Planning For The Sale of a Family Business (Part 2)

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second of a two-part series on matters to consider when preparing a family business for sale. Part 1 of this article discussed the Capital Gains Exemption and techniques to enhance this exemption in the October 2005 issue of The Fine Print.

3. Financial Reporting - Acquisition-minded companies become sophisticated purchasers. They often engage in extensivedue diligence inquiries prior to consummating a share transaction, which always includes a review of a company’s annual financial statements for several prior fiscal years. Family-owned businesses quite often engage their accountants to prepare “Notice to Reader” or “Review Engagement” financial statement reports. Neither of these reports requires the accountants to make diligent inquiries to ensure that management is properly and fairly reporting all material financial information. A sophisticated purchaser, when encountering “Notice to Reader” or “Review Engagement” reports, will exercise extreme caution in negotiating the terms of a purchase of a business. However, if a company, in anticipation of a sale, has its financial statements audited, the purchaser will place more reliance on the fact that the statements were subject to an audit and rely less on the vendor’s representations and warranties in the purchase agreement. If a company begins to have its annual statements audited, years in advance of a sale, the additional expense of this higher level of financial reporting may ultimately be insignificant to the additional price obtained or the reduced exposure of the seller for its representations and warranties.

4. Personal Guarantees and Indemnities - It is not unusual for certain creditors of a business (e.g. banks and landlords) to require personal guarantees of the owners of a family business as a condition to providing financing to the business. The “need” for the personal covenant as a measure of security tends to lessen over years of successful operation of the business. However, since personal guarantees and indemnities can only be released by the creditors who hold them, neither the purchaser nor vendor of a family business can eliminate the vendor’s exposure under the contract which has been guaranteed. Furthermore, creditors are typically not inclined to give up their security, resulting in a sale transaction being completed with the vendor remaining at personal risk.

During the course of the operation of a family business, the owner subject to the guarantee should be mindful of the benefit of being “removed from the covenant” whenever possible (typically at times of renewal of the underlying obligation) and should attempt to negotiate for the release of any such continuing personal guarantee obligations.

5. Employees – Depending upon the nature of the business and its reliance on a specialized workforce, a business owner has the opportunity to make its business more attractive to a purchaser or to reduce its financial obligation to pay termination pay to employees by giving “working notice”. Every employee must be given a reasonable period of notice by an employer prior to his or her termination (except of course if there is a written agreement with an express clause to the contrary). The other, more expensive option, is a payout of an amount equal to the pay an employee would receive over a reasonable notice period. A vendor should exercise caution, however, in providing working notice to key employees who may be an attractive component of the business in the eyes of the purchaser, or necessary employees who could seek alternate employment after receiving notice.

6. Family Name – The corporate name of a business often involves the surname of the family that owns it. Some families wish to ensure that the family name is no longer associated with the business after its sale. Most businesses can withstand changes to its name with no adverse effect on the profitability or value of the company. A cautious purchaser, however, may be concerned that a post-closing obligation to change the name of the business could adversely affect the company’s relationship with its customers which could reduce the goodwill portion of the purchase price that a purchaser would be willing to pay. If a business owner has a plan towards a future sale of the business, it may wish to change the name of the business well before it markets the business for sale with the post-name change financial reports substantiating that the change of name has not resulted in a loss of goodwill.

Business owners should consult with both their financial and legal advisors to ensure that matters relevant to the sale of a family owned business are addressed.