Planning for negotiation and implementation of a third-party sale

If shares are offered to employees under an employee stock option plan, the employees should be required to sign a share ownership or shareholders agreement ...

After years of successfully building and running a business, owners may be unsure of their next steps. While they are concerned the business will continue after they leave, they also want to capture the full value of the work and energy they invested in their business through the years.

To best maximize the value of their company, owners need to properly plan their exit. This applies whether they intend to turn the company over to the next generation of their family, plan for a management buyout or sell the business outright. Current statistics show that up to 70% of business owners will end up selling their business to a third party.

What does proper exit planning involve? Tax considerations are at the forefront of maximizing value and structuring the sale of a business, but there is planning to do on the corporate side as well, which will influence not only the price a potential suitor may offer but also the ease with which the transaction can be implemented.

For example, a company that has two or more shareholders but no shareholders agreement in place loses some of its attractiveness to a potential purchaser, who will have to negotiate the sale with each shareholder individually.

If there is potential for conflict, the purchaser will walk. Even if there is no potential for conflict, the increased transaction cost to the purchaser and the uncertainty of whether the deal will actually close with each individual shareholder means that the offer for the shares will be lower.

With a properly drafted shareholders agreement, both the founder of the business and the potential purchaser will be able to take advantage of the so-called “drag-along” provision, which forces the remaining shareholders to sell their shares at the price agreed between the majority owner(s) and the purchaser.

Conversely, a “tag-along” provision will offer some protection to the minority shareholders, ensuring they are not left owning shares in the company with the purchaser. The key aspect of the drag-along is that it contains a power of attorney to transfer the shares.

Any rogue shareholders will be prevented from holding up the sale because their shares can be transferred in their absence and the sale proceeds placed in trust for them. This can also come in handy where a shareholder can’t be located because he or she has moved away.

Additionally, a shareholders agreement may compel the shareholders to vote in favour of selling the assets of the company when the founder has struck a deal with a potential purchaser.

This mechanism in a shareholders agreement facilitating an asset sale or transfer is also useful where a properly advised company engages in a balance sheet cleanup before a sale and, as part of the cleanup, wishes to spin out assets to new subsidiaries or sister companies.

For tax and liability reasons, vendors prefer to sell shares, while purchasers prefer to buy assets. But proper corporate and tax planning can yield a win-win for vendors and purchasers - hybrid deals that involve a sale of both shares and assets.

Further planning should be done on the employee front in order to ensure that the owners can lead the company to a successful sale. If shares are offered to employees under an employee stock option plan, the employees should be required to sign a share ownership or shareholders agreement when they exercise their stock options.

Additionally, they should also be required to sign a voting trust agreement in favour of the company president, which will facilitate decision-making and prevent delays in the event of a sale. (Even if non-voting shares are issued, corporate legislation requires certain decisions to be made unanimously by all shareholders, whether voting or non-voting.)

These are only a few examples of how the corporate setup can influence the negotiation and implementation of a third-party sale and, ultimately, affect how much value the owner can extract on the sale.

The ideal time for planning is about two to three years before the planned sale in order to take advantage of tax planning opportunities and, if necessary, implement a pre-sale corporate cleanup.

Exiting from a family business can be an emotional time. Ensuring that the transaction is completed in a way that reflects the full value of the owner’s work through the years can make the process that much easier. •

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