EXIT STRATEGIES

IVAN HOFFMAN, B.A., J.D.


        In every deal, even as you contemplate getting into that deal, you must contemplate how you are going to get out of the deal.  By getting out, I do not, in this article, mean  provisions entitling you to terminate for whatever reasons.  Instead, getting out refers to your “exit strategy.”  Exit strategy refers to how you see the project after some period of time and whether you can exit successfully with a significant profit.

        Your exit strategy may be to sell the business or your interest in the business at a certain time.  The strategy may also be to position yourself so that you can buy out the other party or parties down the road.  You may have other such exit strategies.

        This article assumes an exit strategy that you intend to sell your business or your interest at some time.  However, whatever your particular strategy might be, to be viable and potentially successful, all such exit strategies require you to see things backward.  All successful entrepreneurs need to know how to look backward.  This means that as you contemplate entering the deal, you have to picture the deal after some period of time and then say “If I want to be in this place after say 5 years, as an example, what do I have to do in 4 years, then in 3 years, then in 2 years and ultimately, what do I have to do today to make my 5 year exit strategy successful?

        And the place to start, the place that is about today, is the deal and the contract that embodies that deal and the contract’s terms by which you enter the deal.  Such contracts are essential not only to establish legal rights and obligations but to help in establishing value.  If your contracts are not thorough, it is difficult, if not impossible, to establish the value of such contracts and the rights covered by them.  If there are potentials for uncertainty and, in the worst case, litigation, you can probably kiss the sale goodbye.

        Of course there are many other issues facing the entrepreneur seeking to exit including the availability of current and accurate financial information.  I have chosen to focus on just the one issue about which people come to me as an attorney…their legal rights and obligations.

The View From Today

    In today’s world of business, whether it be about the Internet or otherwise, often the 4 corners of the contract are more important than any existing body of law.  This is especially so when it comes to intellectual property issues since such bodies of law currently leave many gaping holes unfilled.  We are in “the day of the deal,” meaning that the law, at least in these areas, is often behind the technology and the deals.  Therefore, it is up to each party, acting in their own self-interest and personal responsibility, to take care of themselves in any transaction.  It is not sufficient to believe the law alone will cover you since, as indicated, there may not be law on the current issue.  And of course those who enter deals believing the other side will look out for them are almost always wrong and often find themselves in a very unfavorable position.  So “the day of the deal” means having a thorough agreement that reflects the realities of the deal.

        In the intellectual property arena, which includes copyrights, trademarks and patents as well as rights in contracts that deal with the same, such agreements include, among other agreements, acquisition agreements of all sorts (with authors, artists, web designers as well as licenses to use other parties’ intellectual property), licenses to allow other parties to use your intellectual property, publishing agreements and so on.  The terms of these licenses and the validity of the written agreements embodying the deals go a long way toward establishing the value of what you have to sell.

        But it is not just intellectual property issues that must be addressed by thorough agreements.  All of the assets as well as the liabilities of the project must be the subject of appropriate agreements.  To the extent that you will have to provide documentation to any potential buyer, these agreements are essential.  Such other forms of agreements include but are not limited to employment agreements, consultant agreements, purchases and leases of equipment.

        As stated above, without the benefit of thorough written contracts, a party may not be able to fulfill its exit strategy and may find itself in litigation if the project is successful.  My long term experience as a deal maker and attorney is that if there is more than $1.82 on the table, people run to their attorneys.  This may seem facetious and of course the amount is but the underlying theory is correct.  If the project is a failure, no one’s probably going to care.  But if the project is successful, if the contracts are not clear and thorough, well the best laid plans oft go awry.

        So Rule 1 in planning how to exit successfully is to enter successfully.  This means that the successful entrepreneur has to have thorough agreements drafted to make certain that his or her contracts protect the back end, the exit strategy.  Of course, all sorts of other protection is required as well but this article is simply about one aspect…the exit.  If the contract is not thorough enough or is vague and uncertain, any “savings” the entrepreneur thought he or she had achieved by scrimping in this area would likely be more than wiped out in legal fees at the wrong time.  The wrong time is when there is that pot of money on the table and when it is exit time.  Then the entrepreneur may find that all the money he or she thought the entrepreneur was going to take off that table may end up in the pockets of attorneys who should have been engaged when the deal began.  Help me is almost always cheaper than fix me.

Specifics

        Many of the areas that the entrepreneur must focus on when getting into the deal so that that entrepreneur can successfully exit the deal relate to rights acquisitions.   As but one example, I am constantly amazed that publishers (of all sorts, books, Internet, CD-ROMs etc.) will spend thousands of dollars getting the project printed, covers designed, illustrated, web sites established etc. but will not spend a relatively small amount of other dollars getting appropriate, legally valid agreements prepared with the parties doing this work so that the publishers will actually own something of value as part of that exit strategy.  Without such contracts, the money spent on the rest of the project is severely jeopardized and in danger of being completely wasted.

        Let me explain.  Under the United States copyright law, without a valid, written and signed transfer agreement, an independent contractor retains all exclusive rights to his or her copyrightable work and the publisher, in this example, has nothing of real value save some unclear set of non-exclusive rights to that work.  These non-exclusive rights are essentially worthless.  So when a potential buyer for a party’s interest in a project comes along and that potential buyer does a due diligence review of rights owned by the potential seller,  it turns out that the Seller has very little of worth because on day one the Seller did not follow Rule 1; the Seller did not acquire the appropriate legal rights via a valid, written and thorough agreement.

        Picture yourself in that position.  Now you are faced with paying an attorney many, many times more money to retrofit your situation, if it is indeed even possible.  Once the owner of the rights knows that you want to sell out and need this contract to do so, it is human nature, i.e. self-interest, to raise the price.  By not doing it right in the first instance, any savings that originally motivated the Seller to cut and paste some agreement together disappears in a flash.

Chances for Success

        Now I realize that the overwhelming majority of instances will result not in successful projects but in unsuccessful ones.  This is not a reflection on you but merely a statement about the odds of success of any venture overall.  So in many instances, failure to lay the proper legal foundation may turn out to be more academic than real.

        But given the long term set of rights granted under the United States copyright and trademark laws, who can say what may turn out to be valuable way down the road?  Could anyone have known 40 years ago that old televisions shows would find new, profitable life with the advent of cable television?  Would you not want to own the rights to the theme from “I Love Lucy?”

        More directly relevant is the issue of what if your project is the one in a hundred that is successful and you have failed to lay this proper legal foundation?  How do you reconcile in your heart that others will make lots of money and you little or none?   And how do you deal with the regret that come from that situation?

        Finally, if you don’t believe that your project is going to be that one in a hundred success, why even bother doing the project?

Conclusion

        There are a number of articles on my site under the link “Articles About Being an Entrepreneur” (see link below) that you should read including “Private Laws,” “The Need for Vision” and “What Business Are You In?” that may help to widen the lens a bit.

        The way many parties approach their business puts them in a lose-lose situation.  If the project is a stiff, they lose.  But even if, in rare instances, the project is a winner, they still lose.  Given the tremendous odds against success, the reason people approach their business in this manner is totally unclear to me.

        Is that how you operate?

© 2001 Ivan Hoffman

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This article is not intended as a substitute for legal advice.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  You should consult with an attorney familiar with the issues and the laws.
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No portion of this article may be copied, retransmitted, reposted, duplicated or otherwise used without the express written approval of the author.

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