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Business Sales – Are there conflicts of Interest?

I was out seeing potential clients this month and came across a couple of businesses with a similar problem.

The issue arises where a business owner sells their business to one or more members of staff. In such a transaction, there is one party looking to maximise the return for their life’s work. On the other side is a party probably with little business experience outside the day-to-day operations of the business at the heart of the transaction. Corporate finance issues will be an alien world but fundamental to their future success and wealth. They probably don’t have much capital and hope to capitalise on their knowledge of the trade to see them through.

At the heart of the transaction is the company accounting advisor who will have guided the owner for several years. They will want to retain any future work he may offer them, along with the fees arising from the sale transaction. They do not know the incoming management very well; they may have concerns about the likelihood of the business succeeding in the hands of the new owners, but they will want to keep the show on the road as long as they can, with respect to continuing fees.

Is this situation a conflict of interest? …….Of Course It is!

How does it manifest itself?

a) The price asked and paid. The incoming management has little understanding of valuation techniques and typical price-earnings multiples for small businesses with little intellectual property. In one case, the profitability of the business was completely out of line with the price paid (16 times earnings).

b) The process. Usually a business changes hand on the assumption that a clean balance sheet, compatible with ongoing operations, will be handed over and will be restated and validated at the completion date. This ensures that an outgoing owner will not saddle the incoming management with obligations they were not aware of or strips out too much cash. Any deviation from the expected asset value is reflected in the purchase price.

c) Tax and other liabilities. Without independent advice, the outgoing management may well fail to disclose all the commitments remaining with the business that should be adjusted in the price. The old owner may even force the incoming management to forego refunds due on the settlement of overdrawn director’s loan accounts as such a balance is cleared with a write-off/dividend rather than a cash payment from the former owner. Equally, liabilities for holiday pay, sales warranties and tax and accounting fees are unlikely to be reflected in the price.

d) The Importance of the Sale and Purchase Agreement and related warranties. This document should ensure fair play for both sides but the absence of independent advice will ensure a one-sided arrangement the incoming management will come to regret at their leisure.

The incoming owners should appoint their own advisors, both legal and accounting. These should be advisors with knowledge of business transfers or sales.

The incoming management should be prepared to challenge remaining accounting firms for their failure to represent their interests in favour of the outgoing owner.

Are you thinking of buying your employer’s business or any business for that matter?

Get in touch to protect your income now and wealth in the future.

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