Preparing for Exit: Getting Your Corporate House in Order Before M&A Due Diligence

The letter of intent arrives: a seven-figure offer to acquire the company you helped build. Then due diligence begins. Buyers start asking questions about early corporate decisions: why the company was formed the way it was, whether there are board approvals for early financings, and whether the cap table actually matches the equity issued.

For many companies, the most difficult diligence questions arise not from recent operations, but from the earliest days of the business. The most common (and most time-consuming) questions relate to corporate structure, corporate governance, record keeping, and equity grants. Let’s consider practical steps a general counsel can take, either at the beginning or as a clean-up item before an exit transaction, to reach closing.

Corporate structure

Limited liability companies offer incredible flexibility and cost-efficiency at formation, which is why they are the most common business structure for early-stage companies. Filing articles of organization is fast and inexpensive. However, LLCs have ownership limitations and may complicate tax planning. Many institutional investors and acquirers, including strategic buyers with complex organizational structures of their own, are unwilling to purchase an LLC outright.  As a result, conversion to a corporation is frequently required as a condition to closing, which can delay a transaction, increase costs, and trigger unintended tax consequences.  

In advance of any exit, general counsel should work with finance and tax colleagues to understand the impacts of a corporate conversion. Sometimes, the appropriate time to make a change will be immediately prior to closing; in other circumstances, addressing the issue earlier allows the company to implement the change on a more deliberate timeline. Analyzing these questions in advance of the Letter of Intent (LOI) phase will allow the legal team to anticipate buyer diligence concerns, ensuring the supporting documentation is in place, and reduce the risk that the corporate structure issues become a distraction during negotiations. 

Corporate governance and record keeping

When the business is growing quickly, routine corporate governance tasks, such as preparing annual resolutions to elect directors or appoint officers, can easily fall down the priority list.  Further, keeping organized files of these documents is even more challenging.  

During an acquisition or investment process, however, every buyer or investor will ask for these documents. They want to confirm that corporate actions were properly authorized, that material decisions received the appropriate attention, and that they are not inheriting risk created by incomplete or undocumented board oversight. 

Neglect is fixable, but requires effort. The legal department can prepare a timeline of business events, including loan closings, out-of-budget asset purchases, decisions related to employee equity, and changes in leadership. Search records for any resolutions that were already prepared and save them in one location.  If any resolutions are missing, the board can approve and ratify them.  These are items that diligence teams will certainly look for, and disorganized records will raise red flags.

The consequence of missing or disorganized records isn’t a dead deal, but you will lose leverage and delay. Legal teams can avoid this time, expense, and risk exposure by reviewing company actions on an annual basis and with an eye towards an exit at any time.

Equity grants

Unlike governance gaps or structural issues that can often be papered over, equity problems, including mispriced stock, missing documentation, or improper option grants, are much harder to remedy after the fact. This makes early and ongoing attention non-negotiable.

The general counsel’s office should maintain a complete, current record of all equity plan documents at all times. HR and legal need a standing process for handling departing employees.  Missed repurchase windows, unsigned termination agreements, or unexercised options will become issues for diligence later.

Get an independent legal and tax review of the equity plan before any deal is on the table. The goal is to identify what can be fixed and fix it, and to understand what can’t be fixed so counsel can advise on what representations the company can defensibly make in a definitive agreement. Going into diligence without this review is a significant risk.

Finally, prepare a sample waterfall for founders and shareholders.  Many people do not understand the impact of these awards on the cash waterfall at closing.  Equity doesn’t feel like you’re giving much away until the founder sees their cash decrease at closing.  By running hypothetical exit scenarios in advance, you will avoid closing delays caused by settlement statement “surprises.”

Legal departments that treat structure, governance, and equity as continuous priorities will control the narrative in diligence, protect value at closing, and give their companies the best chance of a smooth and fully realized exit.