For whatever reason, you’re buying a company. You may be experienced in business. You may even have been involved in buying or selling a business before. Either way, it can be tempting to go it alone, or to just rely on your accountant and your financial team. But to do so might not only cost you dear, but could jeopardise both the purchase itself and the future success of the business. Even with small deals, buying a company can be a complex process and there are significant risks in getting it wrong.
A solicitor brings their specialist legal skills and knowledge along with their practical experience, objective advice and an ability to handle the wealth of issues that are going to need careful scrutiny, attention and ultimately resolution. You should ideally involve your solicitor in the process as early as possible to make your purchase as smooth and successful as possible. Even a short initial free no obligation call at the start of the process can prevent a buyer making costly errors and wasting a lot of time.
The purchase of a business normally means either a purchase of the assets or the company’s shares. In this post I’ll be writing about the latter, but your accountant or solicitor can advise you about whether a share acquisition is the right option and if not why an asset purchase is advisable. Your solicitor can work with a corporate transactions tax specialist to make sure the structure of the deal mitigates potential tax liabilities, although this will be more of a concern for the sellers.
When you buy a company’s shares, you acquire an entity, complete with its assets, rights and liabilities, both past and present. The existing individual shareholders will be the sellers. Apart from any possible issues with the company’s contracts (particularly with customers where there are change of control clauses) the change of ownership should not affect trading. However as a buyer you will need security and protection in the form of a well considered legal framework for the deal, including sufficient and relevant well drafted warranties and indemnities to be given by the sellers at completion. At the outset a solicitor can help flag up potential issues and connect you with other relevant professionals where required.
Heads of agreement
The heads of agreement (otherwise also referred to as ‘heads of terms’, ‘letter of intent, or ‘memorandum of understanding’) outline the basic terms of the deal so as to kick start the acquisition process with an agreed pathway. They do not constitute a binding agreement but do require some legal input as you will want to remove any errors and although they are marked subject to contract once the heads of terms are signed it can be very difficult to get a seller to re-negotiate on any principle points.
Although the template found here has proved useful for many people, there is no one size fits all heads of terms and what is relevant will be business specific. However key areas that should be dealt with include:
The purchase price
This will be subject to due diligence and completion of the share purchase agreement, including disclosures that may be made against the warranties. It should be stated that the consideration is subject to any developments which occur during the purchase process that have a material impact on valuation.
The practical framework
It’s important to agree the timing and form of payment (cash at completion, deferred payments, earn out, shares in the purchaser etc), as well as establishing a timetable to work towards completion.
Targets and earn-outs
Early clarification of any future involvement of the seller is essential. It may be that a director is going to remain on for a period of time after completion to offer a level of protection to the buyer. You will need clarity on the expected outcomes during that period, as well as clarity about earn out targets, trigger events and payment terms. These areas are often a stumbling block during the negotiations and need to be carefully managed.
Again, it’s important to identify these early as they have potential to scupper a deal. They may include the purchase being contingent on a bank’s approval and whether the seller has to pay down existing bank borrowing and sell debt free.
The seller’s solicitor will doubtless want to include a confidentiality agreement. It’s important that you understand the full remit of this and that it is reasonable in scope.
You will also want to ensure that the seller does not negotiate with other prospective buyers, at least for a period of time. Otherwise you may go to considerable expense and effort only to find yourself in a bidding war or out bid.
Both the confidentiality and exclusivity terms, will be drafted so as to be legally binding.
The term due diligence refers to the process by which all the business, legal and accounting aspects of the business are investigated. It’s detailed and time consuming but also fundamental to evaluating the true value of the business and all, or any, incumbent risks. Whilst you may be able to mitigate any risk by way of warranties (see below) these are often personal warranties (which can limit their value) and may be expensive to enforce.
Due diligence is normally instigated by questionnaires raised by both your solicitor and your accountant. These questionnaires are a request for information and documents. Much of the final agreement will be negotiated on the basis of the findings and it takes specialist knowledge of a number of technical and legal areas.
Again, there is no one size fits all formula and what is covered will depend on the business. As a general guide, due diligence will include the following areas:
It’s important to understand the employment status of staff and the extent and nature of any contracts of employment. You need to take into account remuneration packages including benefits and pensions, any anticipated wage increases, bonuses and the effect and cost of any redundancies that may be necessary.
You should also investigate any employee claims or human resources issues and ensure you are familiar with any handbooks etc. You will want to review any restrictive covenants and consider any staff incentives to ensure loyalty. Finally, a review of the company pension and its value is essential.
Customers and suppliers
Just as critical as the workforce are the customers and chain of suppliers. You’ll need careful analysis of the business’s customer base to identify any risk, as well as a full understanding of all existing contracts.
Assets and property
You’ll need an inventory of assets which you will acquire as part of the purchase. This includes company owned property, the specific terms of any leasehold property and equipment. Your solicitor will perform property searches and investigate any easements and / or covenants.
You may be advised to obtain a survey of any property. Due diligence will also include establishing the condition of any equipment and the cost of replacing it, if appropriate. All of which could have an impact on negotiating the purchase price.
Intellectual property rights
Copyright, patent, trade secrets and trademarks are often a very valuable part of the business. An essential part of your due diligence will be to ensure the company both owns these and has registered and protected those rights. Your solicitor should investigate whether there are any pending or possible claims in respect of the business’s IP.
Software, IT and operations
You’ll also need a clear picture of the state, efficiency and vulnerability of any IT, software and company operations. Is the equipment scalable (up and down), fit for purpose and are the company processes well documented? Is there a sufficient degree of cyber security and if not, what is the cost involved?
The business as a whole
Finally, you’ll need to get clear about the bigger picture. This includes the state of the industry that the business is in, regulation, compliance and the ongoing cost of compliance. This aspect of due diligence will also include investigation of licenses, Town & Country Planning Act issues, and Health and Safety requirements.
Ensure your solicitor investigates why the company is being sold and the role of the exiting seller within the company. What impact will their departure have on the business?
Management of due diligence
It’s not hard to imagine how the above process could easily run out of control. Your solicitor will manage the due diligence, establishing a timetable and if necessary arranging a “data room”. This is where all due diligence documents are stored electronically to help make the process more efficient. There could obviously also be delicate HR issues to manage at this early stage of the purchase.
The purchase agreement
Usually drawn up in the first place by the buyer’s solicitors, in an ideal world this would be done after the due diligence process. In reality, the two are often done simultaneously.
The purchase agreement is clearly a crucial legal document which may contain a variety of conditions, warranties and indemnities. Your solicitor’s advice, particularly about how to minimise risk and structure payment will be essential. The precise terms of the agreement will of course be specific to your transaction and subject to negotiation.
These relate to the state of the business. You will want reassurance that the information supplied by the seller is accurate. You may also want to try and retain part of the purchase price during the warranty period by way of security. Warranties provided by the seller are likely to cover such areas as accounts, finance and banking, property, employees, commercial contracts, IP, IT and tax.
Typically, the warranties will relate to facts within the seller’s knowledge, not disclosed to the buyer. They will also need to be drafted to include the legal framework of the warranties i.e. when a buyer can issue proceedings in respect of a warranty claim and the procedure to be followed.
As part of agreeing and drafting the warranties, the seller should provide a formal disclosure letter by which they qualify any warranties they give. The terms of this disclosure clearly need careful, legal scrutiny as they will limit a buyer’s ability to take legal action subsequently.
The negotiation of warranties is also a tactical part of the process, aimed at flushing out any issues and your solicitor’s experience is key here. The content of any disclosure by the seller and the strength of the warranties are both factors which may result in further negotiation about price.
These relate to the business liabilities. An indemnity is an undertaking by the seller to meet a business’s specific potential legal liability. An indemnity entitles the person indemnified to a payment if the specified event occurs. There will probably be a separate document or schedule dealing with tax indemnities.
This complex legal area is designed to prevent the seller setting up in competition and potentially undermining your purchase. The restrictive covenants should address three key areas: non-solicitation of customers, non-solicitation of employees and not to compete with the business. Restrictive covenants will need to be industry and location specific to the business.
You’ll need a clear understanding of your plans for growth to ensure the restrictive covenants provide sufficient protection but they need to be carefully drafted to be enforceable.
Exchange and completion
These may be simultaneous or split, but at exchange the parties execute the formal documentation, including the share purchase agreement, while at completion the requisite formalities to complete and implement the transaction are undertaken. Your solicitor can ensure that all issues have been dealt with adequately and there is a smooth transition, often with the completion payment being released from a law firm’s client account once the solicitors on both sides can confirm the parties are able to complete.
Having the right professional team, who are experienced in this area and have the right approach, in place throughout the purchase process not only brings peace of mind, but is one of the central pillars of a successful business acquisition. We have advised clients on all types and sizes of mergers and acquisitions over the years, while we have also built up a great database of other lawyers and law firms we recommend for helping clients with such matters. Please get in touch and we would be delighted to discuss your proposed transaction and provide a quote or recommendation.