Nick Miller talks to BRR Media about the challenges in selling
privately-owned businesses.
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David Bushby
Today BRR Media speaks with Nick Miller, who's a partner in the Corporate team specialising in private M&A with Clayton Utz in Melbourne. Welcome to BRR Media Nick.
Nick, privately-owned businesses make up the overwhelming majority of Australian businesses and it appears many business owners are actively planning to cash in on their hard work with a future sale.
Nick Miller
Yes, now that baby boomers are reaching retirement age it means that there are lots of privately-owned businesses that need to find a new owner. Private business owners have their wealth tied up in the business – indeed effectively it's their superannuation in many cases – and maybe the next generation doesn't want to be involved in the business, or they don't have the qualifications to be entitled.
The other thing that we're seeing is that private equity is again starting to come back into the market for acquisitions in this $10 to $100 million space, either requiring a foundation business or a bolt-on. But having acted on all sides of the table on these transactions David, my observation is that unfortunately many private business owners are very poorly prepared to maximise their exit value.
David Bushby
Well just on that, what are you seeing as being the most common issues that reduce the sale value of these businesses?
Nick Miller
Probably the most common area that I've seen problems with over the years is in the area of intellectual property or IP. What we find is that there are a range of issues here, but one of the most common is that a private business engages an independent contractor to perhaps design a website, create a logo or prepare a catalogue. The independent contractor will own the IP in their work unless that's been specifically dealt with in their engagement, and very often it's not dealt with as private business owners are unaware of this rule.
So what that means is it turns out that they don't own one or more critical pieces of IP that are fundamental to establishing a brand or a competitive advantage for their business, and so creating value for the business that's independent of their own personal involvement. I find that the more private business owners can make a business stand alone, the greater they can maximise value.
We also find issues, David. in a range of other areas such as employees, key contracts, structure and also preparation of the data room that will be necessary for a sale transaction. So with employees for example, often in a privately owned business there's a reduced focus on compliance and an increased reliance upon relationships, which is possible and indeed it's sensible whilst you're running the business. But if the business is to be sold, the new owners won't be able to rely on relationships to fix problems. If private equity or a corporate buyer is a potential purchaser then they'll want to see a good level of procedure and compliance in the employee area, otherwise they'll just discount what they're prepared to pay accordingly, David.
David Bushby
Absolutely. Well there are a few issues there. Can any of these issues be fixed somehow?
Nick Miller
Yes most of these sorts of issues can be fixed. The key though is to allow enough time so that the business owner has the best opportunity to fix the issue, without presenting the third party who's probably necessarily involved with an opportunity to leverage the situation and take advantage of it for their own benefit.
So for example if the business doesn't own its own logo, but it's continuing to give work to the graphic designer who created it, then the thing to do is identify the problem and when the next piece of work is going to be offered to that designer to ensure that they agree to assign across their IP in past work.
And similarly with employees perhaps it's at the time of annual pay review that problems are addressed, or if there's a problem with an important contract then address it when that contract is up for renewal or renegotiation.
Depending upon the nature of the problem the optimal time to resolve that will be different, so it's a matter of planning ahead to capitalise on the opportunity to do so. A more holistic way though if we stand back for a moment to address these sorts of issues may be to improve governance, perhaps to bring on an advisory board, improve reporting and risk management procedures, or even bring on independent directors. This can help bring focus to these issues and significantly enhance how the business presents to potential buyers.
David Bushby
And just finally and moving to the end of this type of process let's say I've signed on that dotted line to sell my business, am I home and hosed from that point?
Nick Miller
Not quite. It depends again on the preparation that you've done beforehand. Private business owners want to ensure that their proceeds from the sale aren't reduced by any liability that they may have after the signing to the buyer for a breach of warranty or for a misleading statement that they may have made during the sale process. There are a couple of ways to address and minimise this risk.
Most importantly a thorough assembly of due diligence documents to be included in the data room should enable identification of possible misrepresentation and also ensure that all the necessary documents are made available, so that the chance of liability on this front is significantly reduced. But oftentimes we see this being done in a rush at the last minute and it isn't really up to scratch.
The second thing to do, from what I've observed David, is that the better prepared a private owner is in assembling the data room, the greater credibility the seller will have in negotiating with the buyer for how long the seller's going to remain on the hook post the sale, and also how much of the total purchase price is going to be held back as a retention or an escrow. A shorter claim period or a reduced retention both increase the seller's chances of hanging on to the full purchase price. Once again what we see is the preparation strongly equates with value.
David Bushby
Absolutely, and some fantastic insights and thanks again for your time today Nick.
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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.