DAVID V. GOLIATH – Using Indemnification Clauses to Level the Contractual Playing Field

Not all parties to contracts are created equal. In fact, more often than not one party to a contract may have considerably greater bargaining power and financial resources than the other party. This can give the stronger party an incentive to misbehave.  So how can you protect yourself when you are the “David” in a David v. Goliath scenario? Consider using an indemnification[1] clause to help level the playing field.

Indemnification clauses can be among the most important provisions to include in contracts for several reasons.  First, the mere existence of an indemnification clause can help ensure that a party gets what it bargained for under a contract, by giving the other party a reason to “think twice” before breaching the agreement.  Second, in the event the other party does breach the agreement, a well-crafted indemnification clause can give the non-breaching party more leverage to resolve matters favorably, before trial.  Third, an indemnification clause can help the non-breaching party recover its legal expenses incurred in enforcing the contract, thus removing the most costly obstacle to a “David” standing up to a “Goliath”.

Illustration – The David v. Goliath Scenario. Assume David and Goliath enter into a contract where David will pay $50,000 upon Goliath’s delivery of widgets. But, when it comes time for Goliath to deliver the widgets, he refuses.  Goliath may have accepted a higher offer from someone else for the widgets because he knows that David has fewer resources than Goliath and is unlikely to sue.

Let’s look at David’s options. David would almost certainly be entitled to recover “contract damages” for Goliath’s breach – such as the difference in price David must pay to acquire substitute widgets from an alternate source. But actually winning and collecting those contract damages comes with its own significant costs.  If David were to sue Goliath for breach (assuming he could afford to) David must hire an attorney.  However, under American contract law principles, David will not be entitled to reimbursement for the attorneys’ fees that he incurs fighting Goliath.  This results in a very real likelihood that David’s costs to pursue a lawsuit against Goliath will be greater than the amount he may actually recover in damages. This means that David may end up “winning” the lawsuit, but lose money overall after factoring in legal costs.

In short, because the American contract law on damages does not generally reimburse plaintiffs for their attorneys’ fees in contract breach actions, plaintiffs like David face an economic disincentive to stand up for their rights. Conversely, breaching parties like Goliath can have a perverse incentive to breach, particularly if the other party is financially weaker. This is where an indemnification clause can help level the playing field.

I.  Anatomy of an Indemnification Clause.

Indemnification clauses can help address the shortcomings of American contract law on damages by shifting liability or expense from one party to the other.

Here is a simple indemnification clause from a two-party contract:

Indemnitor shall indemnify, hold harmless, and defend indemnitee, to the fullest extent, from and against all claims, demands, actions, suits, costs and expenses (including, without limitation, attorneys’ fees and costs), losses, damages, settlements, and judgments (each, a “Claim”), whether or not involving a third party claim, arising out of or relating to: (i) any breach of any representation or warranty of indemnitor in this Agreement; or (ii) any breach or violation of any covenant of indemnitor in this Agreement, in each case whether or not the Claim has merit.

The three basic components of an indemnification clause are (1) the Parties, (2) the Claims, and (3) the Trigger Events. Each is explained below.

  1. Parties. The effect of an indemnification clause is to shift certain expenses and legal responsibilities from one party, the “indemnitee” or benefitting party, to the contract’s other party, the “indemnitor” or obligated party.
  2. Claims. “Claims” are the things the indemnitee is protected from or against. Claims can be:
  • an allegation (such as a claim or demand asserted by the indemnitor or a third party);
  • a formal legal proceeding (such as an arbitration, lawsuit, settlement, or judgment); or
  • a monetary amount (such as a loss, liability, cost, or expense incurred by the indemnitee).

(While this article focuses on “Direct Claims”, meaning a Claim by one party to the contract directly against the other party, indemnification clauses can also be used to shift liability and expense associated with a Claim asserted against the indemnitee by a third party, known as a “Third-Party Claim”.)

  1. Trigger Events. Usually, an indemnification clause is limited only to those Claims that arise out of, or result from, certain enumerated occurrences or circumstances (the “Trigger Events”). For our simple indemnification clause above the Trigger Events are limited to breaches of the indemnitor’s representations, warranties, and covenants (i.e., the indemnitor’s promise to do something) in the contract. But there can be many other types of Trigger Events; for example, the indemnitor’s violation of laws, its products or services infringing the rights of others, its acts causing personal injury or property damage, etc.

II.  Indemnification for Direct Claims.

With an understanding of the components of an indemnification clause, now let’s reconsider how our illustration might play out if the contract between David and Goliath had contained our simple indemnification clause.

In this instance, David could still sue Goliath for his contract damages.  But now, David has a bigger, more powerful “stone in his sling”.  Specifically, because his lawsuit is a Claim of a specified Trigger Event (Goliath’s breach of his covenant/promise to deliver widgets as required by the contract), David can also make a claim for reimbursement of David’s attorneys’ fees in bringing the lawsuit. The fact that Goliath may now be saddled with having to pay David’s legal fees will likely influence David’s decision to enforce his contractual rights against Goliath.

III.       Effects of Indemnity on Indemnitor Breaching Party.

As we can see, having an indemnification clause for Direct Claims substantially changes the economic calculus in favor of the plaintiff. It has considerable effects on the defendant breaching party, as well.

  1. The Threat of Having to Pay for Two Sets of Lawyers. In a lawsuit to enforce a contract with an indemnification clause, the breaching indemnitor is faced with the possibility of ending up paying for two sets of attorneys—its own and the plaintiff/indemnitee’s. Adding an indemnification clause to the mix has a substantial economic and psychological effect on the indemnitor. While protracting and delaying litigation is a time-honored tradition for some defendants, the benefits of being stubborn is much less compelling when weighted against the potential of having to pay both sides attorney’s fees. This fact weighs more and more heavily on indemnitors as legal fees mount and litigation progresses.
  2. Encouraging Settlement and Dispute Resolution. The example above assumes that a lawsuit was filed and proceeds all the way to trial and judgment. However, the vast majority of lawsuits are concluded before judgment, either by settlement or dismissal. Having an indemnification clause can be beneficial to resolving a lawsuit early on and even before a lawsuit is filed because as the indemnitee’s attorneys’ fees rise, the typical benefit of delay and protraction to the indemnitor diminishes. This increases the likelihood of earlier and more reasonable settlement.
  3. The Indemnitor May “Think Twice” Before Breaching the Contract At All. Of course, David would probably be happiest if Goliath simply performed the contract and avoided a dispute entirely. The mere presence of a clause that could make Goliath responsible for David’s costs of enforcing the contract may give him ample economic incentive to play by the rules of the contract from the outset.

III.  Conclusion.

While the particular facts and circumstances of the parties should always be considered, in many circumstances including a properly-drafted indemnification clause can enhance the parties’ likelihood that they will receive what they bargained for under the contract.


If you have questions regarding indemnification clauses or need further guidance on how to structure your business relationships, contact Scott Harris at SHarris@fh2.com or (770-399-9500).

[1] As used in this article, the terms “indemnity” and “indemnification” include three slightly different legal obligations: indemnity (to reimburse for an incurred expense or cost), hold harmless (a release from liability), and defend (the agreement to defend against a legal claim).  The three are slightly different concepts, but their effect is the same. They shift liability or expense from one party to the other.

Considering Business in California?–Think of These Laws First

Your business is growing and fortune is shining. Out-of-state opportunities are increasing. Perhaps you are considering expanding operations. If you haven’t already, you’re likely to end up serving the world’s sixth largest economy[i]—California.  And who wouldn’t want to be in California? It has nearly 40 million consumers.

Before heading out with your sunscreen and order book, there are a few intricacies of California law that any out-of-state business—as well as any business already operating in California—should keep in mind when doing business involving California-based employees or parties.[ii]

1.  Contract Law.

a.  Restrictive Covenants. Employers would do well to take Section 16600 of the California Business and Professions Code seriously when it says:

. . . every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.[iii]

Section 16600 is the cornerstone of California’s strong public policy favoring worker mobility over employers’ restrictive covenant protections. It prohibits non-compete and employee non-solicitation restrictions in employment agreements, and probably most customer non-solicitation restrictions.[iv] The law covers:

  • employees living in California working for out-of-state employers;
  • out-of-state workers of California companies; and
  • out-of-state workers working in California for out-of-state companies.

That’s broad.

Naturally, over the years employers have attempted various tactics to avoid Section 16600. One popular approach is for out-of-state employers to have their employment agreements with California-based employees governed by out-of-state laws and decided in out-of-state forums that are willing to enforce such restrictive covenants. California recently responded to these tactics with a legislative counterpunch. Effective for agreements entered into or renewed in or after 2017, employment agreements that deprive a California resident working in-state from the protections of California’s laws by use of out-of-state choice of law, out-of-state litigation forums, or arbitration provisions are now voidable, unless the employee was represented by counsel in negotiating the agreement.[v]  Out-of-state employers now face a dilemma. Do they include out-of-state governing law and dispute resolution provisions for their in terrorem effect (knowing that they are likely unenforceable) or do they make sure the employee has his or her own legal counsel, and risk educating the employee about the valuable protections of California law that he or she may be giving up in signing the agreement? Stay tuned.

Employers still thinking they can get around Section 16600 would be wise to consider Section 17200 of the Business and Professions Code. Section 17200 makes it an unfair trade practice to attempt to enforce a provision prohibited by Section 16600.

b.  Trade Secrets. So, in the face of California’s strong public policy favoring employee mobility over employers’ restrictive covenant protections, what can an employer do? Answer: protect its trade secrets and confidential information.

California protects trade secrets,[vi] including perhaps the most valuable item for many employers—customer lists.[vii] In fact, some restrictions in employment agreements that operate very much like non-competes and customer non-solicitations have been enforced by California courts under the so-called “trade secrets exception” to Section 16600, where those provisions were deemed to protect against unfair competition by misappropriation of the employer’s trade secrets and confidential information.[viii] So, employers should take note: they might get a second bite at the restrictive covenant “apple” if they word their agreements appropriately.

c.  Commission Plan Agreements. California requires employers to provide employees receiving commissions and performing services in California with written commission plan agreements.[ix] Such agreements must describe how commissions are computed and paid. Employers must also collect signed acknowledgments of receipt from employees for such agreements. Failure to comply bears penalties of $100 for the first violation and $200 for subsequent violations, per employee per pay period.[x] That adds up.

2.  Community Property. California is a community property state.[xi] In California, community property is any property (other than a gift or inheritance) acquired or debt incurred by either spouse, between marriage and permanent separation. Further, quasi-community property is property that would have been community property, had it been acquired while either spouse was domiciled in California. At the time a divorce is filed in California, each spouse has a one-half interest in each separate item of community property and each item of quasi-community property.

Why should a business located outside of California be concerned about California’s community property law? Consider the situation of a married entrepreneur living outside of California who incorporates his 100%-owned, closely-held business outside of California. Things are going so well that he decides to temporarily relocate to California to oversee a West Coast expansion. During the relocation, his spouse files for divorce—in California. Even though the company was formed outside of California, all of its stock is held in the name of the entrepreneur and all of the stock was issued when the entrepreneur was not a California resident; at divorce in California his spouse owns a one-half community property interest in all the stock of the out-of-state corporation. It matters not that the couple had no intention to move to California when the business was started or during its growth. Now, consider that the corporation receives an unsolicited offer to purchase the business. The entrepreneur wishes to accept the offer. The spouse does not. What happens?

In the absence of an agreement, there is a stalemate. The entrepreneur cannot obtain the approval of a majority of the company’s outstanding stock to approve any merger or asset sale, or a direct sale of a majority of the outstanding stock. Moreover, the company would be deadlocked in any shareholder vote where the two spouses cannot agree.

To avoid a situation like this, companies (even those incorporated outside of community property jurisdictions like California) should consider having the spouses of all shareholders sign carefully-drafted shareholder agreements, even when those spouses do not hold shares and do not live in community property states. Such agreements should certainly be put in place before any shareholder or their spouse moves to California, even temporarily.

3.  Employment Law. California’s public policy protecting workers has caused it to adopt numerous laws that are outside of the mainstream of most other states. Here are just a few examples.

a.  Independent Contractors vs. Employees. For employers, independent contractors hold several advantages over employees. In California, for independent contractors, employers do not have to: (a) pay payroll taxes; (b) comply with minimum wage, overtime, meal periods, and rest breaks; (c) comply with vacation rules; (d) provide workers’ compensation insurance; or (e) make unemployment or disability insurance payments or social security contributions. These advantages provide a strong incentive for employers to categorize workers as independent contractors instead of employees—even if they may not be.

California counterbalances this incentive in several ways. First, California law establishes various rebuttable presumptions that workers are employees and not independent contractors.[xii] In such cases, the burden is on the employer to rebut the presumption that the worker is an employee and to prove that he or she is an independent contractor. Adding to an employer’s difficulty in establishing that a particular worker is an “independent contractor,” is the fact that there is no single definition of, or test for, the term in California. Different tests apply for different situations.[xiii] Second, California law makes persons vicariously and individually liable for advising employers to willfully misclassify workers as independent contractors, rather than employees.[xiv] Third, the burden of proving that a particular worker is an independent contractor shifts to the employer once the worker shows he performed any service for the employer.[xv] These and other principles should make any employer, and its executives, very careful when attempting to classify California workers as independent contractors, rather than employees.

b.  Minimum Wage. California’s minimum wages (note the plural) are higher than the current $7.25 federal rate. In California, the state’s minimum is $10 for employers with less than 25 employees and $10.50 for employers with 25 or more employees. (It will increase to $15 by 2022.) Cities, however, can set their own minimums that are above the state’s. Examples include: San Francisco ($14 effective July 1, 2017); Oakland ($12.86); and San Jose ($10.50).

c.  Vacation. While California does not require mandatory paid vacation, employers offering vacation are prohibited from adopting policies requiring employees to “use or lose” accrued vacation days.

d.  California Leave Laws. Under certain conditions, California provides up to six months of paid leave for the birth or adoption of a child. Separate from paid family leave, California also provides numerous grounds for employees to demand unpaid leave, including participation in a child’s school activities and meeting with the child’s teachers. Leave time can be up to 40 hours in a 12-month period. Employers must, therefore, be careful before terminating employees for absence, lest such absences be protected under leave laws. They should always check the law before disciplining or terminating any employee for absences.

e.  The California Family Rights Act (“CFRA”) and the federal Family and Medical Leave Act (“FMLA”). California affords greater rights than the FMLA for pregnancy, pregnancy disabilities, and bonding leave time. The FMLA requires allowing up to 12 weeks to be taken in the first year, but such leave must be taken all at one time. CFRA allows 12 weeks to be taken in the first year in as many as five two-week chunks, plus two additional one-week chunks of time.

f.  Non-Exempt (Hourly) Employees. Hourly employees are entitled to these privileges in California.

  • Meal periods. Employers must provide an unpaid meal break of not less than 30 minutes for each six-hour shift, and must provide a second 30 minute unpaid meal period if the employee works more than 10 hours per day.[xvi] During the meal break an employer cannot exercise control over the employee’s activities, nor can an employer require that the meal break be spent on the employer’s premises.
  • Rest breaks. Employers must provide paid rest breaks of: (a) ten minutes for every shift lasting between 3.5 and six hours; (b) 20 minutes for shifts lasting between 6 and 10 hours; and (c) 30 minutes for shifts between 10 and 14 hours.
  • Day of Rest. Workers cannot be forced to work for seven consecutive days in the same work week.
  • Overtime. Overtime in Calfornia is calculated on a daily and weekly basis.  Overtime rates kick in after the 8th hour in any day and 40 hours in the week.[xvii] Out-of-state workers temporarily working in California are covered by the same rule.[xviii]

g.  Paid Sick Leave. Employers are required to provide paid sick leave for exempt and non-exempt employees.[xix] Sick days accrue at the rate of one hour per 30 days worked, but not less than 24 hours (three work days) for any 12-month period. An employer’s comparable paid time off policy can satisfy the paid sick leave obligation.

h.  Final Pay. Employers are required to immediately pay all wages due to an employee who is discharged or quits.[xx] Willful failure to pay such wages timely incurs a daily penalty of one day’s wages for each day such payment is late.

Conclusion: Employers incorporated or located outside of California need to be aware of California’s laws, particularly when they employ workers based in or temporarily assigned to California. Knowing these laws can prevent a host of unwelcome surprises, as well as the loss of valuable corporate assets.

If you have questions regarding doing business in California or California law, contact Scott Harris at SHarris@fh2.com or (770-399-9500) for more guidance.

[i] Chris Nichols, Does California really have the ‘6th largest economy on planet Earth?’ PolitiFact (July 26, 2016), available at http://www.politifact.com/california/statements/2016/jul/26/kevin-de-leon/does-california-really-have-sixth-largest-economy-/

[ii] This article is only a limited sampling of California law and does not include every issue warranting consideration.

[iii] The statute contains three exceptions involving: a sale of goodwill of a business; partners in advance of dissolving or dissolution of a partnership; and agreements among members of a limited liability company.

[iv] See Edwards v. Arthur Anderson LLP, 44 Cal.4th 937 (Cal.2008) (striking down a non-compete, customer non-solicitation, and employee non-solicitation in an employment agreement). But see Loral Corp. v. Moyes, 174 Cal.App.3d 268, 219 Cal.Rptr. 836 (1985) (enforcing a covenant prohibiting a former employee from “raiding” the former employer’s employees).

[v] California Labor Code Section 925.

[vi] California Uniform Trade Secrets Act at California Civil Code Section 3426 et seq. A recently publicized example of the extent to which California protects trade secrets is the partial injunction won by Waymo (a Google affiliate) in its lawsuit against Uber involving self-driving car technology. See Waymo LLC v. Uber Technologies, Inc., No. C 17-00939 WHA, 2017 WL 2123560 (N.D. Cal. May 15, 2017).

[vii] Brocade Communications Systems, Inc. v. A10 Networks, Inc., 873 F.Supp.2d 1192, 1214 (N.D. Cal. 2012) (under CUTSA, “confidential customer-related information including customer lists and contact information, pricing guidelines, historical purchasing information, and customers’ business needs/preferences … is routinely given trade secret protection.”).

[viii] See Kindt v. Trango Systems, Inc., No. D062404, 2014 WL 4911796 (Cal. Ct. App. Oct. 1, 2014) (enjoining former employee’s use of former employer’s customers’ identities under unfair competition theory); see also StrikePoint Trading, LLC v. Sabolyk, No. SACV071073DOCMLGX, 2008 WL 11334084 (C.D. Cal. Dec. 22, 2008) (enforcing restrictive covenants preventing employee from undertaking “any employment or activity competitive with Employer’s business wherein the loyal and complete fulfillment of the duties of the competitive employment or activity would call upon Employee to reveal, to make judgment on or otherwise to use, any confidential information or trade secrets of Employer.”).

[ix] California Labor Code Section 2751.

[x] California Labor Code Section 2699(f)(2).

[xi] The eight contiguous-states girding the United States’ southern and western perimeter in the “Community Property Belt” are: Louisiana, Texas, New Mexico, Arizona, California, Nevada, Idaho, and Washington. The ninth is outlier Wisconsin.  A tenth, Alaska, applies community property if both spouses opt-in.

[xii] When determining whether a worker is an employee or independent contractor for issues including wage & hour, meal periods, rest breaks, and workers’ compensation insurance, the California Department of Labor Standards Enforcement presumes that a worker is an employee. California Labor Code Section 3357. Where a worker performs services requiring a license or provides services for another who is required to have a license, that worker is presumed to be an employee. California Labor Code Section 2750.5 and California Business and Professions Code Section 7000 et seq., respectively.

[xiii] For example, the three-factor test for when a worker performing licensed services is an independent contractor is at California Labor Code Section 2750.5.

[xiv] California Labor Code Sections 226.8 and 2753.

[xv] See Bowerman v. Field Asset Services, Inc., No. 3:13-CV-00057-WHO, 2017 WL 1036645 (N.D. Cal. March 17, 2017).

[xvi] California Labor Code Section 512.

[xvii] California Labor Code Section 510.

[xviii] Sullivan v. Oracle Corp., 254 P.3d 237 (Cal. 2011).

[xix] California Labor Code Section 246.

[xx] California Labor Code Section 203.

Why You Should Prepare Your Business For Sale (Whether or Not You Are Selling)

Thinking about selling your business—eventually? Here’s some advice on how to maximize its value, reduce costs and minimize risks. (P.S. This advice is equally as useful if you’re not selling your business.)

As it turns out, business buyers are looking for the same things as business owners—sound businesses that produce predictable cash flows with quantified risks. (Who wouldn’t want that?) But what makes a “sound” business? A “predictable” cash flow? A “quantified” risk? These are subjective concepts ultimately intended to support the most tangible of outcomes: a factually-derived, cold, hard purchase price.

Because previous performance does not guaranty future results, financial performance is not the only factor helpful in determining a business’s value.  Buyers want assurances that past performance is likely to be repeated (and/or improved).  So, when valuing a business, buyers want to see tangible proof that the business’s valuable relationships and assets are protected and its risks are quantified (and, where possible, managed). This proof supports the proposition that past financial performance is more likely than not to be repeated or improved and gives buyers something tangible to “put their hands on” in valuing a target business. This proof allays buyers’ natural skepticism and allows corporate sales to be concluded cheaper and faster. So important is this proof that, we submit, creating and maintaining it increases a business’s value—whether or not the business is being sold.

So, what is this “proof”? That depends on the particulars of a given business’s valuable relationships, assets and risks.  What are the business’s sources of revenue?  Where does its money come from? Upon what assets and properties are the business’s cash flow dependent? What are the risks to that cash flow? To illustrate, let’s apply these principles to a hypothetical manufacturing business.

“Proof”A Hypothetical Manufacturing Business

Our manufacturer obtains the bulk of its revenue from selling finished goods. What’s necessary for our manufacturer to continue producing cash flows from sales of finished goods? That depends on the particulars of this manufacturer. It could include intangible things like its relationships with customers, vendors and sources of raw materials, and unique manufacturing “know-how” that makes what or how they manufacture more valuable. It could also include physical assets, like its manufacturing facility, particularly if it is strategically located near customers or raw materials, so that it allows the manufacturer to save transportation costs and time, making its prices cheaper and its products faster to deliver than its competitors. The “proof” of these things (both intangible and physical) might include: customer and vendor contracts; proprietary trade secrets, confidential information or even patents supporting unique manufacturing processes; and the deed or lease for its manufacturing facility.

What are the risks to the manufacturer’s continuing cash flows? Again, these depend on the manufacturer’s circumstances. What if the manufacturer is threatened by an infringement lawsuit from a competitor? What if the long-term lease for its manufacturing facility is coming to an end? What if its source of supply for a key raw material is threatened? These things are important for assessing risks to the business’s ability to continue producing its historic cash flows. Proof of these matters would include copies of the infringement lawsuit and the contested patent or other intellectual property upon which such suit is based. It would also include files documenting the status of lease renewals or the search for an alternative location. Lastly, the manufacturer’s current raw material contract for the threatened source of supply would be critical, as would be contracts representing the status of negotiations or agreements to secure alternative sources of supply.

But what if there was no proof or paperwork documenting these relationships, assets or risks? What if the manufacturer relied upon its president’s personal relationships with vendors and suppliers, instead of having contracts with such parties? How would a buyer be able to evaluate the likelihood and strength of continued cash flows based on those relationships? What if the president intends to retire after the business is sold? What if the manufacturer has not filed applications for patents to protect its unique manufacturing processes or taken steps to protect the confidentiality of its trade secrets (making it very easy for another company to use those processes)?  What if the manufacturer has not secured written confidentiality obligations from its employees and contractors who are familiar with such matters (and who could take them with them when they leave)? What if there was no written lease for the manufacturing facility, but instead, the lease was based on a “handshake deal” between the manufacturer’s president and the lessor many years ago?

Such a lack of proof supporting valuable relationships and assets and allowing quantification of risks obviously makes cash flows much more difficult to predict. In fact, at some point, gaps in proof might make future cash flow predictions so tentative that a transaction, at any price, might not even be possible. Moreover, even if the business is not being sold, a lack of such proof increases the risk within which the business operates—and its value, even to the current owner.

It’s Time to Determine what “Proof” Your Business Has—and What It Needs

So, what should the prudent company executive do? Our recommendation is to:

  • identify the assets, sources of revenue, critical relationships and risks unique to your business; then
  • list the sources of “proof” that your business needs to maintain, support and quantify how these are likely to affect future revenues. (Don’t forget your business’s proof of its relationships with its most valuable resource—its employees.)

Once the business has listed the proof that it needs to maintain, it should then:

  • identify areas where insufficient or no proof exists and begin documenting those matters to substantiate important relationships and assets;
  • evaluate existing sources of proof to make sure they are adequate, up-to-date, organized, and available; and
  • create systems allowing these proofs to be accessible, organized and secure.

Going through these procedures will cause the business to focus on those things that generate and maximize your business’s value—whether or not you are currently considering its sale!

Start Today. Some Areas of “Proof” to Consider

Below is an incomplete list of typical relationships, assets and risks that businesses might consider in evaluating their “proofs.” (Apply these to your unique circumstances before settling on the list of “proof” that is most relevant to your business.)

As you can see from this list, there are many things to consider when documenting—and thereby maximizing—proof of your business’s value. What’s important is that the business start developing this proof early and continue to identify where additional proof may be needed or improved.

If you need help identifying, prioritizing, creating, or improving the particular “proofs” for your business, we can help. Contact Scott Harris at Friend, Hudak & Harris, LLP.

Potential “Proofs” for Businesses to Consider

  1. Customers: contracts with each customer; list of customers lost and added in the past three years; purchasing policies; credit policies; list of unfilled orders; advertising or marketing contracts, programs and materials; and list of major competitors.
  2. Contracts with Third Parties: subsidiary, partnership or joint venture agreements; “insider” contracts between the business and officers, directors, shareholders and the business’s affiliates[1]; license agreements (both those for licensing of the business’s intellectual property to others, as well as those permitting the business to use intellectual property that it does not own); security agreements, debts, mortgages, collateral pledges, etc.; guarantees by or in favor of the business; installment sales agreements; distribution, sales representative, marketing or supply agreements; letters of intent or agreements relating to the purchase or sale, merger or consolidation of the business or its assets; agreements to purchase equity in other entities; contracts with customers, quotes, purchase orders, invoices and warranty terms; and non-disclosure or non-competition agreements to which the business is a party.
  3. Products and Services: list of all products or services sold in the past three years or currently under development; tests, evaluations and other data regarding existing or developmental products or services; descriptions of all products and services, correspondence, applications and reports relating to regulatory application and approval for products and services; and descriptions of all complaints and warranty claims.
  4. Legal Matters: articles of incorporation or organization and all amendments; bylaws and amendments; voting agreements; shareholder and/or operating agreements (whichever is applicable for the particular entity); stock ledgers and certificates, subscription agreements and shareholder lists; stock option, stock purchase plans and grant or award agreements under each; puts, calls, warrants, subscriptions and convertible securities; minutes of director, director committee and shareholder meetings (both annual and special meetings); certificates of authority to conduct business as an out-of-state company or LLC; list of all states and countries where the business has employees, property (whether owned or leased) and conducts business; annual company reports filed in each state; and list of all trade names and registrations for fictitious names.
  5. Financial Information: last three to five years’ year-end balance sheets, income statements, statements of changes of financial position (whether audited or not); auditor’s and CPA’s letters and responses; most recent interim financial statements; list of all debts (both long- and short-term); credit reports; general ledger accounts; descriptions of internal control policies; and projections, budgets and strategic plans.
  6. Real Property: list of all business locations; deeds; mortgages; leases (including renewals); title insurance policies; surveys; and zoning approvals, variances and use permits.
  7. Personal Property: lists of all personal property of the business, describing the property, its type, location, and date of acquisition; motor vehicle registrations; all property leases, including vehicles; and list of capital equipment purchased or sold in the past three years.
  8. Intellectual Property: lists of patents, copyrights, trademarks and service marks, and all registrations for same; list of trade secrets and confidential information of the business; any agreements or other documentation evidencing the business’s ownership of, or rights in, such intellectual property.
  9. Employee and Consultants: employee lists with name, address, last three years’ salary and bonus, title, position description, initial employment date, and years of service; employment agreements; consulting agreements; non-disclosure, non-solicitation and non-compete agreements; invention disclosure and intellectual property assignment agreements; separation agreements; employee handbooks; lists of accrued holiday, vacation and sick day leave; employee benefit plans and their descriptions; workers’ compensation claims and history; discrimination, grievances, harassment, labor disputes, requests for arbitration, workers’ compensation, unemployment, and wrongful termination claims and history; list of all employee benefits plans, summary plan documents and descriptions of qualified and non-qualified plans; list and description of all health, welfare and disability insurance policies and self-funded plans; and collective bargaining agreements.
  10. Licenses & Permits: business licenses; any governmental approvals, consents or permits; and copies of applications to, or proceedings before, regulatory agencies.
  11. Environmental: for each property ever owned or occupied: environmental audits, list of hazardous substances, environmental permits and licenses; property owned or occupied; and lists describing all environmental litigation, investigations, liabilities or continuing indemnification obligations.
  12. Taxes: copies of all foreign, federal, state, and local tax reports and returns for the last three to five years; sales and use tax returns; audit or revenue agency reports; tax settlement documents; employment tax filings; and tax liens.
  13. Claims and Litigation: a description of any pending or threatened litigation; copies of insurance policies possibly providing coverage as to pending or threatened litigation; all documents relating to any injunctions, consent decrees, or settlements to which the business is a party; and list of any unsatisfied judgments.
  14. Insurance: list and copies of the business’s general liability, personal and real property, product liability, errors and omissions, key-man, directors and officers, worker’s compensation, and other insurance policies; and list of insurance claims history for past three years.

[1] Which means any person or entity, controlling, controlled by, or under common control with, the company.