Selling A Share of Your Business to an Investor

SELLING A SHARE OF YOUR BUSINESS TO AN INVESTOR

 
Sarah Pilcher, Partner, MacDonald Pilcher, August 2007

 

One area that catches my interest is the people side of funding start ups and growth in business. In particular, I am referring to where you go into a new venture with a partner or investor, or, where to fund growth you look at introducing others into the business on an equity and participation basis.

 

We have worked for many clients who have wonderful ideas, inventions or business models that they have struggled to get to market due to lack of funding.  Other than the money, there are many things you need to consider before bringing a new owner into your business.

 

For every disappointed would be entrepreneur whose idea does not develop, there are another one or two who have managed to make it to the start up stage, and launched their product or service, or purchased an existing business or franchise.

 

When traditional borrowing is not an option, or the costly exercise of seeking capital at a formal level is beyond available resources, many people look to friends, colleagues or new contacts to jointly take on the cost and benefits of a business. 

 

In my experience, where the input and creation of the concept, systems and effort are equally shared, then as long as the shareholders have common goals and shared understanding of how to achieve those goals things seem to be loaded in favour of success. Key to this is good communication between the shareholders, at both operational and strategic level. 

 

More difficult is when one person came up with the ideas or has developed a concept or system then invites others on board to help with getting “their” project off the ground. The founder has more of an emotional attachment to the business and sense of ownership, and it can be hard to let go of that.

 

This is even more pronounced when investment is sought in an established business to fund growth, or to let the founder step back from involvement. 

 

Business relationships are often compared to marriages and inviting someone to buy into your business could be compared to asking them to pay off your mortgage and come and live in your house.

 

We have seen so many examples of clients in all types and sizes of businesses introduce new shareholders into their company, from the completely passive investor, through to an equal or majority working partner. (I use the word partner in a practical, not legal sense here). For the owner looking to exit, or someone with a lack of time or business management skills, this can be ideal. 

 

For the owner forced to take this path to keep their business going or growing it can be very hard. They can feel that they have lost control of a business that was part of them. And they would be right. By inviting someone to take on the risk of the business, the balance is that you lose some of the benefits, and you are no longer the sole decision or direction maker. 

 

The new shareholder might want to use their lawyer for the company, or switch to their bank. They might want to introduce key staff and systems to the business that change the dynamics of the work place. They will want to see good financial controls in place to protect their investment, and they might consider that you are not a good business person and need to learn to do things their way! The founder could change their goals and realise this person is not the right fit. You might simply not like each other! The investor may have no ability in the areas they said they would assist.

 

Negotiation of the deal, once accountants and lawyers become involved, can be a lengthy and stressful process. The founder and purchaser have very different interests at this time. I suggest that this is a good time to be making judgements on a potential ‘partner’. If the negotiations are hard work and seem unreasonable, does this indicate that this person is going to be hard to work with, or, does it show that they will be a strong person to have on your side? I don’t know the answer – but I do ask the question.

 

Once you have found the person and agreed in principle there are still many issues to identify and agree on. For example:

 

v     The structure of the purchase and ownership is important:

·        Sale of your shares in your existing company or new company incorporated to purchase your business?

·        The investor may prefer to see their money go into funding the company rather than lining your pocket – either by requiring you to put the purchase price straight back into the business, or by purchasing new shares issued by the company. 

·        Some accountants recommend avoiding company ownership altogether and having the business owned directly by a trust.

 

v     Ongoing shareholder roles, responsibilities, and remuneration:

·        P.A.Y.E employees, independent contractors or simply working directors collecting directors fees?       

·        There should written employment contracts with the business to keep these relationships at arms length. 

·        Performance based remuneration needs to be measurable to avoid resentment.

 

v     Shareholder exit strategy:

·        Restrictions on sale of shares.

·        Death or disability of shareholder.

·        Share Valuation on transfer.

·        Dispute / deadlock resolution– buy back? Buy out?

·        Relationship Breakdown.

 

The Sale and Purchase agreement setting out the transaction and a Shareholders Agreements covering the ongoing relationship and issues such as those listed above are both important and can be complex agreements.

 

If business can be compared to a marriage, then the Shareholders Agreement is the pre-nuptial. It may be uncomfortable to discuss some things, but isn’t it better to have guidelines, objectives, agreements and mechanics in place should you ever need them?

 

It is important that you are made aware of the different options, and their financial, legal and tax implications. This can be a highly specialised area and if your legal and accounting advisors are not experienced in this area and aware of the options you will not have the opportunity to select the best ones.