The art of getting out of an unworkable business

What do you do when you’ve partnered up with someone in business but the relationship breaks down? How do you get out of the venture without losing your investment, reputation or clients? A well known art gallery faced this problem and instructed Gannons to find a way out.

What happened?

The gallery owner set up a new company to act as an on-line business separate from the gallery business. A team was hired and co-directors appointed. As part of the agreement our client along with his new co-director also invested into the business in return for 65% of the business. A number of other investors invested under EIS.

The idea was the gallery would supply the on-line business at cost plus a small mark up. The profits of the on-line business would be shared. There were restrictions on the gallery business setting up a competing on-line business.

What went wrong?

A couple of years into the on-line business the boost in marketing and online sales that was promised had failed to materialise. The business was making a loss and continuing to decline. Our gallery owner wanted to get out of the on-line business and set up his own on-line business to support his gallery.

With two directors in disagreement all board decisions would be in deadlock and so they would have to revert to shareholders. There was an investment agreement which set out various matters which required 75% of shareholders to consent. However with only 65% our gallery owner therefore only had the right to veto key decisions but not to force them through. What could be done? This is where Gannons stepped in.

Offer to buy out other business owners

We worked with an accountant to put together a commercial offer to purchase the assets of the business, being its current stock, trademarks, goodwill and crucially, its domain name and website. After many discussions, negotiations stalled. It became clear that the co-director was not willing to sell to the gallery owner, despite the reasonable terms on offer, so we worked to find an alternative.

Offer to sell

The co-director had at the same time been in negotiations with a third party purchaser to buy the on-line business. This third party turned out to be a competitor to the gallery business. We worked with the gallery owner and industry advisers to carry out some due diligence – on them and their offer. Reviewing the available financial records it was not clear where the funds for this offer were coming from.

Having analysed the gallery’s existing finances (and increasing debts and cash flow problems) the offer seemed to be too high. The gallery owner, as a director, had fiduciary duties to act in the best interests of the on-line company – with this in mind, we suggested allowing the buyer to proceed with due diligence once adequate confidentiality protection was in place – but we advised the gallery owner to proceed with caution.

During the due diligence process the true state of the company’s accounts became clear and the buyer start chipping away at the purchase price to take account of these losses. As a gesture of goodwill, the gallery owner agreed to re-offer his initial purchase terms – but these were not agreed by the co-director and again the negotiations stalled.

Retaining goodwill, customers and trading name

Crucial to the gallery owner was retaining the goodwill, customers and trading name that he had built over the years. With this in mind, we suggested a compromise: agree to a sale of the shares at a reduced price and separately, agree with the buyer a transition period during which he could rebuild his business – this time without the other investors.

The gallery owner withdrew his offer to purchase the business and the competitor revised its offer to a lower figure, based on its due diligence of the business. As it was still a commercial price we advised the gallery owner to accept. The co-director also agreed to accept, presumably on the basis that it was not being sold to the gallery owner. With the two directors on board there were sufficient votes to approve the sale and to drag the minority investors on the same terms. This removed the deadlock and got the gallery owner out of business with the other investors.

At the same time we were separately negotiating a transition agreement with the buyer, to allow the gallery owner to continue to use the trading name, resources and website for 12 months after the sale. This gave the gallery owner continued use of the goodwill and contacts he had built up over the previous decades, providing a strong platform to launch his new business, which we agreed would be allowed to compete after the 12 month transition period.

By negotiating this transition we were able to help the gallery owner not only get out of business with disagreeable investors but also to retain his contacts and set up for a new venture.

Alastair Manning

Before joining Gannons, Alastair worked for international law firms in the city advising on a wide range of Corporate, Commercial and Banking matters.

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