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Changing Business Owners: Five practical considerations for business transfer

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By Alicia Hill, Principal, MST Lawyers

It is commonly accepted that, as individuals, we are resistant to change. We like the status quo, the comfort and familiarity of the known.

But what if it is more than that? A 2010 study conducted by Eidelman, Pattershall and Crandall and reported in the November edition of the Journal of Experimental Social Psychology (Vol 46(6): 993-998), found that after five studies the longer that something is found to exist, the better it is considered to be.

Unconsciously the participants believed that longevity = preferred.

Owners of businesses are not an exception to this sentiment often staying in business together longer than practical, efficient, healthy for the owners or the longer-term performance of the business.

When life provides a catalyst to exit the existing arrangements, in the form of death, a significant illness diagnosis, divorce with assets needing to be split, retirement, financial distress or some other factor, this can cause significant disruption, distress, cost and dispute between business owners who have not planned for orderly transfers of ownership interests.

Practical Consideration 1 – Prevention is better than cure

Discuss in advance of life changing events how a transfer of business ownership will be affected. Have this documented by your lawyer so that in the event of a crisis, all parties understand what is to happen next.

At law, there are three common outcomes for the change of business ownership:

  • Sale of the Business with the owners sharing the balance proceeds after payment of debt in agreed proportions between themselves; or
  • Sale / Purchase of the share of the business held by the outgoing business owner, usually by the incumbents, or family members of the incumbent, but sometimes third parties such as management staff of the business, venture capitalists or others using an agreed valuation methodology and terms for payment; or
  • Appointment of external administrators to wind up the business through receivership, administration or liquidation.

Where parties do not have documents setting out the process for the transfer of business ownership, a frank discussion between the business owners, the business accountants and legal advisers needs to be had.

Ideally, this will reach agreement on how a transfer can be achieved that is fair, tax effective and legally complete in separating the interests, obligations and liabilities at law.

Practical Consideration 2 – Have practical mechanisms to facilitate transfer

Ensure you agree how a party will indicate a wish to transfer, value their interests in the business and when they can expect payment for their share of the business.

If sticking points occur, consider:

  • utilising a trusted third party as an intermediary to facilitate discussions, This could be an accountant, lawyer, former business owner,  mentor, or a person respected by the business owners with skills or experience to assist with transfer issues;
  • appointing a mediator skilled in business disputes to facilitate a mediation to bring the parties to the table; or
  • appoint an industry expert, where applicable, to provide a binding determination on the points of impasse. For example, should the multiplier for calculating value of the business be 3.5 times average net revenue for the past three years or another multiplier based on data from other
Practical Consideration 3 – Call on others to assist with deadlocks

In the event of a deadlock between the owners, consider using a trusted third party, mediator or expert as an intermediary.

If agreement appears impossible then recourse is available through the courts for partnerships, joint ventures and companies to obtain orders to facilitate one of the three identified options occurring.

Depending upon the type of business, the conduct that has been engaged in by the parties, the rights available to parties under any securities, causes of action may be available to an owner because of:

  • oppressive conduct of a majority against a minority owner of the business;
  • insolvency or the risk of insolvency of the business;
  • it being considered just and equitable for orders to be made providing relief for one owner of the business from another; or
  • inappropriate conduct by one business owner that should be injuncted or prevented from taking place.

One pilot programme (extended after its initial expiry) being run by the Supreme Court of Victoria provides a fast track / simplified process for oppressive conduct claims determination.

In this instance, parties have the opportunity to work with Associate Judges to reach a resolution ahead of incurring significant legal costs resulting from conducting a trial of issues.

The difficulty, of course, in relying on the courts to adjudicate on issues such as the value of interests and orders to effect the business transfer, is that outcomes can be ordered which neither party has sought or believes is what ‘ought’ to have occurred.

In Strategic Management Australia AFL Pty Ltd & Anor v Precision Sports & Entertainment Group Pty Ltd & Ors (No.3) [2017] VSC 35 for instance, two valuation reports were provided to the judge with different values of the shares which were the subject of the transfer. The judge determined he could not rely on either of the valuations and used his own reasoning and assessment of parts of each of the expert reports to arrive at a third value which was ordered to be paid.

The introduction of a third party, in this instance a judge to determine matters for the business owner removes the certainty of outcome that can be achieved if the business owners reach an agreement between themselves.

Practical Consideration 4 – Courts provide a further avenue to assist

Recourse to court process is available in the event of oppression, unjust and inequitable conduct including a Pilot Programme in the Supreme Court of Victoria which endeavours to assist parties reach resolution ahead of a trial; to better preserve the value of the business and interests held by the owners.

Finally, where all else fails there are experts who are appointed solely for the purposes of winding up businesses. These professionals understand the rules governing sale mechanisms, appropriate processes and the steps required, including whom to appoint for various aspects of winding up the business depending on the business and its structure, how financiers, security interest holders, suppliers and customers need to be interacted with to smoothly give effect to any sale.

Where business owners fail to reach an agreement ahead of this step means that the appointee will be entitled to charge and have deducted from the assets realised their fees and costs of winding up the business and remitting any balance to the business owners at the conclusion of that process.

Depending upon the complexity, issues raised and status of the business this could result in a significant reduction in the value realised from any sale of business or business assets affecting the return for business owners. In some instances, especially if the conduct of the business owners causes significant work to be undertaken by the appointee and their staff no return may be possible.

Practical Consideration 5 – Let someone else deal with it for you

Failing all else, appoint an external party to sell the business, pay out the debt and creditors and then remit the balance proceeds to the owners. Understand however that the costs of doing so will come out of the amount realised and can substantially reduce a return to business owners.

MST Lawyers assists business owners through the entire spectrum of business transfer. If you have any queries about this or anything mentioned in this article please contact Alicia Hill, an Accredited Specialist in Commercial Litigation, Nationally Accredited Mediator and graded Arbitrator with the Resolution Institute by email or call (03) 8540 0200.