Welcome to another episode of The Polestar Podcast by VELA Wealth. Today, Rob Wallis speaks with Ryan Howe, a business lawyer from Alexander Holburn Beaudin Lang. Ryan acts as general counsel to various BC based businesses with national and international operations on a wide variety of corporate and commercial matters.

In this episode, Ryan and Rob provide insights about selling the business, different transaction types,  transaction uncertainties and potential risks. They also discuss share preparation, negotiation and closing recommendations.

 

 

About the Guest – Ryan Howe

Ryan Howe is a Partner in the Business Law Group at Alexander Holburn Beaudin + Lang LLP. Ryan acts as general counsel to various BC based businesses with national and international operations on a wide variety of corporate and commercial matters. Ryan also acts as chief coordinating counsel for multi-business entrepreneurs who require personal legal representation to protect their personal and family interests and to coordinate their various other legal professionals across their holdings. To read more, please visit the AHBL team page.

About the Host – Rob Wallis

Rob Has provided senior financial planning and advice to VELA clients for over 15-years. He excels at working with entrepreneurial professionals and business owners to define their individual ecosystems and establish meaningful life and financial goals. He has specialized expertise in guiding healthcare professionals who are building multi-location, and specialist clinics. To read more, please visit the VELA team page.

 

The episode is also available on:

    

 

Disclaimer

The information expressed in the podcast is designed for general informational purposes only and is not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.

 

The Podcast Transcript

 

Rob Wallis:

Welcome to VELA Wealth Polestar Podcast! Today, I’m very excited to have Ryan Howe from AHBL (Alexander Holburn Beaudin +Lang LLP). We will be talking about business transactions. What makes and breaks deals. Welcome, Ryan and please introduce yourself.

 

Ryan Howe:

Thank you very much for having me, Rob. My name is Ryan Howe. I’m a business lawyer with Alexander Holburn Beaudin Lang or AHBL for short. I’ve been practicing business law for the last twelve years here in Vancouver at the same firm that makes me a lifer. I focused on private clients and their myriad of business law problems and successes.

 

Rob Wallis:

Thank you, Ryan. We have a lot of business owners as clients and a lot of the time the trend of the conversation around about selling their business one day. Sometimes it can be confronting, or it can be a joy, or it can be somewhere in between depending on who you are and what stage you’re at your business. What we like to talk about with people in addition to what are they going to get for their business if it is indeed even salable, is how they actually get there. When it comes to that transaction happening – what can help that be successful or indeed even happen in the first place? We feel there are three steps in that: the prep, the negotiation, and then the closing of the deal. So, if someone was coming to us saying that they want to sell their business in three to five years, what would you be saying to them from the standpoint of being the legal counsel?

 

Ryan Howe:

Well, the first thing I would probably start with is asking them whether they are selling because they have to or they are selling because they want to? So, if they “have to” that’s a different assessment than if they want to. If they “want to” – the first thing I’d say is to reach out to their tax advisors and ensure that we’ve got this thing structured optimally to take advantage of tax treatment such as lifetime capital gains exemptions. At the same time, we’re going to optimize the structure. We’ll probably be able to start digging in a touch, to what we call presale diligence, where we’re looking at problems that we know a purchaser is going to identify when they run diligence on the business and trying to prevent it before we actually get to the negotiating table. This allows us to negotiate from a position of strength when we’re negotiating the terms of the transaction.

 

Rob Wallis:

Okay. So, out of a scale from 1 to 10 when someone comes to you and says they want to start selling in 3 to 5 years, typically, how ready are they?

 

Ryan Howe:

That’s a great question. I think it goes back to that “I want to sell in 3 to 5 years”. Is that “3 to 5 years sale” a part of the plan that’s been structured with their investment advisors, their tax advisors, and their significant others, or is that just a kind of a very loosey-goosey plan? Is this a deliberate person that follows steps and they’ve got a prescription and they’re following it or is this just a lot of wishful thinking?

If it’s wishful thinking they may not have the stick–to–itiveness required to really push this thing through the right way. They might have been in a sort of desperation sale later when health issues or financing issues hit. So, a lot of it is part of the plan. If is a part of the plan, such as they plan to retire at 65, the kids are graduated, they are moving to Mexico, whatever the thing is – THOSE are very high success rates versus the ones where it’s “well I’m just kind of tired of what I’m doing…” and they haven’t really thought nor done any deliberate action to move that agenda along. So, I would say 50% are on the right path ready to rock and we’ll have a successful sale.

 

Rob Wallis:

Interesting. A lot of the time we find people’s idea of the value of their business is somewhat different from the reality of the value of that business. Then an exploration into what is the market value of my business at relative to where am I now financially and what can I actually do if I do want to retire or maybe work optional, am I there yet? Tends to drive more in-depth looking at planning and figuring out what is actually realistic. Do you find that on the offside too?

 

Ryan Howe:

Yes, hundred percent. I think you and I talk before about the notion that sometimes clients set the purchase prices as the amount, they think they need to retire. So, if their advisor is telling them they need 2,5 million to retire they’re like “Well, guess what? The purchase price is 2,5 million”. What that does is – it just shows to purchasers that you’re unsophisticated and unreasonable. Instead of that, if you need to get to 2,5 million – a lot of business sales are based on EBITDA functions or Multiples and if you are close you got to roll up your sleeves and maybe you can get there within the two-year period required to get that tax planning in place. Most people are not structured properly to maximize tax planning on sales and that’s a two-year lookback window, right? So, if we know we’ve got two years, the same time you’re going to the accountants for the restructuring should be the same time you should be thinking “let’s pull up our bootstraps here, and let’s get this EBITDA maxed”. This way we can come and get exactly the number we want. If you’re way out to lunch and you can’t possibly get that number where you are, you need to change your expectations or explore. I would call this an “alternative transaction structure”. Those you sometimes see when you’re selling to management or you’re selling to the next generation in the family in which case we typically get the number we want, and we effectively delay the sale or partition it in like a 10-year period. So, instead of getting cash on closing, you get money over 10 years. There’s a risk, but you get more than you would otherwise get on the open market or at closing.

 

Rob Wallis:

Okay. So, what about other things in the business that need to be cleaned up apart from tax planning? What other things do you see?

 

Ryan Howe:

The most common I see, and this is because it creates such a massive liability, are employees. So, if your employees aren’t on contracts that reference the employment standards act and cap their severance at eight weeks, you could have a mass of severance obligations sitting there, which is going to hit you if you do an asset sale because the purchaser is going to force you to terminate everyone. So, that can be a massive liability. We had one recently where we sold an iconic company in the Lower Mainland, and it had 250 employees of which 200 were not on contract. So, you can imagine the liabilities associated with that and that’s a big shock to clients when they haven’t thought about it. So, getting them (employees) on contracts and making sure you got that severance and then protecting the company against other things such as making sure there’s a confidentiality term, non-solicitation agreement and etc. That leads a little bit to confidentiality to IP (Intellectual property), right?

Sometimes you have freelance contractors or employees that have prepared IP for the company. Maybe they did it before the company was incorporated and it’s unclear whether the company owns that IP. Do we have an assignment of intellectual property rights and a waiver of moral rights? Do we fully own the thing? You can be a hundred percent sure that a purchaser’s diligence is going to reveal that absolutely immediately and if intellectual property is a key component of the business assets being purchased, having gaps in that chain ownership is going to be a major problem ultimately may kill the sale.

 

Rob Wallis:

So, that sounds like that could take many-many months to clean up.

 

Ryan Howe:

Absolutely! But once again, we always think about a two-year warning. If we’re thinking about a two-year minimum seasoning period – we’re really talking three (years). For true planners, they would be thinking five (years). Humans are just in a certain way always tend to attack the whole number and half number. So, 60 is a big birthday, 65 is a big birthday, and 70 is a big birthday. So, it’s your 65 birthday and if you’re thinking 70 is the chart, start moving then.

 

Rob Wallis:

 

Right. So, in preparation for a sale, it pays to be uber prepared?

 

Ryan Howe:

Well, yes. It is hard to explain how that works unless I could show what it feels like trying to negotiate terms in a deal where we are absolutely pristine condition: all the sheets are pressed, they’re white, there are no stains, the bathroom’s been scrubbed clean versus walking into an Airbnb where you’re going to leave a negative review immediately and there’s a dog pissing in the corner. That’s the reality. So, when someone comes in and looks at what you’re selling and they’re like “Wow”. If you get a “Wow” experience, then they’re absolutely not going to have the leverage they think they can, and really the only things they can attack are sort of future financial performance-oriented things. So, that EBITDA Multiple might get eroded a touch but, once again, the nice thing with a vendor is if you got a really nice product, you could find other purchasers. That walkaway power is what allows you to really set a price and get those terms that you want. But you can’t get that if you’re living in an illegal sub- suite.

 

Rob Wallis:

So, around 90% of businesses are not saleable. What do you do if you don’t have a buyer or you can’t find a buyer? My business is worth X but there’s no market for it.

 

Ryan Howe:

Well, that’s where you kind of fall in. So, I think you start looking at different options there. The one of the three that immediately jumped out to me would be selling to staff, right? We sometimes call it management buyout (MBO). That typically involves leverage on the company and the seller. So, you’re effectively propping them up and giving them very nice financing terms and maybe even guaranteeing their own borrowing. Because you just want cash out, you want to step down, transfer the reins and you want a little bit of liquidity, and then probably you’re going to be structured in a payout over 5-10 years. The same thing works for the next generation, for kids, even nephews, nieces, and extended family. The nice thing with kids is there are some tax benefits to intergenerational wealth transfers. So, we’re seeing quite a bit of that where generation 1 is going to generation 2 or generation 2 to generation 3. Once again, those are pretty loose least structure purchases because ultimately that kid’s going to inherit the estate. So, if the parent is relatively old, they’re not going to go through all that money. And once again, you’re not looking at a huge purchase price you’re looking at pretty loose financing terms probably getting paid over 10 years, and if the company craters because of the change in management your host. Then the final one I would say is thinking about partitioned asset sale, where you’re looking at your competitors in the market. They would otherwise acquire you but for the fact they don’t want the liabilities with your employees, they don’t want your office space. All they really want is your contracts. So, you could turn around and wind up the business and strategically sell off assets. That’s not a great way to go because your workforce is going to hate you. I mean, that’s effectively liquidation downsizing, kind of stuff but I mean in some instances if your heart’s out of it, your health’s not there, you can’t find those other 2 options then that’s kind of the way it goes.

 

Rob Wallis:

Interesting. So, could you just give us a couple of soundbites on asset versus share sale to start? Super concise, please.

 

Ryan Howe:

Sure! Speaking from the vendor’s perspective, the vendor is always going to prefer a share sale wherever possible because of the capital gains exemptions and lifetime capital gains exemptions that can be triggered. Specifically in that two-year planning when we were talking about – that’s where you want to put in a family trust and then try to take advantage of as many capital gains exemptions as available for the beneficiaries. So, share sales are riskier to purchasers because they end up stepping in and absorbing effectively all the liability of the company by buying the shares. Asset sales are more preferred for purchasers because they can pick and choose what liabilities they assume. It’s not as favorable to vendors, because vendors don’t get that lifetime capital gains exemption. Then they do get capital gains treatment and if you structure the transaction in such a way that the majority of the purchase price is allocated to goodwill you can sometimes end up with a tax result that’s not that bad relative to a share sale. But once again, it really depends on what kind of share sale you’re looking at. Let’s say if you’re selling your business, Rob, and you got a family trust, you’ve got 2 kids and your wife – that’s 4 capital gains exemptions typically. So, that’s indexed at 900K, you’ve got almost 3.6 million in the shelter there for that exposure. Whereas in an asset sale, even if we crank the goodwill, we might not be able to get there. So, there’s an inherent tension in the way that you structure the transaction itself and depending upon this goes back to, you know, the housekeeping if you have dirty sheets, right? They’re not going to want to buy them. So they’re going to say “you can keep your sheets. We just want this nice little Bose. We want this tv …”. So, you don’t want to give them an out on the share sale. You want them to lean in and say, “yes I want to buy the shares”.

 

Rob Wallis:

Okay. Let’s move into negotiation. Let’s say that the sheets on that bed are crisp. They’ve been starched. It’s squeaky clean. It’s beautiful. We’re going in to start negotiating. How does it roll from that?

 

Ryan Howe:

So, I think in that instance, what it allows us to do is really set favorable terms in the term sheet or the Letter of Intent (LOI) and those two terms are used interchangeably, they mean the same thing. Effectively, it is an agreement to agree. We want these things to be largely non-binding. The only binding provisions are typical with respect to deposits if applicable and then exclusivity. The rest of it is effectively non-binding. So, it gives the parties a framework for how they would approach the transaction. Purchasers typically want to jam in the loosest one-page LOI on the planet that may talk to a possible price and then nothing else. And then they bury you in details on the definitive purchase agreement. The problem is that by the time everything shakes loose, vendors who have never been through this process before get overwhelmed very quickly because of all the documents and information and decision requests that are happening. They get something called transaction fatigue that affects them and they become very poor negotiators. They lose their spine, they give in across the board and they lose the tactical advantage. Our recommendation for when you have “crisp white sheets” is we negotiate the hell out of the LOI or the term sheet. And what we’re trying to do is modify risk allocation at the outset. So, the way we do that is we say “listen the purchase price is X and we want 95% of that on closing. This is not a structured payday”. We’re getting all of it and then there’s a 5% holdback for known indemnities or whatever the case may be.

You want to get as much cash as possible on closing and ideally nothing else unless it’s there’s no other deal on the planet. Then you would typically want to avoid holdbacks and earnouts because that affects the total purchase price and it’s unclear where that’s going to come from. Also, that can affect tax positions and then from there, we want to look at things like indemnification. What’s our indemnification obligation? Is there a cap? Are there deductibles? Are they baskets? Are they tipping baskets? What’s the survival period? Can they come back on us indefinitely or can they only come back on us two years after the deal closes? Are there conditions to closing associated with us signing employment agreements or are senior people signing employment agreements that we may not like? Do we have to do transition services? There’s a whole bunch of sort of ticking time bombs that you could diffuse very early on in the transaction at the LOI stage. The nice thing is that you’re not really exposed to professional fees at that level. Negotiating a term sheet typically is not very expensive relative to getting to the end of the line on these definitive purchase agreements of getting ready to close.

So, in my experience, the best time to negotiate and use your negotiating power is at the term sheet level with the pure understanding that it may not go, and they may walk away. You have to be prepared for that and you have to look in the face of them walking away and accept it. We’ll find someone else, and you just learn from that.

When he desperate clients that are terrified for approval of the purchaser – we end up with terrible purchase terms and they’re always unhappy. We just successfully negotiated 1 for 1 of our clients and it took us two months to negotiate the term sheet. We got everything we wanted! But it was a horrendous process. Now they’re set. So, we know when the definitive purchase agreement comes in – all these matters already done. So, we’re not going to have to fight about it when the client doesn’t have the energy to do it.

 

Rob Wallis:

So, if both parties agree to walk away or one wants to walk away. Is there a risk that valuable information could have been given away from the seller?

 

Ryan Howe:

Well, that’s an excellent point. Typically, we have phase disclosure of information. One of the things we like to do is before we even enter discussions with someone, we want to get a nondisclosure agreement. So, the nondisclosure agreement will protect us against any disclosure we give. Beyond that, the other way to protect us is to segment the disclosure of information into multiple tiers. So, tier one would be after the nondisclosure is signed, tier two might be after the letter of intent or term sheet is signed, and tier three would be after the definitive agreement is assigned. That makes parties more and more committed at each level and the likelihood of the transaction increases exponentially. So, the likelihood of them just kicking the tires to take sensitive information and run with it is very low.

Also, we wouldn’t give them sensitive information until the very end.  We would not disclose things such as IP trade secrets, employees’ names, material, customer names, material suppliers and etc. We would give them loose data on that, we might give them charts that say here are top customers or clients, but we would anonymize them. We’d give them the raw details, but we just would say customer A, B, C and etc.

Then you disclose that on the definitive. Sometimes if we really get stuck, we’ll do an escrow delivery of sensitive information to their lawyer. So, their lawyer gets to see it, but the client never sees it until the deal closes, and then we know it’s protected because the lawyer’s going to be bound by undertakings to me. That’s how we protect against that.

 

Rob Wallis:

Very interesting. So, been super clean in the prep, very selective in the negotiation about how you disclose information, strong on the LOI… What about when we got through all of that? Everybody’s happy. Well, let’s assume everybody’s happy. They should be if they’ve done everything properly. What about closing? How does that typically roll if everything’s all in order and stacked up?

 

Ryan Howe:

Well, one of the things that we’ve been noticing recently is that even though we recommend to our clients to start working on the disclosure schedules early they typically don’t do it. Disclosure schedules are qualifications for reps and warranties. So, when you’ve got a purchase agreement, a purchaser is going to say “Rob, I want you to say that your company has never done anything offside with respect to the income tax act” and you’ll say “I’m pretty sure we haven’t done that”. So, you might say “to my knowledge, I’ve never done that” or maybe you know you did do something you can say “to my knowledge and except as disclosed in schedule 1.1-2, I’ve never done anything offside the tax act”. So, that except as disclosed in schedule X is a disclosure schedule. So, disclosure schedules are often used for the vendor to qualify reps and warranties that they don’t want to give and then often used by the purchaser to force disclosure at a diligence level for certain things. So, for instance, schedule 1.1 sets out the authorized share capital of the vendor. So, now we’ve made a representational warranty with a schedule that says “…here’s the shares as issued”. Those disclosure schedules can sometimes run 200-300 pages long. What happens is when they’re due, and they are due pretty much 5-10 days before closing realistically, the clients are completely overwhelmed. They are so busy trying to do integration, close bank accounts, get client consent, make payroll, and pay the accountants to run the balance sheet… there’re probably 25 different material things that they are responsible for in those two weeks prior to closing, so they tend to not pay attention to this. And then what happens is they do bad disclosure. That bad disclosure comes back to haunt them. If it’s wrong or if it’s a materially misleading in which case, then they get hit for indemnity. So, I would say the major keys to success in closing would be getting those disclosure schedules done way in advance and making sure that you have someone dedicated to your team to run the information disclosure. That could be a transaction advisor who comes in and negotiates the deal for you, they run the data room and handle a lot of upper-level technical requests. Also, it can often be a controller within the company. The only issue with the controller is that he/she is probably busy running your business. So, giving them another full-time job on top can be very stressful. So, you might want to hire an assistant for the controller to let them do this because some of these diligence windows can be as long as six months. Although we generally prefer to get these things closed in 90 days.

I’d say have good help and remember to get moving on your obligations early. You will never have enough time. Always be proactive because it always ends up being a rush and then it’s terrible.

 

Rob Wallis:

Okay, and if I’m selling a business. How do I ascertain that the purchase has actually got the money to close?

 

Ryan Howe:

That’s a great question. One of the ways we can do that is we can put in the term sheet or the LOI that serves as a representation and warranty from them, that they have sufficient funds to close, and they don’t have to go get financing. A lot of purchasers are hesitant to do that because they like to rely on debt wherever possible. However, once again it depends on the nature of the transaction. If they come and approach you with an unsolicited offer from a strategic buyer – they better have cash. If it’s desperation and you’re going on the market and selling to anyone who’s got hope – you’ll take the financing condition. It is what it is. This goes back to your leverage on how saleable you are and whether you can pick and choose amongst different buyers.

 

Rob Wallis:

Totally. Then, what about the order of signing and closing?

 

Ryan Howe:

That’s an interesting one. I think you and I talked in the past about the difference between simultaneous sign and close agreements versus a sign and then close agreements, with our preference being for the latter. Sometimes with weird tax transactions or public companies they can’t sign the document until the closing date. That means you as a vendor are exposed that entire time because they’re just sitting back saying “we’re not going to sign until you do this”. “We’re not going to sign” versus assign and then close – let’s say you sign the purchase agreement today and then maybe thirty days to close. So, now you’ve got some certainty as a vendor. As long as nothing happens in the window in between we’re good to go. Whenever possible we want to avoid simultaneous sign and close because it gives an infinite amount of leverage to the purchaser. We always recommend for our vendors the traditional approach which is a sign and then close.

 

Rob Wallis:

Our point of view in the planning work is that we work with our clients’ proactivity: planning for the future, considering what you want your life to be now and what you want to do in the future, and how your asset position support whatever that is and if it’s a business transaction that’s required to deliver some capital into the family balance sheet to ensure that there are sufficient funds into the future, what is that and then how is it going to be allocated? So, to deliver income and capital needs into the future for a family, what do you see from your end? Are people showing up knowing that they’ve got a clear plan for funds when they get them, or they are “I’m going to go and blow this money” or “I’m going to put it in another business!”. Quite often we see business owners wanting to go into another business and we need to remind them “well, let’s think how hard you’ve worked so far on the journey to get where you’re at and this is what you’ve made. Do you have the capacity for loss, for money to go into a new venture or is it more sensible to use someone else’s money?” What do you see?

 

Ryan Howe:

That’s a great kind of starting point. To your point once again, it comes back to the delineative people. If they’ve got a plan with their advisor that they’ve worked out and this has been going on for 5-10 years – they’re following the plan.  So, when that money comes in (when that “twenty mills” comes in), we know exactly where it’s going. It’s part of the plan. It is to do A, B and C and that’s why it has to go to X, Y and Z to do A, B and C. Those people that get it without a plan… there’s almost this insecurity that comes with entrepreneurs and business owners. There are feeling naked without a business. “What I’m no longer a business owner? I’m just Rob?” and the answer is “Well, no, you are always just Rob”. Sometimes they get a little bit terrified, and they immediately jump into something else. Our recommendation typically is to think about why you left in the first place? What were you doing? What were you trying to achieve and is this the right decision for you?

A lot of our clients do end up back in some sort of commercial enterprise, but they tend to be very low risk, low Involvement, straight cash…we’re talking parking lots, storage locker or owning bare land, just holding land and then selling it, that sort of things are easy. It doesn’t take a huge amount of time or effort to make smart commercial plays there with the right advice. Often, they’re doing that as a hobby, to maximize that total asset pool for them on retirement and then ultimately for their kids. But the ones that immediately jump into a high involvement and high-risk business, unless they’re very young and very hungry, always make me terrified and worried they’re going to absolutely lose everything. But some people are serial entrepreneurs and they got to do it. So, I think that’s where you as the advisor can really show your worth in terms of making sure that they feel confident in the plan and that they stick to the plan.

 

Rob Wallis:

Yeah, well back to that family of 4 with the 3.6 million of capital gains exemption. That’s a one-time thing, right? So, that money got to work even harder for growth.

 

Ryan Howe:

That’s a one-time thing, yes. So, it’s indexed around 9, so all those kids have used it up. So, if they want to be an entrepreneur in the future, they can’t use that. I mean if they’ve used their entire exemption. With the idea being that capital created will ultimately end up in their hands when their parents pass. that’s… I think there’s a difference between enough and then enough to stop.

So, there are just different personality types there and you got to figure that out. But there are so many worthwhile efforts out there and so much need for capital in targeted areas that would be more fulfilling than a purely commercial enterprise, right?

Some people may dream about running a bar on a Commercial (Drive). Good luck. I can’t wait to see what will happen here. Versus people who wanted to focus on regrowth options in this part of BC and doing a little bit of side planting and supply. Well, that’s great.

But once again, who am I? I’m just the lawyer, right? I’m not the one that’s got the moral suasion here. I’m simply the guy who’s seen 250 deals and here’s the way it shook out for these people. So, you have quite a bit of perspective, but they don’t come to you for the perspective they come to you for protection and making sure they got paid and are not screwed over. It’s not about “I’ve done it. What should I do Ryan?”. That’s more your domain, right?

 

Rob Wallis:

Well, we’ve both got lots of stories, that’s for sure. Thanks, Ryan, it’s a really interesting conversation.

So, the key points are to be squeaky clean, negotiate very-very hard and very selectively, make sure your purchaser can close, have a plan for what you do with the money and don’t blow it or open a bar unless you can afford? Right?

 

Ryan Howe:

A hundred percent! That’s the key takeaway! Thanks, Rob.

 

Rob Wallis:

Appreciate your time. Thank you!

 

Ryan Howe:

Thank you.