Crain’s Cleveland – The sale of a family business may create unexpected tensions and conflicts

The sale of a business is often the largest and most important business decision an individual may encounter during the ownership of the enterprise.  If the business has multiple owners, particularly family members, the process may become more stressful due to the various interests and conflicting positions that may arise.

NON-COMPETE AGREEMENTS

Many times there is only one owner actively involved in the business while the other owners remain in the wings or uninvolved in the business. In a sale situation, the buyer will expect the owners to provide noncompetition covenants that preclude the owners from entering another business that competes with the sold business. The non-active owners will generally have no problem providing a noncompetition agreement, whereas the active owner may have an issue agreeing to anything that deprives him from engaging in activities that have been his livelihood for years. The active owner may insist on being compensated for this prohibition. From the buyer’s perspective, the non-compete is part of the purchase price. How the purchase price is allocated and paid among the owners is generally not a critical issue.

If the active owner has at least a majority of the business, there is generally not a separate payment to him in consideration of his non-compete. However, if the manager has a minority interest, it is not unusual for the individual to insist upon and to receive separate compensation for such covenant. The size of such payment could put the owners in a conflict situation, and the attorney who is handling the sale of the business must be cognizant of the conflict that has arisen among her clients. Obviously, any payment made entirely to the active owner reduces the size of the payments made to the non-active owners.

CONSULTING AGREEMENT

Related to the issue of non-competes is the question of whether the active manager receives a consulting or employment contract from the buyer for service post-closing. Many times, to ease the transition period, the buyer will want the former managers to stay with the business for a period of time.  The amount of such salary could be perceived as part of the purchase price if the amount is in excess of what would normally be paid a third-party manager. 

The length of such an agreement, the compensation and the benefits demanded by the active manager may put the manager at odds with the other owners. Often, the active manager may need separate counsel for the negotiation of his consulting agreement, particularly if the existence of such an agreement is a condition demanded by the buyer. Otherwise, the counsel handling the sale is conflicted, with some of her clients insisting the sale proceeds, whereas, the active manager is prepared to stop the sale because his demands for compensation will not be met.

INDEMNIFICATION CLAUSE

A third area of potential conflicts arises in the provision of indemnification. In the sale agreement, the sellers will generally provide the buyer representations, including, among other items, ownership of the assets, the lack of environmental or tax issues, the collectibility of receivables or the condition of the building or equipment used in the operations of the business. Buyers will look to all of the owners of the business to give these representations. The non-active owners are reluctant to provide indemnification with respect to facts relating to a business of which they have little knowledge. The active manager may be willing to provide such representations, but will be reluctant to be responsible for more than his pro-rata share, particularly if his ownership percentage is substantially less than 100%. From his perspective, all owners have participated for years in the profits of the business and should then also participate in the provision of standard representations.

This area of conflict is often resolved by a portion of the purchase price being placed in escrow for a certain period, generally 12-24 months. The escrowed monies provide the sole source of funds available to the buyer for breaches of representations or warranties. Funds that remain available for distribution to the sellers after the end of the escrow period are then distributed pro-rata among the owners. In lieu of an escrow, often a portion of the purchase price is evidenced by a promissory note. The buyer can utilize offset rights under the note to satisfy the indemnification obligations.

Obviously, from a seller’s perspective, an escrow is preferable since it eliminates the risk that the buyer will financially be unable to make note payments or allege false or weak claims for indemnification. As long as the buyer has the funds due seller, the buyer remains in a stronger position. If neither buyer nor seller has control of the funds, there is an incentive for both sides to reach agreement on the disputed claims.  However, having all buyers have the funds available at closing to pay the full purchase price is not always possible and taking a note may be the only avenue available to effect the transaction. 

DISPUTE RESOLUTIONS

Finally, with multiple owners come multiple views on the resolution of disputes that may arise post-closing. While the agreement of all or the majority of the owners may be necessary to sell the business, if an issue arises over an indemnification claim, or interpretation of a contract provision, the buyer will want to deal with only one representative of the sellers. Accordingly, the definitive agreement should specifically appoint a single representative or small committee with authority to negotiate on behalf of all sellers’ disputes that might arise with the buyer. This representative should not be the active manager if such individual is, post-closing, an employee or consultant to buyer. This would create its own potential conflict, placing the individual between the current employer and her former partners.

The sale of a family business or any business with multiple owners, creates potential conflicts among the owners, as well as potential issues for the attorney representing the sellers. However, if these issues are identified early and are properly addressed, the sale process can go smoothly.