What is Important to the Owner When Selling a Family Business is Generally Not of Interest to the Buyer

It is estimated that family businesses account for two-thirds of companies worldwide and that in the European Union they generate about 50% of GDP. In Croatia, family businesses employ about 50% of the workforce, making them an important economic factor. One common situation for owners is the sale of the family business. Excluding subjective feelings, there are certain elements in the sales negotiations that require special attention. These are primarily the conditions for the transfer of ownership, important elements in negotiations, and preparation for due diligence.

Different Interests

In the sale of a company, each owner starts from themselves and their private interests, which is quite understandable due to the nature of the relationship and their significant involvement in their own company. However, there are many foreign and domestic corporations and investment funds in the market that regularly explore the market for small and medium-sized enterprises. Their interest often lies in acquiring a share of the market, patents, specialized workers, eliminating competition, or simply entering the market. It often happens that the owner does not recognize what type of investor they are dealing with and what the true value is that investors want to obtain from them. One example is real estate and production halls, which may be the largest item on the company’s balance sheet for the owner, but may be encumbered by liens in favor of banks, which is why they perceive them as something detrimental, believing that real estate is an unquestionable and significant value of their business. The investor may be an investment fund whose interest is to acquire the company and send quality specialized workers to work in foreign companies from its portfolio. The aforementioned also includes acquiring patents and other values, and almost never, except in the case of tourism, are production halls the primary focus for investors, but rather the value that the company can create after the transfer, whether through continuing production or something else. A family business differs from corporations and investment funds in terms of management style, decision-making, goals, and resources. Sometimes it is quite normal for owners to pay full salaries to workers even when there is no ongoing project, and the workers are, for example, on standby. Owners often exhibit social responsibility, and flexible forms of employment or subcontracting are not applied; in corporations, this component is examined in detail. From such different perspectives on the same issue, questions arise about how to pay workers, what their rights are, and how much it would cost to lay off workers if it is determined that there is a surplus. One common situation is that owners in due diligence submit employment contracts drafted on inappropriate forms that do not take into account the specifics of the job, so the same contract is made with a secretary as with an engineer who creates intellectual property, or they copy some employment contracts that someone gave them, considering it an unimportant formality.

Personal Engagement

The same applies to extensive work regulations that, instead of being written to allow flexibility – such as a temporary reduction in salaries for all workers by a few percent until the company’s financial situation improves – actually complicate regular employment relationships, making it difficult for the future owner in their business planning. The question also arises regarding the copyrights that workers create while performing their jobs and whether those rights have been transferred to the employer or not. It is common that intellectual property rights are not appropriately valued. There are frequent cases where investors seek the personal engagement of the owner even after the transfer, especially when it comes to the technical specifics of a particular job or when the owner’s reputation is crucial for attracting customers and new projects. In such cases, new owners do not take over the entire company but offer to retain a stake for the old owner even after the transfer, but they require them to remain the leading figure in the company and continue to run the business as they have been, while they are responsible for providing funds for faster business development. However, all activities and plans must align with the policies and values of the new owner, and agreements on prices and market divisions, as well as other provisions regarding the prohibition of competition violations between competitors, hiring workers through tenders, and generally different risk management styles are just some examples of changes that occur after the transfer. Some business policies become undesirable, especially if they significantly affect business activity, such as in cases of market competition violations. It is also necessary to consider the regulations of other countries from which investors come, as they apply to the acquired company, so the UK anti-corruption regulation, which is stricter and more comprehensive than ours, applies to all companies whose direct or indirect owner is linked to that country; it does not apply to domestic competitors. Since most of our family businesses are established as limited liability companies (d. o. o.) and lack experience in applying stock market rules in business and communication with the public and investors, if the corporation that acquired the company is listed on the stock exchange, the rules of that exchange apply to the d. o. o. after the transfer.

Mixing Family and Business

To ensure that new owners are confident that money is structurally invested and spent and that obligations are met on time, it is essential to appoint a professional financial officer – a CFO, choose a well-known auditing firm, and engage legal and other advisors for professional risk management. They are paid directly or indirectly by the company, paying fees to the holding company. This reduces the company’s profit, and they are, in fact, accountable to the new owners. The trigger for such demands is often unprofessional business management and the mixing of family and business. Documentation that is not stored in the company’s premises or to which only family members have access, legal disputes that continue even after it is evident that they will lose or pay a high amount for interest and legal representation costs, issuing goods without quality collateral, inability to finance obligations, and the need for borrowing – all these are management deficiencies that need to be prevented in the future. Their existence shows that control is needed to ensure that new owners are not intentionally or unknowingly shortchanged by the old owner regarding their rules and expectations. Such and similar cases of undesirable business behavior are visible from the findings of legal and financial auditors, findings from due diligence. Price negotiations soon fall into the background, and the owner is expected to either rectify such a situation before the transfer or be warned about it and seek ways to prevent similar actions in the future. In the case of a breach of agreement, monetary penalties are anticipated, and the payment of the price is postponed until the danger of potential problems escalating ceases, which ties it to the passage of time, rectifying breaches, and maintaining profitability. At the same time, the old owner is required, in the case of their retention, to renounce the possibility of developing any parallel business in the same industry or generally and to devote all their time solely to the sold company. The prohibition also applies to their relatives and close associates, so starting a business with a brother-in-law cannot prevent the activation of the contractual penalties.

Not Everyone Needs to Know Everything

All these provisions are part of the share sale agreement, agreements among future shareholders, and other acts that are concluded during the sale. Given that the transfer of business shares in our country is conditioned by the registration of the transfer in the court register, and the data in the court register is publicly accessible to everyone, it is not desirable to make all details of the relationship available to everyone. Therefore, a special document of several pages is also drawn up during the sale, which only discusses the new owner and that they are now the owner of a larger or smaller business share, while the remaining provisions, from the price to special conditions after the transaction with a list of problematic issues, are included in documents that have dozens of pages. It is common practice for documents to be drafted in English, which is often not the native language of any negotiator, and the terms used in business communication are unknown to the general population and do not relate to the profession in which the company primarily operates and in which the entrepreneur is an expert. Therefore, care must be taken to avoid confusion in negotiations, especially when dealing with topics that we, due to ignorance, consider important to the other party, while not questioning topics crucial for later business and the entrepreneur’s own long-term interests. There is no universal formula for success in the transfer of a company. Timely selection of quality collaborators and advisors who will prepare the owner for the options they can choose, alert them to what new owners might see as obstacles in their business, and before entering negotiations and disclosing information about their business while at the peak of business success are common characteristics of all sales processes that ensure the best outcome for the current owner.

Author: Danijel Pribanić