Clayton Utz Insights
29 March 2012
By Nick Miller.
To maximise value, a buyer must be convinced of the worth of the business, but privately-owned businesses have a credibility problem in the eyes of the sorts of buyers they are likely to encounter
You're a private business owner who's been running a business for some years. It's a terrific business that generates good profits, doesn't demand heaps of capital and is well run. You think (as much as you really can ever think this) that you are on top of running the business after all this time.
Then, out of the blue, you receive an offer for the business from an international group in your industry that's looking to establish a presence in Australia. Recent research suggests that despite our high dollar, international buyers tend to pay higher multiples. Or, it could be a private equity buyer that's been scouring the market and spotted your business.
The offer proposes a fantastic price; materially more than you thought your business would be worth. But this offer is only open for acceptance for the next two weeks and the sale will need 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 the next two months.
Is your business prepared for sale, so that you can capture the value offered and avoid undue risks?
Over the next few weeks, I'll be looking at some of the issues that private business owners should be thinking about now to ensure they're best placed to capture maximum value when the big offer comes. In this article, I'll focus on the buyer's perspective, and the sorts of problems they perceive in privately-run businesses.
Considering the buyer's perspective
To maximise value, a buyer must be convinced of the worth of the business. What works well to generate good cash flows and good profits when running a business, while obviously important (indeed, fundamental) in the sale context, are not the only things that are important in order to maximise sale proceeds. Privately-owned businesses in general have a credibility problem in the eyes of the sorts of buyers they are likely to encounter, who can think that the business may:
- not rigorously prepare its financial information;
- not have proper asset management and risk procedures, so there is a greater exposure to risk;
- have more lax employee procedures; and
- not be properly separated from the owner's personal affairs, so private expenses might be run through the business, and there might be some concern about tax compliance and risk.
Problems with intellectual property are very common when it comes to selling privately-owned business. Examples include:
- not having a strong, independent brand, so that the business is too closely identified with the founders, reducing value to potential buyers accordingly;
- not dealing expressly with the ownership of copyright in agreements with contractors who have created critical marketing tools of the business, such as catalogues, a logo or website, or a critical piece of software for the business which now provides a competitive advantage;
- not registering intellectual property, such as a domain name, logo or brand; or
- not properly acquiring intellectual property.
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 become unwieldy over time and not readily transferrable to a buyer.
For example, a company runs a number of businesses, but buyers are likely to only be interested in one of them, not the whole package. Practically speaking, the only way to sell is by a business sale. However, in certain situations selling in that way could present a serious problem.
Perhaps for historical reasons or inadvertence, a key customer contract, critical to the revenue and profitability of the business, may not be in the name of the party that now operates the business. This might not be a day-to-day issue for a private business owner, but will be a problem upon sale, especially if it's done as a share sale.
Key contracts can present other issues – basic ones such as whether they are written, whether they are they signed and when they expire, and more major ones, such as whether a major contract can be disclosed to a buyer and if so, when. If the buyer is a competitor of the other party to the contract, can the contract be assigned to the buyer?
Often private business owners take a basic approach to employee issues because they have good relationships with employees and know most of them personally – none of which will be available to private-equity or corporate trade buyers.
So the business might not have policy manuals for dealing with employee issues, or processes and policies to address statutory requirements. Employment contracts might not contain appropriate restraints upon some of the more critical employees.
Although a buyer can avoid taking on the potential liability under any litigation that is on foot by acquiring the business and assets, rather than the shares in the company that undertakes the business, any unresolved (or recently resolved) litigation will likely still concern potential buyers.
Litigation can be an indicator of some systemic issue in the way the business is run, which could mean further litigation or costs to change the system. This is so even if the business is suing, rather than being sued.
Data room preparation
If there are gaps or errors in the documents, the owner loses credibility and buyers have the opportunity to leverage off this to argue for a discount.
Next edition: Selling a privately-owned business: how can you fix the common problems before a buyer appears?
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.