Chapter 15
Partners, Vendors, and Other People Who Care
You may think that events, such as the sale of your business, are your life decisions to make, but what you will soon find out is that there are many other people who care and will have an impact on the sale of your business—“care” meaning they believe they have a vested interest in what happens to your business, not “care” as in they are concerned with your future well-being.
While you were growing your business, you were also building a network of people you worked with, interacted with, and relied on. They were your financial partners, vendors (suppliers), key employees, and customers, who all interacted and supported your business in many ways. They are the network of people your business has depended on. Some have been very loyal supporters; some are business acquaintances; and some you barely know but have developed a mutual business arrangement with for your benefit or theirs. As you move toward your sale, some of them may wish you well, but others may also see this as an opportunity for themselves, even when the opportunity they see may be detrimental to you.
While you were growing your business, you were also building a network of people you worked with, interacted with, and relied on.
Maybe it’s just human nature or the way some people do business, but anticipate a line of people asking,
“What about me?”
“What’s in the deal for me?”
Most of these people weren’t there when you started your business, or when you took big risks, or certainly not when you were putting your house on the line and asked to give personal guarantees to creditors to grow your business, but they’re going to be there now. A client once told me,
“I can feel their hands in my pocket and the deal isn’t even done.”
Keep in mind, most of these people will no longer be doing business with you—although they may hope to stay in the casita at your beach house on occasion—once you move on from your business. You may have very little leverage or influence on them in the future. Breaking the network ties you developed over years can be difficult. It is best not to make any assumptions about the way those same people, even the loyal ones, will react to the news of your leaving.
Cleaning up the Ownership of Your Business
Does any part of the following scenario sound familiar? When you started your business, you were operating on a shoestring. You found a person with excellent skills to help you get your start-up going but you just couldn’t afford that person’s salary. To entice them to help you, you offered them part of the business if they would take a lower initial salary and come work for you. Ten percent, 15 percent, 25 five percent, or even 50 percent of the business—start-ups generally don’t have much value, so the promise you made to hire that key employee didn’t have much value at the time either. Maybe not back then in any case.
They helped you get going . . . chief engineer, sales manager, chef, jack-/jill-of-all-trades. You made a promise, and they kept their part by accepting a lower salary, putting in extra hours, or doing whatever it took to get your business going. Now you’re ready to sell, and your business valuation today is $10 million. Now that promise has value attached to it. Your promise to your loyal key employee is now worth $1 million, $1.5 million, $2.5 million, or even $5 million. They were good at what they did and helped you get you to where you are, but let’s face it—are their engineering, sales, cooking, or whatever skills they brought to the table worth that much? Far too many small businesses fall into this trap.
Far too many small businesses fall into this trap. The owner is far too generous and thinks about today’s needs instead of tomorrow’s value.
When you were starting your small businesses, you were overly generous and thought about today’s needs instead of tomorrow’s value. It’s the only coin you had to trade. And to make it worse, your original promise was never formalized. It was just your word.
If making the promise was unavoidable to start your business, then plan on keeping that promise, even if it was verbal or documented only in an email or letter. You placed a value on it when you offered it. You just didn’t know what that value was. Keep your word. This is not the time to test whether your employee knows a good attorney and it’s not the time to create an obstacle that could get in the way of your closing.
“Yes, your honor, as this email confirms he offered me 10 percent of the business if I came to work for him, which I have done loyally for the last thirty years.”
Let’s complicate this scenario a little bit more. In your second year of business you needed growth capital and reached out to an angel investor who put in $1 million for 25 percent of the business. The good news is that you did formalize that relationship. But did you explain to your loyal key employee that their ownership was being diluted when you brought this new investor in?
In small businesses, the importance of key employees (whom you made a shareholder when you offered that person part of your business) tends to diminish as other employees are hired and as time goes by. They are no longer asked to play a role in strategic decisions, but their expectations and your promise don’t diminish. You can bet that, when they hear that the business is being sold, they will not forget or hesitate to mention that initial promise. One of the greatest issues businesses face is the ownership promises they made as a start-up but failed to treat as valid afterward.
One of the greatest issues businesses face is the ownership promises they made as a startup but failed to treat as valid afterward.
And then there is your former spouse. It was a nasty divorce and your ex had a great lawyer that has a court decree giving her or him ownership of half of everything you owned. That was four years ago, when your ex accepted 50 percent of the stock in the business. You were glad they didn’t want the cash back then, and your spouse knew that there was nothing to be gained by pushing the issue at that time. But today they will no doubt call their lawyer and ask what price you are getting for the business—and they won’t care whether or not you can afford your new life at the beach with your new wife.
Maybe it’s not a spouse but an ex-partner you had a falling out with. The partner walked out and left you so busy trying to run things by yourself that you never quite had the time to get with your attorney to legally dissolve the partnership. When you go into a partnership, it is almost the same as getting married—except without the family or the love! Now your ex-business partner, who didn’t put in any of the work, not only wants his name off the Small Business Administration (SBA) loan, he wants part of the sale.
Your buyer will require that the ownership of the business be squeaky clean. They don’t want unknown ownership claims to muddy the water after the sale. To keep these things from becoming obstacles to closing you will need to negotiate with these people in advance. It takes time to negotiate and settle ownership issues, particularly once a dollar sign has been attached to those shares. The cleanup may require its own negotiations and closings before you ever talk to a buyer. The best time to clean up the ownership of your business is prior to entering the sales process. There is nothing to be gained and a lot to be lost by delaying. If there is anything that could cloud your ownership, you need to get an attorney involved as soon as possible. These negotiations are often best held between third parties, but you will need your negotiation skills to be at their best. The other parties have everything to gain, and it will cost you. The closer you get to closing, the more difficult these negotiations will become. Take care of these issues before you decide to sell. Begin it today.
To keep these things from becoming obstacles to closing you will need to negotiate them in advance.
Prior Investors
Maybe you had some “family and friends” who invested in the business when you started or bought your business, or maybe you reached out to an angel investor at some point for growth capital. Maybe you even did a funding round with a private equity group or borrowed money from the bank. These are formal relationships that will need to be dispositioned at the closing. They must all be negotiated and payouts agreed to in writing in advance so that checks can be written and closing documents can be prepared.
If these were equity partners who bought shares in the business, you are going to have to review the terms of that purchase, have your CPA calculate the current equity value of their shares, and prepare to meet with them to explain your plan. If you have been regularly notifying them about your strategic plans, the sale won’t be a surprise to them. Partners are often a good source of support when you are building a transition team or when you need someone to act as an independent operations assessor while you are preparing to sell your business.
“I could use someone to assess the sales team and recommend improvements that might add value.”
Because they are already vested and may have something to gain (or want to cut their losses), they are more likely to be enthusiastic about the sale than someone with nothing to gain. They may even turn out to be a potential buyer. Be careful what kind of deal they may try to talk you into! If the business has lost money since they invested, they may not be as enthusiastic about the sale, and you may have to stick to your guns with your decision to sell at this time.
Because they are already vested and may have something to gain (or want to cut their losses), they are more likely to be enthusiastic about the sale than someone with nothing to gain. They may even turn out to be a potential buyer.
Outstanding Debt
Special attention must be paid to any funds that were provided to the business as debt. You must carefully review the terms of those notes. Potential buyers will expect you to retire all outstanding debt. You will clearly want to end any note where you provided a personal guarantee. For some lenders this will be a straightforward transaction —“here is your payoff”—but with others there may be room for negotiation. In all cases you will want to establish a position with the lender and be prepared to pay off the note either before or on the closing date.
The exception to this may be the small operational accounts with vendors, primarily used in the normal course of doing business, such as advances on inventory and supplies. This type of rotating account should have been written against the business account (not your personal account) and should be transferred as part of the negotiation between the vendor and your new buyer. The buyer will likely wish to retain these accounts. If you gave a personal guarantee, you will need to be sure to change that and have your name removed. You need to make sure the buyer is aware that these accounts exist, so the buyer is prepared to have the conversation with the lender (or vendor). This is not the time to surprise your buyer.
Any existing capital equipment leases must be dealt with in the same manner; however, with these types of leases, early termination is generally not an option and not to anyone’s benefit. Buyouts are possible but don’t make sense unless it is late in the lease term. You will need to point these leases out to the buyer and maintain a position that they are, and will remain, part of the deal; they have already been factored in your balance sheet and income statements (which presumably they have).
Vendors and Critical Suppliers
Most people assume they can make a simple introduction of their critical vendors to the new owners, maybe over lunch, and it will be in the interest of the vendors and the new buyers to start a new relationship where yours is leaving off—particularly if the buyer plans to continue operating the business. Unfortunately, it doesn’t always work out quite that way. If the new buyer is dependent on the same supplier, the supplier may see this as an opportunity to raise their prices. This has become a common practice in some industries.
“We would be happy to continue as your supplier once you buy the business but we will have to raise our prices.”
“But I have had a contract in place with them for years and didn’t miss a single payment.”
You may even have paid in advance because you knew how important the supplier was to you as a critical part of your product or service. If the new buyer is planning to use different suppliers, then your current supplier may try to hold the new buyer to the terms of the existing agreement you already have in place. It is easy for these relationships to get off the rails. In either case, the supplier is creating an obstacle to your sale.
If the new buyer is dependent on the same supplier, the supplier may see this as an opportunity to raise their prices.
Whether your business is a manufacturer, buying critical components from a vendor; a software developer embedding third-party components into your application; or a florist depending on the supplier for expedited cut flower deliveries—all businesses depend on their relationship with vendors and critical suppliers to some extent. Most businesses could be brought to a standstill with the loss of a critical supplier. What is the risk to your business if a critical supplier stopped delivering?
Now look at your agreement with the supplier—the critical supplier you were in a hurry to sign with way back when you were dependent on them to release your product. Many small businesses are so glad to get an agreement in place with a critical supplier they sign the agreement without paying attention to all those little details—why bother having an attorney review it? Does this sound familiar? Many vendor agreements include a term that requires notification if your business is being sold or going through a major management change, which makes your sale cause for terminating the agreement. Well there’s no risk there, right? After all, this has been a lucrative contract for the vendor. Why would they ever consider terminating their agreement with your business whether you’re there or not?
Here is why they want to terminate a lucrative agreement and pretend to walk away from it: to make it more lucrative. You negotiated an agreement with them two or three years ago and got a great rate. They were happy to get that rate at the time. You weren’t as dependent on them in the beginning and had another vendor you could have chosen, but because they offered you the best rates, you went ahead and designed your product around theirs. Maybe you made long-term commitments with your customers knowing you had a secure agreement with that critical supplier. It would be hard to change now, maybe impossible—and they know it.
Now that you are selling your business, and they have a contract with a termination clause just for that event, they may want to renegotiate the price of their product for what it lists for today—not at that two- or three-year-old price they negotiated with you in the past.
Many vendor agreements include a term that requires notification if your business is being sold or going through a major management change, which makes your sale cause for terminating the agreement.
The problem is, when a supplier raises their rates, and the buyer doesn’t want to start off as the new owner by raising their prices, it cuts into the business’s profitability. Your buyer will notice this and reflect it in the EBITDA value. They will immediately recalculate to justify lowering their offer. This is a difficult problem to resolve. It helps if you renegotiate your vendor agreement before the sale and insist on dropping that termination term. They may guess what you’re up to but be willing to accept a small, guaranteed increase now instead of risking being dropped later. This will test your negotiating skills!
Remove Any Blurred Lines
Small business owners generally operate as members of their community and often make informal agreements with individuals and other businesses for mutually beneficial products or services. The barter method is generally alive and well with small businesses.
“I will provide you with computer support, and you will repair my truck.”
“I’ll provide fresh flowers for your store, and you will provide me with good cuts of meat.”
These agreements do not always include a product swap or trading of something with tangible value. Sometimes they trade shared or common service the business has with another party, such as their landlord:
“Yes, you can park your truck in the driveway at our building across the street. No one parks there at night.”
These are just a few examples of how the lines between one small business and another can become blurred. You might be a great guy. and the other party may have known you for years. and you might have done lots of mutual favors for one another. but the world as you and the other business knew it is about to change. Maybe you even agreed to hire your cousin Jake away from the other business a few years ago to keep them from having to fire him! The point is, small business owners tend to be integrated into their community—which is a good thing! —and they reach out and rely on that community often for many reasons. The problem occurs when you are selling your business is that those blurred lines may not be available to the new owner.
“Of course, we would be glad to support your computers. Our rate is $45 per hour.”
“Sure, you can park your truck in the parking lot across the street—for $200 a month.”
Without the existing relationship, the blurred lines become bright lines, and your buyer’s expenses may go up. Your buyer may also see a blurred-line relationship where you are providing the service and no longer agree to provide it.
“No, we have our own mechanic.”
“You will have to start paying for computer support.”
Make sure you identify any blurred relationships you may have, give your friends notice as soon as possible, and either end the relationships or formalize them before you speak with a buyer. Your goal is to turn all blurred lines into formalized, bright-line relationships; if they are significant and could become a negotiated adjustment to your EBITDA calculation, try to end them. You want to remove any blurred lines and make all interfaces with your business bright-line, formal relationships.