United States: Here's The Recipe: How To Ensure Your Food And Beverage Company Will Be Ready For A Value-Maximizing Sale

You’ve created a great product and built a valued brand. You’ve devoted countless hours to building relationships with key distributors and retailers, designing attractive packaging, and forging a social media presence. But are you doing everything to ensure that your business is set up for sale? Have you taken the steps to address the potential pitfalls—those issues that will reduce the value of your company in a sale or even scare away potential buyers? If you address these 10 key issues as you build your company, you will be positioning your company for a value-maximizing sale.

1. Document the Company’s Ownership and Protection of Its Recipes

The taste profile of a company’s product, and the recipes that create it, will often be one of a food and beverage company’s most valuable assets. Demonstrating that the company owns its recipes and protects them as trade secrets is critical to retaining the interest of potential buyers.

You should keep a list of your company’s recipes and the details of each recipe’s development, including which employees and whether any third parties were involved. It is essential that the company have a standard form intellectual property assignment agreement (IP Agreement) that it enters into with each and every employee of the company, ensuring that all recipes and other intellectual property created as part of the employee’s tenure with the company is the property of the company, with no rights retained by the employee. Company founders who may have brought recipes to the company need to specifically assign those recipes to the company in writing, as do any consultants or other third parties who contribute to a recipe. Agreements with other third parties—such as contract manufacturers (sometimes called co-packers)—should also make crystal clear that the recipes are owned by the company, even if the manufacturing processes are claimed as proprietary by the co-packer.

It is also imperative to keep the recipes confidential, since doing so is required if the company wants to protect them as trade secrets. Treating the recipes as trade secrets provides many benefits. Most importantly, the company can block third parties who misappropriate the recipes from using them. (On the other hand, if the recipes are not trade secrets, the company has limited recourse against those who use them without permission.) Contracts with employees and third parties such as co-packers should require them to maintain the confidentiality of the recipes. It is also crucial to have policies and procedures to safeguard the secrecy of the recipes, such as limiting access to only those who “need to know” and are subject to confidentiality obligations, password protecting electronic copies of the recipes, and labeling any copies as “Confidential.” Additionally, all circumstances where confidentiality was breached should be promptly summarized and explained.

2. Establish Ownership and Protection of the Brand

The intellectual property that supports your company’s brand(s) probably comprises the lion’s share of the company’s value. A successful brand is so valuable because it can inspire loyalty in consumers, command price premiums for products sold under the brand and provide a launching pad for new products. They are also notoriously hard to build. For these reasons, when an up-and-coming food and beverage company is acquired, the buyer is principally paying for the brand. If the buyer cannot get comfortable that it will own the intellectual property necessary to support the brand in all of its current and intended future uses, it will walk away.

The brand can include the corporate name and logo; product name and logo; product packaging shape, packaging color, and other packaging trade dress; tag lines; point of sale or advertising materials; domain names, website and social media content; and other tangible and intangible brand identifiers. There are two key forms of intellectual property rights that a company must own in connection with its brand: copyrights and trademarks.

Copyrights. U.S. copyright law grants certain rights to individuals who create original works of authorship, such as the exclusive rights to reproduce and distribute such works. Many brand identifiers—for example, the artwork on the label or the design on the packaging—will be a form of copyrightable work. You need to make sure that your company owns the copyrights related to its brand—and not an employee or a third party (for example, an advertising agency that designed the logo).

As with the recipes, keeping a list of the brand’s identifiers and noting the details of their development is important. While the U.S. “works made for hire” doctrine may result in the company automatically owning the copyrights in works that employees create in the scope of their job responsibilities, it still makes sense for the IP Agreement mentioned above to cover copyrightable works created during any employee’s time with the company. In addition, company founders need to assign to the company, in writing, any brand and other copyrights that they own personally. And agreements with third parties must specify that the company owns—or, at minimum, has a broad license to—any applicable copyrights, regardless of who had a hand in their development.

Trademarks. A trademark is a word, phrase, symbol, or design, or a combination of these elements, that identifies and distinguishes the source of one party’s goods from those of another. Many aspects of your company’s brand will be considered a trademark. U.S. trademark law allows you to register your company’s trademarks with the United States Patent and Trademark Office (USPTO). Registration with the USPTO confers many benefits, including legal presumptions of validity, ownership, and the exclusive right to use the trademark on or in connection with the goods listed in the registration. It also provides nationwide rights and, if the registration symbol—®—is used with the mark, constructive notice for purposes of recovering damages. Buyers want to see that all key brand identifiers have been registered with the USPTO.1

Trademarks cannot be registered for any and all uses: they can only be registered for the specific goods and services—like coffee or restaurant services—for which the trademark is actually used. If a company has stopped using a trademark for specific goods or services, the mark can be considered abandoned and the registration cancelled by third parties. Similarly, when a trademark is registered for only some of the goods and services for which it is used, the trademark does not receive the benefits and protections of registration for the goods and services for which it is not registered. In addition, it is always prudent to consider whether applications for the company’s trademarks should be filed for markets that the company may enter in the future. Unless you can register the trademarks for goods and services in those new markets, your company will find it difficult to capitalize on the brand if and when it expands into the new markets.

Having policies and procedures in place for managing your company’s trademark portfolio is key. These policies and procedures should cover topics such as trademark development, use, and control. Your company must also have procedures for monitoring its trademarks: unless you consistently object to applications of third-party trademarks that are similar to your company’s trademarks or send cease and desist letters or bring lawsuits against those who are infringing your company’s trademarks, it may become difficult to enforce your trademark rights under U.S. law.

It is also essential that the company retain the right to exercise quality control over its trademarks whenever the company enters into an arrangement that allows a third party to use them. Such arrangements can relate to distribution, manufacturing, advertising, and co-branding. For each arrangement, the company needs to have a written agreement in place under which it has the right to control the nature and the quality of the products in connection with which the trademarks are used. If the company does not have these quality control rights, the subject trademarks could be deemed abandoned and unprotectable.

3. Be Able to Defend the Label

The claims made on a company’s labels entice consumers to purchase company products as well as give them valuable information. But in today’s environment, labels are scrutinized heavily, not only by the FDA and FTC, but also by consumer groups and class action lawyers—all of whom bring costly lawsuits for mislabeling. Buyers want comfort that the company’s labels are accurate and therefore unlikely to be the subject of expensive litigation.

Before putting out a label, your company should verify all express or implied claims that the label conveys to consumers. This is important and you must be careful. For example, does the label say “No GMOs” or “No preservatives”? If so, know that these are some of the many “red flags” on labels that class action lawyers look for. If you say “No GMOs,” note that most corn and soybeans are GMOs, so even small amounts of corn starch could put you at risk. Likewise, if you say “No preservatives,” you may regard an ingredient like citric acid or calcium chloride as acidification agents (pH control), but class action lawyers may claim it is acting as a preservative. By understanding the risks and verifying your claims in advance, you will decrease the chances of finding yourself fighting a legitimate lawsuit for mislabeling.

How to verify a claim depends on the claim being made. There are many types: claims about health (e.g., “heart healthy”), claims about nutrients (e.g., “good source of vitamin C”), claims about ingredients (e.g., “all natural”) and so forth. For health claims like “heart healthy” you need reliable scientific evidence to back your claim; for many nutrient claims like “good source of vitamin C” you must make sure that the amount of the nutrient meets the applicable legal standard (for example, “good source” claims require that the product contain 15%-19% of the % Daily Value); for a claim like “all natural” it is key that you confirm that all of the ingredients in the product are in fact natural, which may entail getting supplier certificates and making sure ingredients are not overly processed; for certain other types of claims—like “organic” or “kosher”—your company’s manufacturing processes need to be certificated by an appropriate certifying group.

4. Ensure Food Safety and FDA Compliance

It goes without saying that your company must comply with food safety laws, FDA regulations, and various state laws and regulations (like Proposition 65 in California). Unless you can establish that your company has a history of compliance, buyers will not pay a value-maximizing price for your company because they will discount the value for the perceived risk.

Thoughtful policies and procedures addressing food safety laws should be in place at your company. Among other things, these policies and procedures must be comprised of a food safety plan, allergen control plan, recall plan, environmental monitoring program, HACCP plan and procedures for compliance with current good manufacturing practices (cGMPs). Having policies and procedures like this will limit the risk of violating food safety laws or having an investigation or action brought by the FDA. It is also imperative that the company holds all registrations required by the FDA and other regulatory bodies (for example, registering the company’s manufacturing facility with the FDA).

If the company outsources any of its manufacturing to co-packers, the agreements need to specifically require the co-packers to have the plans mentioned above in place and that these plans be delivered to the company for review. In addition, agreements with co-packers must detail the procedures for compliance with cGMPs. It is also good practice to monitor co-packer compliance with the agreement so you can make sure that the plans, programs, and procedures are being followed.

5. Secure Supply Chain

A secure supply chain allows your company to maximize revenues, limit costs, and keep customer satisfaction high. It also adds a level of comfort that, even when issues develop, the company’s activities will not be materially disrupted. Buyers want to see that the company has a secure supply chain that consistently and timely allows it to get its product to the market.

If your company manufactures its own products, the company should source its materials from multiple suppliers. If your company outsources all or a portion of its manufacturing to co-packers, it is important that the company has multiple co-packers and that these co-packers themselves have multiple suppliers. Having multiple sources of supply makes it less likely that a problem at one of the suppliers will materially harm the company. For example, if your company’s sole supplier suddenly goes bankrupt or has a strike at the plant, you may not be able to manufacture product on a timely basis, thereby losing revenue and harming your relationship with your customers. But if you have multiple suppliers, you could likely divert production to the other supplier, thereby offsetting the impact of the adverse event.

Having multiple suppliers will also give the company more leverage when it negotiates the terms of its supply agreements because the company has alternatives to doing the deal being negotiated. Additionally, the company’s supply chain needs to be able to sufficiently supply an amount of product to allow the company to hit its financial forecasts. If the company does not have access to sufficient supply to meet those forecasts, the forecasts will be discounted by potential buyers.

6. Have Binding Agreements Memorializing Key Relationships

Your company’s relationship with material third parties—like your brokers and distributors, label maker, co-packer, and landlord—is fundamental to the operation and success of your business. Because of their importance, when buyers and their counsel conduct due diligence on your company, they will be keenly focused on understanding these relationships. It is important that all of your company’s agreements with material third parties be in writing, both as good operational practice but also to make it easier for buyers to understand them. Only after a buyer is satisfied that it understands these relationships will it be prepared to pay a value-maximizing price for your company.

7. Produce Reliable Financial Information and Supportable Projections

Reliable financial records are a prerequisite for any well-run business. In order for buyers to be satisfied that your company’s financial records are in fact reliable, they will generally require you to produce audited financial statements (i.e., an independent accounting firm has reviewed your company’s books and has confirmed that your financial statements fairly present your company’s financial performance) and a quality of earnings report (i.e., a study of the company’s revenue and costs). To be in a position to produce audited financial statements and a quality of earnings report for the buyer during the sale process, it is essential that your company’s financial statements be prepared in accordance with U.S. generally accepted accounting principles and that you keep the necessary financial records. Failure to do so will prevent your company from producing financial statements that can be audited and a quality of earnings report, which will have a detrimental effect on your efforts to sell the company.

8. Incentivize Key Employees

Your company’s employees are among its most important assets, as they possess the skills, knowledge, and experience to operate the business. Potential buyers will want to meet the company’s key employees to understand their roles and qualifications, confirm facts about the business, and get a sense of morale at the company. A buyer will form meaningful opinions about the company based on its interactions with employees. In light of this, it is important that you treat your employees well and instill in them a vested interest in the success of the company. One of the (many) ways to do this is to provide your key employees with incentive compensation such as equity or options to purchase equity in the company. This allows them to participate in the company’s upside and thereby encourages them to think like owners.

Buyers recognize the benefits of your employees’ skill sets, knowledge, and experience, and will want to retain those benefits for at least some period of time after the closing, typically between 6 and 12 months. Buyers want to ensure a smooth transition and integration, which is not possible if your employees are headed out the door as soon as they hear about the deal. To incentivize your employees to remain at the company, it is often beneficial to provide them with retention bonuses when the company begins to seriously contemplate a sale. Although they can be structured in many ways, a retention bonus grants an employee the right to additional compensation at some future date or dates. Payment dates vary depending on a variety of factors, but deal-related retention bonuses are often paid partly at closing and partly on specified post-closing dates, such as the 6- or 12-month anniversaries of closing, with payment contingent on the employee’s continued employment with the company through the payment date. By issuing retention bonuses, you will help assure the buyer that it will be purchasing a going concern.

9. Diversify Your Customer Base

It is always exhilarating to land the big box retailer or large e-commerce site as a customer. They place large orders, provide prestige, and will not default on their bills. Indeed, sales to the big box retailer or large e-commerce site may catapult your business to the critical mass necessary to attract a buyer. But you must be cognizant not to allow such a customer to account for an exceedingly large percentage of your company’s revenue, as this will present an obstacle during a sale process. Buyers prefer to see a diverse customer base. From their perspective, one large customer that monopolizes the company’s revenue stream presents a serious risk, as its loss could decimate sales or worse, bankrupt the company. So it is important, while you build your company, to focus not only on growing sales but growing sales to many customers to avoid undue customer concentration.

10. Ensure Privacy and Data Security Compliance

Your company’s website is a great way to furnish information about the company as well as an avenue to sell products directly to consumers. Yet maintaining a website requires your company to comply with certain privacy and data security laws. This includes having terms and conditions and a privacy policy that are appropriate for your company’s website as well as observing laws covering personally identifiable information—for example, names, addresses, and credit card information—when collecting information from customers. Buyers are very focused on these areas in light of overall concerns in the media and among customers about privacy and data breaches, and will want confirmation that you are in compliance with these laws.

The authors gratefully acknowledge the valuable input of Eric Skae, former CEO of Rao’s Specialty Foods, Inc.

Footnotes

1 Registration with the USPTO, however, does not provide protection outside the U.S. To the extent your company operates in foreign jurisdictions, you need to consider the trademark laws of those jurisdictions. Depending on the significance of the foreign operations, buyers will want to see that the company has complied with foreign trademark laws for the key brand identifiers.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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