Structuring your business for a successful sale

As a family business, even if you’ve tried to ‘control the controllables’, the chances are some areas will get overlooked in the early phases. This can cause challenges when it comes to exiting a business or seeking external funding. Here we focus on just a couple of issues we see regularly and some of the challenges this can present.

Equity Issues

What we see

Particularly common in entrepreneurial businesses that have been self funded or sought investment from friends, family and others through their growth phase, is an equity structure that has evolved into something that gives rise to unwanted tax and legal issues at the point of exit.

Two common examples we regularly see are:

1. Ineffective share buy backs

To facilitate the desired ownership structure for the future, often entrepreneurial companies will buy-back shares as the business grows and the aspirations of founders or investors change. There are a myriad of company law issues surrounding the process of completing share buy backs with very specific steps required to ensure the buyback is legally effective and ratified. Any deviation from these strict requirements can render a share buy-back ‘void’ – meaning it legally has not taken place.

Funds can change hands and shareholders can continue to grow their business in the belief that they own the whole company only to find out, during a sale process, that a buy-back undertaken years ago was not effective and an historic shareholder still legally owns a share of the business.

This can be a stressful discovery and, whilst it can be resolved, it introduces an unnecessary risk for both buyer and seller and can be costly to rectify.

2. Promised shares

A share in the equity of a growing company is a powerful incentivisation and recruitment tool. The tax incentive for equity ownership is generally linked to the ability to benefit from lower Capital Gains Tax rates on the sale of shares, compared to a bonus which attracts higher rates income tax and National Insurance. However, the absence of an effective equity structure to allow this can often result in equity participation being either not structured tax efficiently, or, worse, promised but never delivered.

It can be demoralising, disruptive and expensive to get to the point of a value realisation event with key employees believing they have a share of the equity (and the sale value) only to discover that the promised equity interests were never formally issued or were incorrectly issued such that tax advantages are not available.

Transferring shares into the hands of others close to, or during, a value realisation event undermines the tax advantages of equity incentives and can create significant tax burdens on both the individuals and the company, meaning the process does not deliver the expected tax advantages.

How to avoid these issues

In both these instances the key mitigation available is to take proper advice at the time. Whilst corporate advisors can appear costly in the growth stages of a business, investing in strong advice early can significantly mitigate issues and costs in future.

• Appointing experienced legal advisors to ensure share buy-backs and transfers are effectively undertaken is strongly recommended. It avoids future complications giving the peace of mind that the desired share structure is correct and effective.
• Taking the time to establish a proper equity incentive structure, with the support of lawyers and tax advisors, and undertaking the appropriate filings when utilised, will ensure equity incentives are clear and effective and act as the incentive and reward they are designed for.

Overly complex group structures

What we see

Often as businesses grow, they make acquisitions or form subsidiary companies to service their customers in different sectors, service lines or geographies.

It is not uncommon for growing enterprises to evolve with complex corporate structures, with numerous corporate entities in diverse geographies and minority shareholders or joint venture partners participating in the ownership of subsidiary entities throughout a group structure.

Whilst these structures can serve a purpose in a business’ growth, when it comes to selling a business, or group, the existence of minority holdings in subsidiary entities can cause complications and challenges.

Buyers will usually want to acquire 100% ownership of a business. If there are minority interests throughout a group, they will likely want to acquire these to ensure they are buying 100% of the economic rights of the business. ‘Drag-along’ and ‘tag-along’ rights associated with minority shareholdings can cause complications on a sale process. In addition, the debate around the valuation of minority holdings throughout a group structure can cause conflict between sellers.

Failure to identify these issues and have a clear, and agreed, approach to deal with them in a sale process can be very disruptive when selling a business and potentially cause a deal to fail.

How to avoid these issues

Where possible keep a corporate structure and equity ownership as simple as possible. Whilst equity structures often need to have some level of complexity to allow for appropriate incentives, keeping equity incentives and minority interests within the holding company of a group should help ensure a far simpler and smoother sale process should the time come to exit.

If it is not possible to remove minority interest ownership from subsidiary companies it is important to ensure there is a clear and legally enforceable procedure in place to deal with a sale of the group, taking account of ‘drag/tag-along’ rights and valuation methodology and allocation, to avoid any complications and disputes in a group sale process. Clarity among shareholders and the ability to present the same to a buyer should go some way to help alleviate some of the deal completion risks complex group structures can present.

When growing a business and putting incentives in place it is important to have one eye on the end game. If the eventual goal is to sell the business ensure the structures you are putting in place as you grow will help facilitate a smooth and successful exit, and not frustrate it.

This article provides a high-level overview of some typical issues that cause cost, complexity and conflict through a realisation event. Investing in good advice will pay off in the long run. Working with a team of experienced advisors throughout your business lifecycle will help you to be deal ready whenever the opportunity arises.

For more information about getting your business ready for sale, speak to Matteo Timpani, Corporate Finance Partner or your usual Crowe contact