Selling a Family-Owned or Other Closely Held Business: A Buyer’s Market at the Crossroads

By Michael J. Brandt and Matthew S. Hale

 

In January 2020, the first COVID-19 case was confirmed in the United States, changing the direction of the U.S. economy and bringing many businesses to, or even past, their breaking point.

 

According to Fortune Magazine, as of September 28, 2020, almost 100,000 small businesses in the United States had closed permanently after closing temporarily in April. This number will surely continue to grow, and will do so for the foreseeable future.

 

Small businesses, including family-owned businesses, which have survived until now, may be at a difficult crossroads.

 

Should they:

• Try to survive?
• Declare bankruptcy?
• Dissolve and liquidate?
• Sell the business to a new owner?

 

The struggle for these businesses coincides with one of the hottest buyers’ markets in recent memory. Strategic acquisitions (buy rather than build) are in vogue, and there is a significant amount of private-equity cash in the coffers, partly as a result of governmental pandemic assistance and low interest rates but also due to the increased  desire for private investment. These trends are expected to continue through the rest of 2021.

 

Based on the current market, this is an ideal time for small business owners to consider an exit strategy rather than a distressed sale. Business owners who decide to pursue a sale should keep in mind all of the following due diligence considerations when structuring their transactions.

 

1. Consider the obligations owed to other owners before moving forward

 

Many companies’ internal organizational documents, such as an agreement among shareholders or members, will contain provisions restricting or otherwise affecting the ability to sell an owner’s interest. In the event a majority owner wishes to sell such owner’s interest, these restrictive agreements need to be considered.

 

Even if there is no agreement containing so-called “tag-along” rights (which permit minority owners to participate) or “drag-along” rights (which permit the majority to require the minority owners to participate), it may be beneficial to consult with other owners and negotiate with the proposed purchaser to see if a transaction can be accomplished that would be beneficial to everyone. Additionally, regardless of legal and contractual requirements affecting owner’s rights, the more input received, and the more discussions had, the better the outcome may be for all involved. This will make the final process significantly less challenging in the long run.

 

2. Focus on stock rather than assets

 

Sellers of businesses are frequently better off focusing on stock during a sale. Historical performance and the one-time position of strength help support a better valuation. Liability transfers with the stock from the seller to the buyer (absent an agreement otherwise), leaving the seller to walk away with less liability than an asset sale. Conversely, buyers typically prefer an asset sale because they can pick and choose the assets and liabilities that they take on.

 

3. Be sure to value your assets and assess tax issues appropriately

 

It is helpful for any business considering selling to get an appraisal of all assets, including facilities, equipment, and intangible property such as patents, trademarks, copyrights, and trade secrets. Not only does this help the seller in obtaining the best price for the business, but it also provides necessary inputs when considering tax implications of the sale.

 

The intangible property is especially crucial in calculating the value of the business, as it is the hardest to assess but potentially the most lucrative aspect of the business. Additionally, the seller needs to be aware of the tax implications of the sale while negotiating asset value. It is possible that the highest-valued offer may in fact not be the most profitable for the seller due to tax considerations.

 

4. Prepare for non-competes and ongoing post-sale transition

 

A non-compete clause from key members of the seller has been a common request from buyers, even pre-Covid. In Alabama, these clauses are considered reasonable with a limit of one or two years depending on the type of sale. However, frequently the buyer is willing to keep the selling owner on staff to aid in the transition after the sale is complete. The selling owner has much more institutional knowledge, better client relationships, and familiarity with brand positioning than the new owner.

 

It may be in everyone’s best interest for the transition period after the sale to include both the buyer and the seller in an effort to keep the business running smoothly.

 

5. Anticipate potential post-Covid contractual provisions

 

In today’s fading Covid world, there are additional factors to take into consideration during the sale of a business. The buyer may require a “material adverse effect” clause as a kind of insurance if the business is unable to recover from Covid-fueled economic crises. This will allow the seller to cancel the sale if it is determined that the business’s value has change significantly and to the buyer’s detriment during the pendency of the sale transaction.

 

Material adverse effect clauses can become even more significant when they are paired with a longer-than-normal due diligence process. The due diligence period will include examination of health and retirement benefits, the financials of the company, and analysis of important contractual relationships. The buyer likely will request a covenant that the seller continue to “operate in the ordinary course of business” during the due diligence period and closing process.

 

Buyers in this Covid-defined world also tend to request more warranties, as well as having extended closing deadlines due to business disruption and remote negotiations, all of which put a higher risk on the seller.

 

Lastly, if the seller or buyer took out a PPP loan, an analysis of the effect on the company’s income and expenses should be undertaken, and the SBA must be notified of the sale. Sellers should expect buyers to want to exclude the PPP funds from calculations that affect the purchase price.

 

Letting go of a family-owned business is never easy, even in the best of times. The present market provides an opportunity to sellers to recover the value (or even more) of the work put into building and operating the family business.

 

Buyers are looking, and are ready and able, to purchase businesses. If your business is in a difficult financial position, selling may be your best option.  Begin assembling your team of accountants, attorneys, and other professionals today to guide you through the process.

 

Alabama Rules of Professional Conduct require that the following language accompany any communication concerning a lawyer’s services: “No representation is made that the quality of the legal services to be performed is greater than the quality of legal services to be performed by other lawyers.” 

 

Deciding whether to sell your business? Wallace Jordan can help. Contact us today.