are needed from third parties, licenses and certificates remain in place, and immediate onboarding of staff and temporary employees/consultants to a new entity is avoided,allowing for a simpler and quicker transaction. Stock or membership interest purchases have become more popular in recent years with the increased presence of private equity buyers who generally will require the seller to retain a 10% – 30% ownership interest after closing, and with the use by sophisticated buyers of tax elections (such as Section 338(h)(10) of the IRS code in the case of a stock purchase and Section 754 of the IRS code in the case of a membership interests purchase) which allow the buyer to treat the purchase of stock or membership interests as the purchase of assets for tax purposes, obtain a step-up in basis of the seller’s assets to fair market value, and depreciate/amortize those assets after closing. Asset deals are preferred by buyers of smaller staffing firms or where there are risks a buyer is unwilling to assume, because the buyer can purchase only those assets it wishes to own, and generally assume only specific liabilities of the seller it wishes to assume. In addition, based on current federal tax laws, a buyer of assets can step-up the basis of the assets purchased to fair market value, depreciate them over time, and amortize over 15 years the goodwill of the purchased staffing firm. This can mean a significant tax savings for the buyer, since the largest component of the purchase price of a staffing firm is generally its goodwill (the amount by which the purchase price exceeds the book value of its assets). However, if the seller is a “C Corporation” for tax purposes, selling assets can result in additional corporate level taxes that would not be incurred if the shareholders sold stock. In that case, a seller will need to negotiate either to cause the purchase to be structured as a stock sale or to structure the sale so as to minimize the corporate taxes.
5. Closing Contingencies. Will the closing contingencies be limited to standard terms (such as that all representations about the seller’s business be true at closing, that there have been no material adverse change in the business since the purchase agreement was signed, that all assignments and consents have been obtained, and that all liens on the assets or stock/membership interests to be transferred have been removed), or will the buyer ask for significant additional contingencies?
6. Employment or Consulting Agreements for Shareholders or Members. If the shareholders or members are to continue with the business after closing, employment or consulting agreements for 6 months to 2 years are frequent. Apart from base compensation, a seller should explore what incentive compensation can be obtained. A buyer reluctant to offer a
   greater earnout in the purchase agreement where it will be amortized over 15 years and not contingent on the shareholders’ or members’ continued employment or consulting services, may be willing to offer part of it in an employment or consulting agreement where the shareholders or members are at risk of not receiving the additional payment if their services are lawfully terminated by the buyer, and the buyer can expense the payments as paid.
7. Non-Compete, Non-Solicitation, and Non-Raiding Covenants. After closing, the shareholders or members will be required not to compete with the buyer, not to solicit or do business with customers of the business, and not to solicit, hire or engage employees/consultants of the business. Those provisions are generally for 3 – 5 years after closing and within some geographic area surrounding the location of the seller’s business. As with most issues, the length and scope of these covenants are subject to negotiation.

These issues can be more successfully negotiated by a seller before agreement in principle is reached, when the buyer is seeking the seller’s commitment and everything is negotiable.

Conclusion

Selling a staffing firm is a complicated process. To properly structure an acquisition and minimize the risks throughout the acquisition process, it is essential for a seller to use legal counsel, brokers and other professionals with
substantial acquisition experience in the staffing industry, and to consult with those professionals before commencing discussions with potential buyers. It is easier, and ultimately less expensive, to structure a transaction properly from the start than to try to correct a poorly negotiated transaction.

PART II – THE ACQUISITION PROCESS

1. Introduction of a potential seller to potential buyer.

2. Confidentiality Agreement. This is the written agreement of the buyer and seller that, among other things, all documents and information exchanged will be kept confidential and used solely to evaluate the potential
   acquisition, neither party will disclose the existence or content of their discussions, and if the potential acquisition is not completed all documents and information received from the other party will be returned to
   it. The confidentiality agreement might include a covenant by the buyer that if a sale does not take place, it will not for an agreed amount of time solicit or hire any of the seller’s employees or solicit or do business with any (or certain) customers of the seller with whom the buyer is not already doing business.

3. Exchange of information, such as the number and location of offices, nature and longevity of the business, the desire of existing management to remain after the closing, financial statements, current rate of sales,gross profit and mark-ups, billing and pay rates, mix of business (including VMS/MSP vs. direct customer
   employees/consultants and corp-to corp contractors, and other relevant information. A seller should be prudent not to release particularly sensitive business information until a later stage in the acquisition process.

4. Agreement in principle on the purchase price, what is to be acquired, the structure of the transaction (purchase of assets or stock/membership interests), payment terms (including seller notes or earn-out provisions), employment or consulting agreements, non-compete provisions, and other key terms.

5. Letter of Intent. This is a generally non-binding outline of the agreed upon business terms, including:
   1. Purchase price and terms.
   2. What is to be acquired.
   3. Structure of the transaction (stock/membership interests or assets), and any tax elections to which the seller must agree.
   4. Any escrows.
   5. The purchase of representations and warranties insurance and/or tail insurance (if applicable).
   6. Employment or consulting agreements.
   7. Conditions to, and consents needed for, the closing.
   8. Non-compete, non-solicitation, and non-raiding provisions.
   9. Timetable for due diligence, signing the acquisition agreement, and closing.

Binding provisions typically include: confidentiality, a “no-shopping” clause (the seller will not negotiate with other buyers or entertain competing offers for an agreed period of time), both parties’ agreement to pay their own professional fees in the transaction, and both parties’ agreement not to issue press releases until the sale closes (unless required by law).

6. Due Diligence Investigation. This is a detailed examination by the buyer of the seller’s business
   including:
   1. Examination of licenses and certificates.
   2. Examination of all contracts and leases.
   3. Examination of financial statements, billing and payroll records, and other financial records.
   4. Review of accounts receivable, bad debt, financing arrangements, and related matters.
   5. Review of tax returns, and potential state and local tax liabilities.
   6. Review of any CARES Act tax elections, Payroll Protection Program loans, and Employee Retention Credits.
   7. Examination of corporate minute books, stock ledgers and certificates, shareholders’ agreements and operating agreements.
   8. Discussions with key staff employees to be employed after the closing.*
   9. Possible meetings with key customers.*
   10. Discussions with seller’s accountants and financial officers.
   11. Examination of any real property owned by the seller.
   12. Examination of office premises and equipment.
   13. Examination of computer systems and cybersecurity.
   14. Review of prior, pending and threatened litigation, regulatory compliance, claims and liens.
   15. Examination of staff employee, temporary employee/consultant and corp-to-corp files and records.
   16. Examination of employee benefit plans.
   17. Review of HR forms and procedures.
   18. Review of insurance policies and claims history.
   19. Examination of other assets to be transferred.

7. Acquisition Agreement.
   1. The acquisition agreement contains all of the terms of the transaction. It describes the seller’s business and what is being sold, and requires the seller to make representations and warranties about various matters relating to the business,
      including:
      1. Title to the assets or stock/membership interests to be transferred.
      2. Current and historical financial information.
      3. Contracts with customers, employees and others.
      4. Identity of customers (including billing and pay rates).
      5. Current staff employees, their compensation and benefit plans.
      6. Temporary employees/consultants and any corp-to-corp/independent contractors (including billing and pay rates).
      7. Real property.
      8. Office and equipment leases.
      9. Furniture, equipment and other personal property.
      10. Computer systems and cybersecurity.
      11. Licenses and certificates.
      12. Trademarks, service marks and intellectual property.
      13. Compliance with law.
      14. Files and records.
      15. Pending or threatened litigation.
      16. Liens or claims against the business, assets or stock/membership interests to be transferred.
      17. Tax compliance.
      18. Any Payroll Protection Program loans or Employee Retention Credits.
      19. Insurance.
   2. The acquisition agreement typically will provide that the buyer’s obligation to close is contingent on all representations and warranties being true at the time of closing, that all required assignments and consents will have been obtained, that the transfer of assets or stock/membership interests will be free and clear of any liens or claims,that there will have been no material adverse change in the seller’s business between signing the acquisition agreement and closing, and that all other closing conditions have been satisfied.
   3. The acquisition agreement typically will provide for indemnification of the buyer for misrepresentations by the seller, liabilities arising from the operation of the business prior to the closing, tax liabilities of the seller, and other similar items.
   4. The acquisition agreement typically will provide for non-compete, non-solicitation and non-raiding provisions by the selling corporation or LLC (if assets are being sold), its shareholders/members and affiliates (generally 3 – 5 years from the closing date).

8. Obtaining required assignments and consents, including customer consents, any vendor consents, landlord consents, any regulatory approvals, any necessary financing, and the removal of any liens on the assets or stock/membership interests to be transferred.

9. Closing. Transfer of ownership and receipt by the seller of that portion of the purchase price to be paid at the time of such transfer.

10. Issuance of press releases, if appropriate.

About the Author:
Paul H. Pincus, Esq. is a partner at the international law firm Ortoli | Rosenstadt LLP and head of the firm’s Mergers Acquisitions and Staffing practices. He can be reached at (212) 829-8931 or php@orllp.legal.