You have a client who is a private business owner. He has run his business for 20 years, it generates good profits, doesn’t demand a lot of capital and is well run. Out of the blue he receives an offer for it that seems too good to refuse.
However, the offer is only open for acceptance for two weeks and the sale needs to be fully transacted – that is, due diligence materials assembled, due diligence and management presentations undertaken, all documents drafted and negotiated then signed and completed – within two months.
A business that’s poorly prepared for sale can suffer a significant loss of value. Often, that value can be readily preserved if private business owners identify the issues, have a plan to address them and some time to implement their plan.
To maximise value, a buyer must be convinced of the worth of the business. What works well to generate good cash flows and profits won’t be the only things critical to maximising sale proceeds. Generally, privately owned businesses have a credibility problem in the eyes of likely buyers, who may expect:
- Poorer procedures generally, especially for employees, so more risk
- A lower standard of financial information
- Some mixing with the owner’s personal affairs
To maximise value and demonstrate that a business can operate without the involvement of the founder, having a strong brand and other intellectual property (IP) is critical.
However, IP problems are common in privately owned businesses. Any owner thinking of selling should immediately review their IP portfolio. Often a business does not own the IP it thinks it owns. It might need the co-operation of a counterparty which may have no inclination or incentive to assist and may indeed take advantage of the situation.
Business owners should also review their contracting arrangements to ensure that future IP developed is clearly theirs.
A key customer contract, critical to the revenue and profitability of your client’s business, may be in the wrong name. This will be a problem upon sale, especially if it’s done as a share sale.
Key contracts can present other issues – from basic ones such as whether they are written, signed and when they expire to more significant ones such as if and when a major contract can be disclosed to a buyer. If the buyer is a competitor of the contract counterparty, can it be assigned to the buyer? Armed with knowledge, a plan can be actioned to fix issues at the most opportune time – for example, upon contract renewal.
A business structure often reflects how it has been built up over the years, influenced by the then prevalent tax or succession planning solutions, and not be readily transferrable to a buyer. It is not unusual for a single company to run several businesses, but buyers are likely to be interested in one. Practically speaking, the only way to sell is by a business sale, but in some situations selling in that way could present a serious problem.
The issue might well be able to be addressed by preparing the business for sale by transferring contracts, other assets and employees to a newly established subsidiary that only undertakes a particular business (tax treatment should be carefully checked). This could be done as contract renewals roll around and at annual review for employees.
Once all contracts, assets and employees have been transferred to the subsidiary, it is readily saleable as all that is required is the sale of its shares.
Often private business owners take a basic approach to employee issues because they have good relationships with employees and know most of them personally. This may mean the business does not have policy manuals for dealing with employee issues, or processes and policies to address statutory requirements. Employment contracts might not contain appropriate restraints on important employees.
A privately owned business can readily address these issues by reviewing template contracts, and creating or updating employee procedure manuals and policies for current business risks (occupational health and safety, competition from departing employees, preserving confidential information and so on) and changes in legislation.
If employee contracts need to be put in place or amended, this is usually best done at annual review.
Although a buyer can avoid taking on the potential liability under any current litigation by acquiring the business and assets rather than the shares in the company that undertakes the business, any unresolved or recently resolved litigation will probably still concern potential buyers.
Litigation can be an indicator of a systemic issue (even if the business is suing, rather than being sued), which could mean further litigation or costs to change. Owners should resolve outstanding litigation and be prepared to explain how the underlying circumstances that led to the litigation can no longer recur.
It is best to have a year or two between the resolution of any material litigation and a business being up for sale.
Governance can assist to reduce risk and fix issues and is a means by which a business can present as less dependent on the involvement of its founders, adding very significantly to value.
Often, formal governance policies and procedures are not needed and may not be of much value when running a privately owned business.
Many owners also think the absence of governance procedures makes them more flexible, adaptable and opportunistic. That may be, but the benefits should be weighed against the benefits of formal governance when planning a sale. Overall, preparation equals value.
When it’s time to take governance seriously
If the business has grown to the point where you really need to focus on governance, there are ways to introduce greater formality.
- Without changing the makeup of the board, the company can implement a more structured system of monthly meetings. These may or may not be formal board meetings, but should involve directors and those who report to the CEO.
- A company can set up one or more committees. These can be formal board committees or more informal, but they are set up to address areas of need, bring in expertise when necessary and focus on improving risk management. Examples are an audit and risk committee, a brand development committee and an employee policies committee. The committees might include outsiders, depending on the need and expertise available in the business.
- An advisory board can be established. Properly structured, its members will not carry directors’ duties and liabilities and it can be a sensible stepping stone to a more fully independent board.
- Governance can also be improved by implementing the development of appropriate policies and procedures.
Nick Miller is a partner in the Melbourne office of national law firm Clayton Utz.
This article is from the October 2012 issue of INTHEBLACK magazine.