Selling a Business: Who Owns It?
Selling a business involves considering no small number of issues, some large, some small, some complicated, some not so much.
But one question that few brokers – and even fewer buyers – ever ask is, “Who owns it?” Or, more generally, who has a claim to ownership?
Our course, “Learn How to Value and Successfully Sell Businesses“, includes a lecture on this very topic.
And for anyone that takes the course, there’s a live webinar every Friday – affectionately called the Friday Afternoon Wrap Up or FAWU – during which course participants ask questions and we sort through any thorny issues that anyone is facing.
Well, during this past Friday’s FAWU, I spent a good portion of that session addressing questions from course participants on this very topic.
The question of who owns a business that we’re bringing to market has been a hot topic for new brokers for years. Almost no one has ever given it much thought – until, of course, a deal collapses at the last minute when the question is answered by someone tossing a metaphorical live grenade into the conference room.
Know ALL the Players!
When selling a business, knowing who the actual owners are – all of them – is critical.
I’m not sure I need to explain the importance of this crucial aspect but let me give some examples of how not knowing can torpedo a deal.
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Three young girls – high school friends – start a “business” on a lark making special nail polish colors. They offer it to their school-mates and it’s all the rage for the 10th and 11th graders. It’s a hobby; some fun while trying to get through school. They call it Kookie Colors.
None of them thought of Kookie Colors as a real business.
Soon after graduation, one of the girls finds a love interest and decides to move 1,000 miles away wishing her friends good luck. Shortly thereafter, another decides to go off to dental school and has no more time for this hobby.
But the third one hangs on.
Against all odds, the business takes off. Lipstick and other makeup products are added and what was once a “hobby”, 10 years later is doing $12 million in revenue and the last partner wants to sell. She wisely chooses a business broker (rather than a real estate agent).
The broker, properly trained and experienced, does a valuation and the broker and the owner agree to list the business for $5.9 million.
After a couple of suitors come along, the owner decides that an offer from a private equity firm makes the most sense. A deal is signed, due diligence is performed, inventory taken, assignments of all intellectual property are prepared and a formal closing is scheduled for a Wednesday, three weeks in the future. The owner is ecstatic but the broker advises her to hold off on the champagne until the closing agent or attorney hands her a check.
But word, needless to say, gets out and the two friends from the early days, now living in different parts of the world, hear about the sale. A week before closing, a letter from an out-of-town lawyer arrives stating that her firm is representing the two other original partners and each is claiming an ownership interest in the business and, therefore, a share of the sale proceeds.
You think that closing is going to happen?
Long Lost Relatives
That was an example of a business that had multiple owners only one of which was active in the business.
A similar situation can arise if there was an early family investor; for example, an Aunt Millie that lent her nephew $50,000 to get started and wisely took an ownership stake that, if things went according to plan, her nephew would buy out when the business became successful.
But as with many family interactions, some things get a little hazy or even forgotten over time and, 10 years down the road, the nephew is sitting on a business worth $7 million. Aunt Millie passes away and as her estate is settled, her two adult children hear about her investment for the first time.
All of a sudden the nephew has new partners.
If you’re the broker the nephew hired to handle the sale of the business, the nephew – your client – probably “forgot” to mention Aunt Millie.
Ownership Claims by Non-Owners
There are also instances where one person legitimately – that is, “on paper” – owns the business but one or more others might make a claim of ownership.
Here’s an example of exactly that situation – one that we were involved in.
We received a call from a law firm in New York asking to set up on online meeting to discuss the valuation of a business. The background we received during that initial call was as follows:
A man starts a business in the garage. It starts to grow and he needs to bring on some help. His wife jumps in to lend a hand. After a few months, she finds herself working full time in the business.
Together, they continue to grow the business. All outward appearances would have anyone that becomes a client, customer, vendor or employee believing that this is “their” business.
Ten years, two kids and three expansions to the facility to accommodate growth later, the husband and wife are at each other’s throats and they decide to split up.
What happens to the business?
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Well, what happened is that the husband, who never added his wife to any of the business’ organizational documents, thought he should sell the business, pocket the proceeds and hit the road in a hurry, before any divorce proceedings got started.
Well, everybody in the industry was under the impression that the business was owned by the couple and word soon got back to the wife that the husband was trying to sell. Needless to say, the room quickly filled with enough legal talent to compare favorably with the amount on display in Washington, DC during the Trump administration. Four of them were on the call with us.
As it turned our, the husband was nearing a deal with a buyer when the wife’s lawyers showed up and hit the brakes. All the work that had been done prior to their arrival was completely wasted. She had a legitimate ownership claim and this deal was suddenly a LONG way from closing.
So, how can you avoid these situations when selling a business?
It may be impossible to completely shield yourself and your practice from such events but there are a couple of things that are taught in our course that might help you from seeing all your hard work on a deal get flushed down the tube at the 11th hour.
The Broker’s Due Diligence
First, once the owner of a business decides to hire you to sell his or her business, among the documents that you should request – along with the necessary financial information – are the business’ organizational docs.
For a corporation, that includes the Shareholders’ Agreement. For a limited liability company or partnership, this would be the Member’s Agreement and Partner’s Agreement respectively. These agreements will list all owners/partners – or the original ones, at least.
Second, you should include in your Engagement or Listing Agreement – the agreement that the business owners will sign – a standard statement that asserts and affirms that he, she or they is/are the owner(s) of the business and that they “have the authority to sell the business, to enter into an agreement with you to sell and to bind the business.”
Yes, it’s possible that all your diligence to determine, in the early stages, the actual owners could be for naught; there ARE dishonest owners out there.
But getting the business’ organizational documents – which you’ll need anyway for any buyer – and a signed statement from the person that purports to be the owner that he or she has the authority to sell, will go a long way to insulate you from any lawsuit that is sure to erupt if some wayward nephew or a child from an alcohol-fueled assignation 25 years earlier shows up shouting, ‘What about me?!?”
The Bottom Line
If you’re dealing primarily with Mom and Pop businesses, most are likely to have only one owner, possibly two. But unless you prepare to the extent possible and upfront, any transaction you’re working on to sell a business with more than one owner has the potential to flame out in spectacular fashion when you least expect it – and too often right before you were expecting to get paid.
When you’re getting ready for the meeting at which you expect the owner to sign your listing agreement, make sure you remember to take the two steps mentioned above. They won’t completely shield you from this problem when selling a business but they’ll give you some sense of certainty on the issue – as well and some protection from the inevitable legal and financial fallout that is sure to follow if a previously unknown “owner” comes a’callin’.
Besides, if you’re prepared and the worst case scenario comes to pass, you’ll probably be able to join the legal fray and make a very creditable claim that you’re due your commission or success fee!
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.