partners in your business

Partners in Your Business

Contributors: Gareth Banks, CHAMP Ventures Anthony Short, Blackwell Short Lawyers James Price, JPAbusiness

2 jpabusiness.com.au +61 2 6360 0360

Table of Contents

Introduction ........................................................................................................... 3 Assessing the risks ............................................................................................................................................... 3 Meet our contributors… .................................................................................................................................... 4

Chapter 1: The role and focus of Private Equity ...................................................... 5 What is Private Equity? .................................................................................................................................... 5 How does it work? ............................................................................................................................................... 5 What type of business opportunities does Private Equity look for? .............................................. 6 What does Private Equity require? .............................................................................................................. 6 As a business owner, how can I benefit from the involvement of private equity? ................... 7 As a private equity investor, what affects your appetite to invest? ............................................... 8 As a business owner, how do I become 'private equity investment ready'? ............................... 9 Where to go for more information .............................................................................................................. 9

Chapter 2: Pros and cons of business structures: Sole Traders, Companies and Partnerships ........................................................................................................ 10 Legal business entities – which one is right for you? ........................................................................ 10 Sole Trader (Proprietor) ............................................................................................................................... 11 Company ............................................................................................................................................................... 12 Partnership ......................................................................................................................................................... 14

Chapter 3: Pros and cons of business structures: Trusts ....................................... 16 Trusts ..................................................................................................................................................................... 16 Partners’ Agreement: your ‘blank canvas’ ............................................................................................ 19

Chapter 4: Key Business Partners: Banking Partners and Key Staff ....................... 22 Partners in the banking world ................................................................................................................... 22 Key employees – partners in your business ........................................................................................... 24

Disclaimer: The information contained in this eBook is general in nature

and should not be taken as personal, professional advice.

jpabusiness.com.au +61 2 6360 0360 3

Introduction Partners in your business can take many forms.

Businesses involving more than one party owning either share capital or a formal stake in a private business can significantly impact the operations and performance of the business.

While this is true for both publicly listed and private companies, this eBook focuses exclusively on private businesses.

Partners in business – whether they be spouses, employees, work colleagues, private investors, working directors or shareholders – can significantly benefit the business’ capital base, value, risk profile and growth path.

Senior people who are ‘invested’ as owners also tend to drive the business to another level, mitigate succession issues and cement performance expectations.

The dynamics of partners in your business can be very positive if planned, structured and managed effectively to ensure a shared vision and direction.

However there can also be downsides, as control is shared and expectations relating to risk, reward and exit can present challenges.

Assessing the risks

If you do take on a partner, what are the practical business and legal issues you both need to consider in order to protect against risks such as relationship breakdown, or to ensure a smooth process in the event one of you wants to exit the business? Also, what can a partner offer your business in terms of opportunities?

This month we’ve asked private equity investor Gareth Banks and solicitor Anthony Short to share their expertise on the subject of ‘Partners in Your Business’, with JPAbusiness director James Price focusing on banking partners and key staff partnerships.


Meet our contributors…

Gareth Banks

BSc (Mathematics Hons), ACA

Gareth is a director of CHAMP Ventures, a leading Australian mid-market private equity firm which is currently investing its seventh fund of A$475 million. CHAMP Ventures invests in small- and medium-sized businesses in Australia across most sectors of the economy. Gareth joined the CHAMP team in 2004, after working with underperforming businesses across Europe, Asia and Australia. Since January 2011 he has also served on the Australian Private Equity and Venture Capital Association Limited (AVCAL) Council.

Anthony Short

BAS (Computing), BBus (Accounting), Bachelor of Laws (Hons)

Anthony is one of the principals at Blackwell Short Lawyers in Orange, NSW. Anthony worked for 14 years as a chartered accountant, including four years as a partner, advising clients in structuring their business, asset protection and estate planning. He has been in regional legal practice for 10 years and continues to develop a practice in business transactions, superannuation, property and taxation.

http://www.champventures.com

http://www.avcal.com.au

http://www.blackwellshort.com.au


Chapter 1: The role and focus of Private Equity Comments by Gareth Banks, CHAMP Ventures

What is Private Equity?

Private equity is a partner, enabler, supporter or contributor to small and private businesses.

Private equity is much more than just some capital. You can get capital from plenty of places, but private equity is an aligned partner, helping a business to grow, set strategy and problem-solve.

How does it work?

The money for private equity investments comes predominantly from industry superannuation funds, both Australian and overseas, investment houses and sovereign wealth funds.

There are a range of private equity firms servicing different segments of the market. Some firms target equity investments of $5 to $20 million, CHAMP Ventures mainly invests $20 to $60 million, while others target $100 million plus.

At CHAMP Ventures we receive most of our capital from pension funds. They invest with us for 10 years, so we tend to invest in companies in the first five years of that cycle and then sell out our share in the second five years.


What type of business opportunities does Private Equity look for?

There are two main styles:

• A traditional management buy-out sees private equity firms partner with management teams of a business and buy a business or division from a larger company, or other shareholders. Private equity is usually an 80-90% shareholder in this style.

• Private equity can be invested as a minority stake to help a founder diversify their assets or wealth, to help a passive shareholder in the business exit, or to provide money to help a business expand. In that instance private equity may be a 30, 40 or 50% shareholder.

What does Private Equity require?

Our basic requirements are:

1. Management to back: As a rule we want proven executives to partner with, so management is a key requirement. We can help problem solve, think through strategy and bring complementary skills, but we’re not going to run the business day to day.

2. A desire to grow and at least a basic strategy for that growth: In some cases people have thought that through in detail and our role is to stress test and critique it. In other cases the CEO has a skeleton vision and wants help working it up. We need to buy into a business, help grow its earnings and then sell it, or our share, in four or five years’ time – that’s how we make money.


As a business owner, how can I benefit from the involvement of private equity?

A lot of our opportunities are coming from providing a solution to an ownership transition, or management succession.

We can help a business owner who is looking for someone with complementary skills to help them on that journey.

Here’s a typical scenario:

A business’s founder owns 100%, has many of the key relationships with customers or suppliers, and he/she is finding it difficult to sell 100% of the business because they’re seen as integral to that business.

We can buy a stake from them, maybe 40 or 50%. They diversify their wealth and then we’ll be a partner with them for four or five years and help them recruit a CEO to replace them – maybe the founder can step up to be the Executive Chairman.

We can help them develop systems and begin to corporatise their business so it develops from a one-man family business and over a period of four or five years becomes a small corporate with some management. It’s then a sellable business.

Another way we can help business owners is if they’re looking for capital to expand or there is an acquisition they want to make, but they don’t want to put more of their own money into the business, or over-gear it. Our involvement will help a business owner achieve these aims.

Having said that, private equity isn’t for everyone.

If they want to hand the business down to their kids, then we’re not the right partner. We need an exit event over the medium term to realise value added for risk taken.


As a private equity investor, what affects your appetite to invest?

1. People to back – We’re looking for a CEO or management that we feel comfortable working with and who will run the day-to-day operations. Often we have to help supplement the finance function, because it hasn’t kept up with the vision and growth. We help put in place a more robust finance function and maybe a chief financial officer, because you can’t grow without the right information.

2. Alignment – All the shareholders and management need to be aligned on a goal or journey. If you don’t have alignment, your appetite to invest is gone. You don’t want one shareholder with a 20-year horizon and one with an 18-month horizon.

3. Growth – It’s good to be in a segment that is growing, but it’s not essential as long as the business has a plan or sees an opportunity to grow itself.

4. Point of difference – Do they have a point of difference and can they defend their position? If they’re one of many players who are all competing on price, then that’s a harder way to grow a business.

5. Diversification of both customer and supplier – Often we see businesses where one customer is 60% of the revenue. This isn’t a deal breaker, but it is viewed a bit negatively.


As a business owner, how do I become 'private equity investment ready'?

Often, we come in and businesses are a little ‘green’ and haven’t thought through all the issues.

It’s useful to talk to someone, such as a business advisor or accountant, to brainstorm your ideas. I don’t need people to provide pages of information and glossy charts, but it’s good if they’ve already bounced around their ideas with someone.

It’s also very useful to talk to founders or CEOs who have partnered with private equity in the past, to really understand the process.

Business owners also need to understand their sense of scale and which private equity firms best match their requirements.

While it’s good for me if people have already thought about these things, I don’t mind if the initial meeting is a bit exploratory. That’s part of the education process and not every business is right for private equity, or ready.

Sometimes we’ll have a chat, agree a business isn’t ready and then we’ll get a call from the owner three years later when they are ready.

Where to go for more information

The Australian Private Equity and Venture Capital Association Limited (AVCAL) website is a good starting point.

AVCAL is a national association representing the private equity and venture capital industries and the website provides plenty of information about private equity and venture capital.

http://www.avcal.com.au/looking-for-capital/looking-for-capital

And, of course, you can always talk to your business advisor.

http://www.avcal.com.au/looking-for-capital/looking-for-capital


Chapter 2: Pros and cons of business structures: Sole Traders, Companies and Partnerships Comments by Anthony Short, Blackwell Short Lawyers

Legal business entities – which one is right for you?

You’ve made the decision to take on an investing party, so which legal business structure is best for you?

Over the next couple of chapters we’ll consider the pros and cons of four common legal business entities:

• Sole Trader

• Company

• Partnership

• Trust

There is generally no perfect structure that covers all wish-list items for a given business structure proposal, so we always try to achieve a structure of ‘best fit’.


Sole Trader (Proprietor)

This is the simplest form of business entity with an individual as owner and operator of a business. The sole trader will use their own Tax File Number but will also have a registered ABN and (likely) GST registration.

Sole trader example:

Pros:

• owner is solely in control and therefore fully independent (i.e. decision making);

• simplest and cheapest entity to establish;

• owner takes all profits and has access to all taxable losses;

• speed and flexibility of change(s); and

• privacy.

Cons:

• unlimited liability on the sole owner;

• doesn’t enable other partners to own a portion of the business and share the risk/reward;

• may require assistance or advice from others in decision making;

• limited finance access (fundraising etc); and

• business subject to life and health of owner.

Owner/operator (Fred) t/as ‘ABC Bakery’


Company

A company:

• is a legal association of people that combine for the purpose of operating and financing business operations;

• is created by being registered with ASIC (federal jurisdiction);

• provides for separation of business owners (shareholders) from the business operations (company officers and employees); and

• is a legal person with rights to own property, operate a business and sue and be sued in its own right.

Company structure example:

JKL Co. Pty Ltd t/as

‘ABC Bakery’ Director/Secretary: Fred

Shareholders:

Fred Jane Family Discretionary Trust


Pros:

• finance raising (recognised structure for both debt and equity funding);

• flexible business expansion prospects;

• written shareholder agreement clarifies exit and governance and dispute processes;

• separate legal personality;

• asset protection by corporate veil (separation of operation and ownership);

• limited liability afforded to shareholders;

• unlimited life;

• transfer of ownership by share transfer, allowing for flexibility in introducing partners to the business; and

• tax benefits afforded to companies.

Cons:

• cost of set-up (though basic cost has reduced in recent times for simple company structure establishment);

• ongoing costs (reporting and accounting) where complicated transactions or structure required;

• loss of control (i.e. to a management board, board of directors, etc);

• understanding of company concepts, governance and operations;

• layer of regulation by ASIC and Corporations Act 2001 (Cth);

• limited tax concessions, i.e. Capital Gains Tax in relation to real estate/assets;

• director (office holder) obligations and liabilities, including severe personal penalties; and

• insolvent trading risks to directors personally.


Partnership

The key features of a partnership are:

• comprises two or more people (may be legal entities) that operate a business with a common view to profit;

• has its own ABN, Tax File Number, GST registration and it will lodge its own tax return each year;

• equity interest can be equal or different (i.e. one partner may have 40% interest and another 60%);

• a partnership must lodge a tax return but does not itself pay income tax, as the profits (or losses) are distributed to the partners in accordance with their equity interest;

• partners share in profits and losses in accordance with their partnership equity and any agreements they’ve made; and partners are joint and severally liable for the debts of a partnership at all times.

Partnership structure example:

Partnership t/as

‘ABC Bakery’

Fred – 40% Equity Interest Jane – 40% Equity Interest XYZ Discretionary Trust – 20% Equity Interest


Pros:

• minimal cost in set-up;

• shared responsibility and obligations;

• contribution of different assets (i.e. skills, resources to the business);

• relatively easy to operate and account for on an ongoing basis;

• written partnership agreement can clarify operations and exit expectations;

• control, flexibility and privacy may be positive aspects of partnerships; and

• tax losses are accessible to the partners directly (they are not quarantined like trusts or company tax losses).

Cons:

• unlimited liability (including joint and several liability, where a liability caused by one partner shall cause all other partners to be liable);

• transfer and termination of partners and/or partnerships may have some complications and need to be properly accounted for;

• potential for decision-making conflict and stalemates;

• no permanence i.e. on termination or dissolution; and

• can be limits on number of partners (state jurisdictions apply) so expansion may be limited.

We strongly advise partners (in a ‘partnership’) and shareholders (in a ‘company’) to have their partnership or shareholder agreement in writing as it will save time, effort and cost if there is a dispute later. Consult your business or legal advisor to discuss your options.

We will also cover more on the aspect of agreements between business partners in the next chapter.


Chapter 3: Pros and cons of business structures: Trusts Comments by Anthony Short, Blackwell Short Lawyers

Trusts

Trusts are a very popular structure for owning and operating businesses, particularly where there are multiple business partners and significant tangible assets associated with the private business, along with the going concern trading business.

Trust popularity for business owners relates to benefits associated with asset protection and income distribution, among other things.

All types of trusts have the same essential structure, with minor variations in their rules (i.e. trust deed) to distinguish the trust and allow it to perform different functions.

The essential structure of a trust is:

• A person (settlor) provides property (trust property) to another person (trustee) to deal with that trust property in accordance with certain rules (trust deed) on behalf of and for the benefit of other people (beneficiaries).

• The trust deed (also known as the trust instrument) may also provide for other people (appointors) to terminate and appoint trustees. These people may greatly influence the trust.


The trust deed can be simple or complex, detailing:

• powers of trustees and appointors;

• describing who the beneficiaries are;

• describing the relationship between each party;

• permitting income to be accumulated in the trust;

• detailing which beneficiaries are entitled to trust property (capital);

• detailing which beneficiaries are entitled to income and tax-benefiting distributions (streaming);

• detailing what happens at the end of the trust period (maximum 80 years); and

• defining income.

Trust structure example:

XYZ Trust trading as ‘ABC

Bakery’

Appointer: Jane’s father, George

Beneficiaries:

Fred, Jane and children

GHI Pty Ltd

Religious/charitable

organisation

DEF Pty Ltd (Trustee Company)

Director/Secretary: Fred


Pros: • trusts can be flexible and relatively straightforward to operate and

account for;

• flexibility for income and capital distributions subject to the type of trust (i.e. discretionary trust);

• other tax benefits such as capital gains tax for fixed/hybrid trusts;

• asset protection by separation of business operations by the trustee from the owners;

• written trust deed provides clarity on operations, exit and other factors;

• opportunity for the addition of other business owners/partners or stakeholders (i.e. unit trusts); and

• sole discretion (ability to enshrine control) of trustee in certain decisions.

Cons: • costs in setting up complicated trusts;

• can be tax disadvantages (particularly in relation to unit trust – cost base (Capital Gains Tax) considerations);

• limited rights and other rights of beneficiaries that may be affected;

• need to ensure a trustworthy trustee and appointor of trustee;

• added ongoing costs of complicated trust structures and transactions; and

• understanding of trust concepts.


Partners’ Agreement: your ‘blank canvas’

I heard a horror story on partner relationships the other day.

It related to a Sydney business where two partners had been in business for many years and over various issues their relationship had severely broken down, to the extent they built a physical brick wall down the middle of their premises to divide the area and exclude contact between each other.

Can you image the impact on business value and operations?

Write it down!

If you’re a business owner considering taking on an investing party or shareholder, some form of written shareholders’ or partners’ agreement is vital.

Use the agreement to make clear all parties’ investment and partnership intentions and responsibilities from the outset.

Remember, this is your business, so you can cover whatever you think important, from business relationships, ethics and cultural issues, to insurances and taxation to debt obligations, dividend payments, valuation, disputes and exit provisions; it’s your blank canvas.

The following broad components of a private company’s Shareholders’ Agreement are also relevant to all business partnerships, whatever specific legal form they may take:

• Define the business intent and operations and limitations of the company;

• State the decision-making obligations for directors/partners and shareholders;

• State the procedures if a shareholder/partner wants to sell or transfer shares/equity, a director wants to retire, a shareholder’s/partner’s employment is terminated, or in the event of the death or permanent incapacity of a shareholder/partner;


• Insurances to be held by shareholders or working partners;

• Power to invoke enduring or specific power of attorney in certain events;

• Funding options to the company/partnership by shareholders/partners;

• Provisions and any restrictions on external funds raising (debt and equity);

• Restraints of trade and conflicts of interest;

• Valuation methods/procedures for the shares/equity and/or new business partners or exiting shareholders/partners;

• Business succession and exit conditions (for example, exiting party to offer to existing shareholders/partners and then externally or full sale);

• Confidentiality;

• Dispute-resolution procedures;

• Taxation advice (this is very important as the effects of the shareholders’ or partners’ agreement may have substantial tax implications);

• General matters such as jurisdiction, notices, non-merger, etc.;

• Each shareholder/partner should seek independent legal advice on the document;

• Use the document to state any type of relationship or procedure or limitation on the company/partnership or shareholder/partner actions.

In summary, a good business with multiple partners or shareholders is one where there is clear, open and regular communication between the partners on what each others expectations are and how the business is performing and meeting those expectations.


Inevitably though, because of the pressures of business and also personal lives, sometimes there are risks of relationship breakdown or changing business and personal expectations – that is where a practical, commercially orientated and legally sound agreement between business partners provides a robust framework for issue resolution.

It’s a sound ‘relief valve’ if, as a business owner, you ever need to use it.

Where to go for more information

Contact and seek advice from your business or legal advisor or visit: http://www.blackwellshort.com.au

http://www.blackwellshort.com.au


Chapter 4: Key Business Partners: Banking Partners and Key Staff Comments by James Price, JPAbusiness

Over the past three chapters we’ve talked about partners in your business and what to consider in terms of risk and opportunity when managing those partner relationships.

Now it’s time to examine a couple of other key partner relationships:

• your banking or finance partner, and

• your key employees.

Partners in the banking world

We’ve discussed how to manage relationships with your banking partners in a previous eBook: Managing Your Banking Relationship.

So how do you see your banking partner? As a true business partner, or a necessary evil?

Your banker often plays a key role in funding your business pursuits, either by providing investment capital, assisting with cash flow through working capital, or in managing trade and payment risks.

If your business relies on a banker or finance company for any or all of these things, then you are taking on a partner risk.

http://www.jpabusiness.com.au/e-books/item/managing-your-banking-relationship---why-it's-not-just-about-money!


Should the plug be pulled on any of these finance lines, particularly in a timeframe which leaves you without other options, it could have a serious impact on your business’s operations.

Be warned: a banker is not just a simple supplier to your business

In order to advance funds to your business, the bank must first assess a range of risks associated with your business. Based on that assessment, they then take a risk in advancing you dollars.

Yes, they take security for that risk, which usually ranks before your equity in the business, but ultimately their success in lending money is inextricably linked to your success as a business.

So treating them as anything other than a business partner is not doing the opportunity justice.

Top tips for partnering with your banker

1. Be transparent, open and truthful with the information you provide on your business’s performance.

2. Manage expectations regarding changes or potential changes in your business, so there are no surprises.

3. Have a plan for where you are taking the business and communicate that plan. Explain why, in a robust financial and commercial sense, this business is a good investment for your banking partner.

4. Provide the bank with evidence you are attuned to identifying and managing key business risks, reporting and governance processes.

5. Make sure you develop a relationship with more than one person within your banking partner’s organisation. Banking is still personal, despite all the processes and systems. Don’t rely on the bank to ensure your business and everything about it is known throughout the bank.


Key employees – partners in your business

I recently ran into a friend who works for a top 10 Australian listed company. I asked what he was doing these days and he replied: “I’m still with the company – I’ve been there 41 years!” He’s worked in numerous roles within the organisation but he told me his current position is Chief of Staff to the managing director.

My response was: “Congratulations to you but, more importantly, how fortunate is your managing director to have someone at his right hand with so much corporate knowledge, in-depth understanding and context of history and operation that 41 years in the one business provides.”

We talk about ‘staff retention’ in business - the example of my friend is one of very positive retention; as a business owner, you couldn’t pay for that sort of corporate knowledge and experience.

He’s a great example of why, as business advisors, we like to encourage business owners and leaders to think of their key staff as ‘partners in their business’.

http://www.jpabusiness.com.au/advisors-to-business


Key staff critical to driving business value

As we’ve often said in our eBooks, value is won and lost by the people dynamic because often it’s your people who provide the point of difference a business offers on a repeated basis.

A key employee who is right for ‘partner status’ is:

• interested in the value of the business and the value both you and they are creating in it;

• interested in the direction of the business – what plans the business has and where it is headed; and

• willing to take on risk – they do more and add more value than their simple remuneration package.

How to reward positive ‘staff partnering’ performance

As a business owner you need to contemplate how, over time, you may wish to incentivise and reward positive ‘staff partnering’ performance.

We’re not talking about monthly or annual bonuses, here. Key staff partners should contribute to and share in the long-term value creation and performance of your business.

For example, if the business performs strongly over a period of three to five years and a key staff person contributes greatly to that performance and has taken some risk in delivering the outcome, it’s worthwhile contemplating rewarding their performance.

Commensurate with the employee’s risk-taking, commitment and contribution, this should be over and above a market-related, fair remuneration package and can be realised via a range of mechanisms, such as:

• Employee shares;

• Ordinary equity shares; and/or

• Other classes of shares with various benefits and restrictions.

http://www.jpabusiness.com.au/e-books


Why offer key employees ‘a share’?

1) It can unlock extra potential and desire in an employee to invest their funds and ingenuity to take your business to the next level;

2) It gives employees more than just a short-term, transactional, one-dimensional view of their employment arrangements. Instead they have a long-term outlook on why they’re working the way they are, which is positive for stability and retention. We all need to feel satisfied we’re working toward something meaningful; and

3) It assists in managing key employees’ succession within the business. It means you already have a pool of heavy hitting, critical employees who are ‘invested in the business’.

Share arrangement structures – get some advice

If you’ve decided you do want to treat your key employees as business partners by offering ‘a share and a risk’ in your business, it’s a good idea to get professional business advice regarding the type of incentive and partner structure.

Similarly, as we’ve discussed earlier in this eBook, upon commencement of those arrangements you should have in place a Shareholders’ Agreement which clearly states the company’s and shareholders’ expectations.

A Shareholders’ Agreement can help protect against the risks and ease concerns that business owners often raise when contemplating these sorts of arrangements. It allows you, as an owner, to outline the rules by which you offer a share and a risk in your business, that are fair to both parties.


How do employee shareholdings affect business value?

Many purchasers, including those in private equity, look positively on companies with employee shareholders because they know those employees are more heavily invested, literally and figuratively, in the business.

If you’re concerned an employee could frustrate a sale process, your Shareholders’ Agreement should be designed to mitigate that risk. For example, many agreements provide for the right of the majority and founding shareholders to progress with a sale and/or other material events.

Most people buying businesses need a pool of good staff to continue on in the business, so the impact on business value is usually positive rather than negative.