Ben Wilson, Partner at CCK Lawyers, discusses the process for the sale of a family business and the key factors that should be taken into account. This article is the final instalment of a series which has recapped the key points from Ben’s recent presentation at the Family Business Advisory Conference. In Part 1, Ben considered what a seller should expect during the process of a typical business sale. In Part 2, he explained how to determine whether a family business is ready for sale. Now, in Part 3, he will explain how to present the family business to potential buyers.
The manner in which the family business is presented for sale will determine the type of buyers you will attract and the purchase price achieved. The business needs to appear professional, organised and established. The figures need to show that the business has significant value currently but also room for growth and improvement. Every business has a ‘story’ and that story must be used to help sell the business.
Will the family remain involved in the business post sale?
For family businesses it is important to get the balance right between the family story and the business success story. If the family story is too strong, potential buyers may determine that, without the family, the business might not perform as well or may not succeed. A fundamental decision needs to be made about whether the family members who are involved in, or are integral to, the business are willing to stay on with the business post sale.
Ultimately, the decision comes down to the importance of the family member to the ongoing success of the business and the direction the buyer has for the business. At a minimum, it is usually agreed that the seller will provide a short period of transition and training to the buyer post completion. The period of transition and training ensures a smooth transition between the seller and purchaser.
In other instances, family members will stay on for a longer period. It might be a condition of the sale that the key family members enter into employment agreements or consultancy agreements with the buyer. The terms of those agreements include remuneration, conditions, role, responsibilities, and so on, which need to be negotiated and drafted carefully. It is a big commitment to stay on with the business post completion and therefore those terms have a significant and ongoing role to play.
Buyers now often seek to withhold part of the purchase price until successful completion of the post completion employment or consultancy agreement. Alternatively, there might be an ‘earn out’ arrangement or performance bonus or performance based renumeration connected with the employment agreement or consultancy agreement. This gives the continuing family members the motivation to continue to work hard for the ongoing success of the business.
It is often the case that on sale or after the end of the relevant completion employment or consultancy agreement, the family members will often be bound by non-compete/non-solicitation clauses, which need to be negotiated carefully.
Are there related party business arrangements (for example, property rental)? Are these at market rates?
When a potential buyer values a business they will look at the ‘true’ profitability of the business. This means that any non arm’s length arrangements that are not at market value will be taken into account in the valuation process. Related party arrangements might also complicate the transaction. It may be a condition of completion that these arrangements are put on arm’s length terms.
If time allows in the planning process, it is better to regularise non arm’s length arrangements and put them on market rates before the sale. Where possible, this should be supported by a valuation. Additionally, director/family employment arrangements should also be documented and set at market rates in the lead up to a sale.
Are there non-business family expenditures in the business?
If the business incurs family expenditures, they will be taken account in the valuation and negotiation processes. It is better, if possible, to eliminate those items in the lead up to the sale. If they are not eliminated, the potential buyer may have concerns about the professionalism of the business and may raise tax issues.
It is important to think about how a potential buyer might value the business (for example, a multiple of earnings before interest and tax on a normalised basis). If an asset is not being used for core business purposes or is not adding to the earnings of the business it is probably not relevant and a buyer will want it excluded (or, at least, will not require it to be included).
If there is plenty of time available to plan for the sale, the balance sheet of the business should be tidied up before the sale to reduce its assets to core business assets only. This can be done by selling non-core assets or transferring them to related parties for market value. You need to consider the tax implications of doing this and also the impact on the financials that will be presented to potential buyers.
If it is not possible to tidy up the balance sheet before the sale, the relevant assets needs to be excluded from the sale in the documentation. In a business sale context, that process is quite simple. The relevant assets can be referred to as ‘excluded assets’ and expressly excluded from the assets being sold. In a share sale context the process is less simple. This is because the owner of the shares owns all of the assets in the company. In order to exclude assets from the sale, therefore, there need to be a condition to completion that a transaction will be affected to remove the assets from the company’s assets before the sale.
Alternatively, if ‘excluded assets’ are staying with the business or company, it may be necessary for an adjustment to be made to the purchase price to reflect that the asset was not included in calculating the core value of the business.
As you have seen throughout this series, the sale process requires significant thought and consideration. Done properly, a sale can be a successful and rewarding experience for the seller. In many cases it is the realisation of the seller’s life’s work. However, if the process is not organised properly or the tax and commercial issues are not considered carefully, the sale may not meet the desired outcomes of the seller or the sale may not occur at all. If the sale process fails, the business may be badly affected in the process. The key is for the seller to obtain advice upfront, set a plan and implement it.
The text of this article is only discussion of principles and regulations. It is not to be taken as legal, commercial or financial advice as to any factual circumstances.
Ben Wilson was admitted to practice law in 2001 and was appointed a partner in 2008. Ben is an excellent lawyer, highly regarded in tax circles and a consummate adviser on private wealth and estate planning. Ben has a wide range of experience in corporate and commercial transactions, with a particular focus on taxation and revenue. Ben has extensive experience in preparing various types of commercial contracts including business sale agreements, share purchase agreements, standard terms, partnership agreements and other documents. Ben is a member of the Law Society of South Australia and a fellow of the Tax Institute. He is a former state chair of the Tax Institute, and its South Australian Education Committee. Contact Ben at firstname.lastname@example.org or connect via LinkedIn.