We see many reasons as to why you may want a new owner or partner in your business, these include, but are not necessarily restricted to:
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The need for additional capital;
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It’s part of your succession plan (you may be offering ownership to key employees for example);
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They complement your existing operations, whether it be from their personal skill set (the old saying “two heads are better than one”, is often not far off the mark), a business that can be bolted on to yours or they have the contacts or geographical reach that you haven’t quite yet managed to conquer;
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You just want a running mate and want to de-risk.
All very valid reasons, but before you confirm such an important decision we strongly recommend that you consider the points below.
Ambiguity can often lead to conflict
In our experience, ambiguity from the outset is more likely to lead to conflict in the future.
It is easy to overlook and avoid difficult conversations in the early stages of a business relationship as you want to promote optimism and positivity.
So while it seems counter intuitive to the overall discussion, talking exit is important. The procedure for exit of either party should be clear. How much notice do you need to give, when is exit forced and who can you sell your share(s) to? For example, without a pre-emptive right (i.e. first right of refusal to buy shares or share of the business back) you could find yourself in business in the future with someone that you do not want to be.
Are the parties aware of their roles and responsibilities? We quickly see relationships deteriorate where roles and responsibilities are not clearly defined. In these situations inequity can arise whereby one party carries out more of the functions than the other and is not adequately rewarded. If roles and responsibilities are not to be equally shared, a conversation with respect to remuneration and/or profit share is worthwhile.
We cannot stress enough from our experience that agreements play an important role in successful business relationships. We absolutely recommend robust shareholder and partnership agreements as necessary, to clarify the position in the case of the occurrence of a certain event and prescribe a set of rules that each party agrees to and is aware of. Quite simply they are pre-nuptial agreements for businesses.
Do your due diligence – do you really know your prospective partner?
It’s worthwhile checking their background facts. You are giving up power, control and influence to someone else, we assume that you will want to know who you are giving this up to. It is far easier to give this up, than take it back.
It is also important to acknowledge that you might be taking on additional risk, the extent depending on the legal structure you have adopted. The actions of another may directly impact on you, especially in a partnership where liability is joint and several (in the absence of forming a limited partnership).
What’s out there on the internet, have they been barred as a director of a company in the past…? Often employers will undertake psychometric testing on prospective employees, why not for a prospective business partner?
Expectation – price
Frequently the owner’s expectation of value is vastly different from commercial reality and what it is actually worth. Many will have watched the Dragons’ Den whereby a business owner looks for investment to help in realising the true value of his or her business. What looks to be a great business proposition often falls over because the owner has overvalued the business from the outset.
It is important to remember that all your initial hard work, dream and vision may not be valued in the same way as a prospective investor. We therefore recommend that you obtain an independent valuation of your business to really understand its value and realign expectations (if required), otherwise conversations with prospective investors are likely to be short lived.
Letting go
Ask yourself the question, are you really willing to give up control? If not, then you may wish to reconsider other options. For example, a different class of shares with no voting rights may provide the business with a much needed capital injection, without having to relinquish any control.
Tax
Tax legislation always plays its role and has to be considered. Once the transaction has been executed it is very difficult to remedy or reverse adverse tax outcomes. It is therefore best to canvass the tax position first.
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Shareholder continuity rules for a company to carry forward tax losses and/or imputation credits must be considered if introducing a new shareholder. It is easy to inadvertently breach the thresholds and lose the value of tax losses and imputation credits;
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If you are encouraging an existing employee into the business as a succession plan, price is relevant from a tax perspective. This is a topic that has been widely canvassed recently, but essentially an income tax liability will arise to the extent an employee does not pay full market value for a shareholding;
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Will the introduction of a partner change your legal structure from sole trader to partnership? How does this impact on income tax and GST status? Could this give rise to potential tax liabilities?
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If you are looking to combine businesses, how will you do this? Will this require transfer of assets and liabilities to a new company? A tax cash cost may arise, even though no real income has come in. For example, depreciation recovery income may arise if transferring property from one entity to another;
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Have you considered the operating structure for tax efficiency? Does the introduction of a new business partner change anything?
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At what price will a prospective new partner/owner be introduced to the business? To assist in mitigating risk and to facilitate the transaction, we often see “earn-out” clauses included within sale and purchase agreements. Under an earn-out clause the purchase price is dependent upon future trading activities and performance. The clauses are often coupled with a “lowest price clause” to reduce the risk of adverse tax consequences arising.
A common-sense approach
It’s common-sense, but do you like them? An acquaintance of mine, Martin (name changed to protect the innocent), referred to the “Good bugger test”.
To demonstrate, if you saw your prospective business partner walking down the road towards you, would you stop and have a chat, go for a coffee, a beer….or would you duck into the nearest available shop for cover? The example speaks for itself.
You don’t necessarily need to be great mates and it could be argued that it’s not the be all and end all for a successful business relationship, but you must acknowledge that you will potentially be spending a lot of time with them.
This is not an exhaustive list of all the things you need to be checking off, but they are certainly well worth considering before making what could be one of the most important business decisions you will ever make.