Acquiring a business and leaving previous owner with 49%?

[acquirer22]

Hi all

I'm looking to acquire a small business and am considering how to structure my acquisition

I am thinking of having the prior owner retain 49% and continue operating the businesses while I am a 51% owner / investor (not involved fully in the day to day after an initial 3-6 month period)

Prior owner has been operating business for 30y+

I will of course seek proper legal advice down the line, but for now had a few preliminary questions that I was hoping this terrific community may be able to help with:

1. What are the risks to this approach?
2. I will want to grow the business significantly, which will require a high level of re-investment and therefore lower dividends - would I as 51% owner have total control over the capital expenditures and dividend decision?
3. I would consider some kind of target based compensation for him - say if he hits target (doubling net income or free cash flow say, say) after 5 years will give him a bonus equal to 4x his annual salary. Are there issues with the definition of "net income" here considering I can essentially (along with accountants) decide how to define this using various accounting policies? I want to be fair and don't want to leave myself / the company open to issues. Could I avoid this by saying the bonus is fully discretionary and defining the metric up-front?
4. Would I have total control over who to hire/fire (including the prior owner if necessary)?
5. The premises is currently owned by the owners but not by the business, and is used rent free. I would acquire both and probably charge rent to the company - any issues here legally? This seems most efficient

Thanks all

 

[The Resolver]

I will of course seek proper legal advice down the line,

You prefer to wait until an almost insurmountable problem has arisen before paying for legal advice on how it could have been avoided?

No, now is the time to get advice. Apart from anything else you simply must not proceed without you both agreeing to a form of Shareholders Agreement. See here.

Let me answer your specific questions,-

1. What are the risks to this approach?

A: He begins to resent the lack of influence in particular your dividend policy when he is doing all the work of a man company If you take a high salary he may claim unfair prejudice on a minority. You cannot change the Articles or liquidate without his agreement.

2. I will want to grow the business significantly, which will require a high level of re-investment and therefore lower dividends - would I as 51% owner have total control over the capital expenditures and dividend decision?

A: Depends on what expenditure but that is done by the Directors on a head count so if the two of you are directors then you need his agreement. To make a reduction in share capital you again need his agreement as it requires a 75% vote.. You can, to adegree, agree bespoke arrangements in aShareholders Agreement.

3. I would consider some kind of target based compensation for him - say if he hits target (doubling net income or free cash flow say, say) after 5 years will give him a bonus equal to 4x his annual salary. Are there issues with the definition of "net income" here considering I can essentially (along with accountants) decide how to define this using various accounting policies? I want to be fair and don't want to leave myself / the company open to issues. Could I avoid this by saying the bonus is fully discretionary and defining the metric up-front?

A: To limit disputes (or , worse , non - disclosed mistrust ) important to have a clear method of calculating the bonus that is not open to alternate interpretation.

4. Would I have total control over who to hire/fire (including the prior owner if necessary)?

A: Depends on whether vou are a Director. As a shareholder you have no such powers as to any employees. I'd you sought to sack the other Shareholder you may gift him a right to seek a court ordered liquidation on the basis it breached the whole basis of the arrangement when the new shareholding was set up.

5. The premises is currently owned by the owners but not by the business, and is used rent free. I would acquire both and probably charge rent to the company - any issues here legally? This seems most efficient

A: You would need his agreement as otherwise he could argue, on behalf of the company that it is a breach of contract to charge a rent.

All this is without enough knowledge of the background to give reliable advice.. But i am happy to give more reliable advice if you get in touch.

 

[acquirer22]

Thanks. By 'down the line' I of course mean prior to submitting an offer / during Phase 2 DD. I will be in touch!

 

[Mark T Jones]

@The Resolver is spot on, of course.

But at a simplistic level, how do you think the experienced owner of of 30 years will feel about being your puppet?

Reality - they will only agree to the above if they are a little bit desperate, and then it will all fall apart 18 months down the line.

I'd suggest you start thinking of ways the 2 of you can work together to build the business - or of an earn-out for them.

 

[Paul Kelly ICHYB]

You are not buying a business - you are buying 51% of it!

Buy it all, employ them and give a bonus?

 

[Paul Norman]

I would echo the point about.

You are not acquiring this business.

At 49% shareholding, the previous owner can still do some very significant boat rocking, should they wish to, down the line.

I have bought many businesses over the years. I have never left anyone with anything more than a tiny shareholding. If the deal is to give them a continued financial reward in place of a lump sum, there are better ways to achieve it, for you, and for them.

If the deal is to retain their influence, again, there are clearer ways to do that - such as a clearly worded consultancy agreement.

 

[acquirer22]

I'd suggest you start thinking of ways the 2 of you can work together to build the business - or of an earn-out for them.

That's exactly what I'm doing / suggesting. How to structure it to incentivise them to keep growing the business.

 

[acquirer22]

I would echo the point about.

You are not acquiring this business.

At 49% shareholding, the previous owner can still do some very significant boat rocking, should they wish to, down the line.

I have bought many businesses over the years. I have never left anyone with anything more than a tiny shareholding. If the deal is to give them a continued financial reward in place of a lump sum, there are better ways to achieve it, for you, and for them.

If the deal is to retain their influence, again, there are clearer ways to do that - such as a clearly worded consultancy agreement.

Thanks.

Yes I'm thinking perhaps leaving him with 20% and then saying I will buy him out at 4x EBITDA (or whatever the entry price is) in 5 years - thus giving him an incentive to grow EBITDA as high as possible over 5y

I agree that a 49% shareholding seems troublesome - would you say 20% is more appropriate?

 

[Paul Kelly ICHYB]

That's exactly what I'm doing / suggesting. How to structure it to incentivise them to keep growing the business.

The same way you would any employee - a good basic salary and generous target based bonuses!

 

[Paul Kelly ICHYB]

I agree that a 49% shareholding seems troublesome - would you say 20% is more appropriate?

0% is the cleanest.

If you do move to a share based scheme, as suggested, ensure you get a good shareholder agreement in place.

 

[The Byre]

If the deal is to give them a continued financial reward in place of a lump sum, there are better ways to achieve it, for you, and for them.

This!

If the deal is to retain their influence, again, there are clearer ways to do that - such as a clearly worded consultancy agreement.

combined with this!

The usual thing is to have a hand-over period, perhaps a year or whatever, with stages of payments spread in accordance with the advice from your accountants.

But if I were the present owner, I would want a total buyout and let you knock yourself out and have fun with the company - expand, invest, whatever! But no open-ended deal that drags on and on and . . .

Think what HE wants. If he's been doing this for 30 yrs, he probably wants to be shot of the thing and retire and do something less strenuous. I would rather doubt he wants to become someone else's employee in his own company!

 

[Mark T Jones]

That's exactly what I'm doing / suggesting. How to structure it to incentivise them to keep growing the business.

Someone who has run a business for 30 years isn't going to be incentivised by just salary and bonus (coupled with a conspicuous loss of authority).

Keeping them on for a sustained period will be very tricky - in fact I'd go with @Paul Kelly ICHYB's suggestion of a consultancy agreement.

 

[MarkOnline]

I have a different view of this "structured buyout" malarkey. It looks like "how can I buy a business without actually spending any money, and how can I get the current owner to work for me using the profits of his hard work to finance the deal. Oh and I want the freehold assets too.

Hopefully the current owner is sharp enough to see you coming.

 

[dylanmarlais]

"Hopefully the current owner is sharp enough to see you coming." The current owner may well want the money for the 51%. The buyer could buy the entire share capital and seek to incentivise the founder via an earn-out (tax advantageous to the seller when compared with a bonus linked to his employment). The purchase price can be paid by instalments.

 

[MarkOnline]

"Hopefully the current owner is sharp enough to see you coming." The current owner may well want the money for the 51%. The buyer could buy the entire share capital and seek to incentivise the founder via an earn-out (tax advantageous to the seller when compared with a bonus linked to his employment). The purchase price can be paid by instalments.

True, I would want to see some meaningful money and or substantial assets before I let the "buyer" loose on what I had spent the last 30 years building up.

Different strokes for different folks eh.

 

[The Resolver]

I agree that a 49% shareholding seems troublesome - would you say 20% is more appropriate?

Anything over 25% prevents you passing a Special Resolution if ever needed (primarily to change Articles, change name, liquidate).

If you are considering 20% with 4x EBITDA buyout, the agreement should be clear as to assessing the multiplicand i.e. an averaging over the years, say past 3, but also that either it or the multiplier should be assssed in a dynamic way to reflect the direction of travel, By that I mean that it should reflect whether EBITDA is going up or down or static. EBITDA of £300k 3 years ago. , £200k 2 years ago and 100k last year of trading averages £200k but obviously, as it is reducing year on year . the business (and therefore the 20% shareholding ) is worth a lot less than if the annual EBITDA was reversed (100k,200k,300 kbut which neverthless will show the same £200k average). I often come across share valuations that overlook the dynamic element.

Also, if no shareholders agreement to say the opposite, the valuation would , after calculation, be reduced further to recogise it is a minority.

The Shareholers Agreement which you just MUST enter into as part of the deal should contain a commitment to the detail of the share valuation method .