Middle East business information

By Steven Bainbridge, senior associate, and Taki Osman, associate

If acquiring a family owned company or business, a buyer should keep an eye out for the following issues, which can be easily identified by conducting a proper due diligence review of the target business:

• Proper registration of the shares in the names of the shareholders. Because a family business might be considered a family affair, one or more transfers of shares between shareholders and others may not have been properly registered in the company books or reflected in the amended bylaws.

For example, in the case of inheritance, share-ownership may remain in the name of a deceased family member and not the designated legal heir. In order to avoid such complications, the registered and most updated share ownership structure must be confirmed and signed off on by all target shareholders, failing which, proper registration with the authorities and reflection on the activity license and bylaws must be executed prior to acquisition.

• Proper registration of assets in the name of the target rather than in the name of one of its shareholders. It is not uncommon for shareholders of family companies to acquire assets, land and buildings in their own names and to use them for the target's activities. In such cases, accurate inventory should be made clearly indicating those assets registered in the name of the target and those which are not.

It is prudent to consider adding as a condition precedent to the asset sale and purchase agreement that shareholders must, prior to the acquisition, finalize the due assignment and transfer of ownership of the relevant assets to the target, stipulating lawful registration of such assets in the name of the target. This could significantly affect the value of the company, to the extent of determining the viability of the proposed acquisition, particularly if the target activity is related to real estate or property development.

• Many family owned companies choose not to appoint an auditor and prefer to undertake financial responsibilities in-house, money and finances can be a sensitive and, at times, a secretive aspect of a family. Prior to acquisition, an independent auditor must be appointed to undertake a comprehensive financial review and audit of the target and to report with the balance sheet, cash flow and profit and loss accounts. This is vital to determining the target's liabilities and receivables, and thus determining fair value.

• The separation between the finances of the target and its shareholders sometimes can be a grey area. A company requires separate finances, books, and records however, in some cases, the finances of family shareholders, other affiliated family companies, subsidiaries and the company overlap and, in some instances, are inseparable. Thus separation of such finances, sometimes in the form of inter-company loans or related party loans, and quantification of how much the company owes the shareholders and vice-versa, is key in determining the target's true value. This step would be undertaken by the financial advisor before issuing the audited balance sheets and profit and loss accounts.

• Because there is the possibility that the target's finances and that of its shareholders are intertwined, in granting loans and credit facilities, banks tend to require shareholders to act as personal guarantors. From the bank's perspective, viewing the target and the shareholders as one and the same has merit. Although the position taken by lenders is not entirely correct, prior to an acquisition, a legal and financial review must be conducted of all loan agreements, credit facilities and related collateral agreements, in order to determine the value of the borrowings, due payments, due dates, corresponding collateral, to accurately determine the target's true value.

It is recommended that all encumbrances on the target's assets be cleared, by paying off debts either directly by the target or indirectly using the proceeds of the acquisition, and collateral agreements should be cancelled with lenders through the execution of settlement agreements.

• Family companies tend to enter into contractual arrangements, either with affiliated companies or third parties, either verbally or with insufficient legal documentation. Where such arrangements remain for a period of time, there is an increased risk that they could result in a dispute or misunderstanding that would have no legal reference point for resolution. This may expose the potential buyer to liability to the counter party or third parties, without the benefit of a contract.

In order to avoid such irregularities, a thorough survey should be made of all the targets official and semi-official contractual arrangements. Where formal contracts do not exist, arrangements should be made to execute proper legal provisions with third parties, including those for timescale, termination, governing law and dispute resolution, in order to make the potential buyer aware of its legal rights and obligations as well to avoid potential liabilities and disputes.

In addition, the execution of contracts between family companies within the same group without complete documentation is commonplace. Often such arrangements are not made at arms length and this could result in inaccurate financing and inter company loans which affect the overall transparency and value of the target. The same exercise as outlined above must be performed, prior to acquisition.

• Certain third parties may choose to enter into agreements with family companies because of the existence of a particular individual within the company, having certain know-how, expertise, contacts, market knowledge and influence that make such contractual arrangement tied to the existence and continued good will of that individual. This arrangement is usually industry related and, to the extent possible, should be identified accurately by the potential buyer prior to approaching the target for acquisition.

In the event that these contractual arrangements are of core importance to the target and significant to the main reason behind the potential acquisition, it is recommended that key personnel are retained by the company post-acquisition in order to ensure the continuity of the contracts and related work flow. In the event that the key person is a shareholder, then the shareholder should remain, albeit with a dilution of share ownership. If they are a manager, then a management agreement for the retention of their services should be part of the acquisition documentation package.

• There have been instances in which family companies have tended to use the same set of employees across several companies, which may even operate in different business zones, etc. Depending on the buyer's requirements, prior to acquiring a company, the exact number of employees related to the target should be confirmed, and the employees' visas and work permits examined to ensure they are properly registered and valid under the target's name. If new visas will need to be procured, this is a cost consideration that is reflected in the purchase price.

• Family companies sometimes bear their names as a 'trade name' or a 'trademark', and in many cases these are not registered with the relevant authorities. Factoring in marketing and branding plans as well as accrued good will, the buyer and the seller must agree whether or not the rights to use a family name would be part of the acquisition.

These names can bear intangible value amongst stockholders, for example, a name might be related to a certain level of recognition, trust and reliability, which might not otherwise be associated with a product line, and again might play a role in determining the acquisition price. If the trade names are registered this must be clearly reflected in the acquisition documentation.


Conclusion
Prior to embarking on an acquisition of a family owned company, proper financial, legal and industry expertise must be sought in order to determine the legality, reliability, marketability and profitability of that target company.

Several factors play a vital role in determining a fair price for the target, such as good records, proper registrations and ownership, appropriate levels of separation between management, shareholders, and the target with respect to finances and property ownership, etc. Potential buyers must endeavor to factor in valuation cues based on the findings of the financial and legal due diligence and to negotiate and resolve the recommended corporate clean up prior to conclusion of the acquisition.

For a list of companies offered for sale across the region and internationally visit AMEinfo.com's Businesses for sale section