This article covers some of the key issues which need to be considered when selling a company or a business. People often say they are selling but do not know how the transaction is to be structured, e.g. by selling the shares in the company (a share sale) or by the company selling the business and assets of the business (an asset sale). From a due diligence viewpoint the issues are similar, save where indicated below. For ease we just refer to selling a business here.
ASSET SALE V SHARE SALE
The form of sale transaction is generally decided by commercial issues. However, taxation can be a very important commercial issue. Accordingly, tax issues should be given due consideration at an early stage to avoid expenditure being incurred in pursuing what ultimately turns out to be the wrong course of action. Whichever structure is chosen will depend upon the specific circumstances of the seller and the buyer in each transaction.
TRANSACTION MANAGEMENT
The sale of a business is very much a team process. The team will comprise of the seller(s), its lawyers, and accountants. Good transaction management will enable the team to work in a constructive and positive manner. This, in turn, should enable the sale to proceed smoothly.
REVIEW OF THE SELLER’S BUSINESS
The seller has two objectives in a disposal: 1) to maximise the post-tax sale proceeds – by maximising the sale price and minimising the tax burden; and 2) to minimise the on-going exposure of the seller to the buyer by way of the warranties and covenants given to the buyer. The buyer wants to get a fair deal and minimise the amount of liabilities it takes on or at least be aware of them, so this is crucial as it may have a big impact on negotiations.
To achieve this the buyer will conduct a detailed and vigorous examination of the business. To assist the seller in achieving its objectives, the seller’s advisers must know the business as thoroughly as the buyer’s advisers will know it following their due diligence exercise. The seller’s advisers should review all documents before they are handed over to the buyer. The seller should therefore prepare for the buyer’s due diligence by first carrying out its own investigation. This should flush out any potential problem areas and give the seller time to try and resolve them.
The areas that a review should cover depend on the relevant business, but should include some or all of the following:-
- Financial: Statutory and management accounts; financial history; budget forecasts;
asset values and basis of valuation; tax position and liabilities; borrowing arrangements; off-balance sheet items; shareholdings (on a share sale).
- Legal: contract review; property review; corporate review (on a share sale); validation of a number of areas covered by paragraphs a, c, d and e.
- Trading: plant and equipment details; business volumes; major customer details; major supplier details; contracts and trading terms; market information; agency arrangements; intellectual property details, protection status and licensing.
- Personnel: payroll details; general and individual employment/service contracts; trade union organisation and bargaining rights; redundancy arrangements; pension arrangements; other benefit details.
- General: premises details; environmental liabilities; contingent liabilities; research and development programmes and status; operational/commercial issues; areas of risk; strategic issues if the seller’s business is being merged with the buyer’s business.
HEADS OF TERMS
Heads of Terms (aka Memorandum of Understanding) are a non-legally binding document. They are used to establish the business understanding of the deal; providing the parties with realistic expectations of the contents of the full contract.
CONFIDENTIALITY
The buyer’s due diligence will be carried out before entering into a formal binding contract. The due diligence process will almost certainly involve the consideration of information in relation to business which is not generally available in the public domain. Enforceable confidentiality undertakings should be obtained from any prospective buyer before any information is supplied by the seller.
Commonly, the confidentiality letter will not only impose confidentiality obligations on the prospective buyer but also restrict the use by that buyer of that information for the purpose of the evaluation of the business with a view to agreeing a contract for its purchase (i.e. allowing disclosure to key people, for example its bankers, lawyers, accountants and other advisers). However, this should only be permitted on the basis that the recipient is also under the same obligation to maintain the information as confidential.
If there is a breach of a confidentiality undertaking given by a prospective buyer, the seller of a business would invariably wish to obtain an injunction rather than sue for damages. A well drafted confidentiality letter will ensure that such an injunction can be obtained quickly through the Courts. The use of a confidentiality letter will also help avoid “fishing expeditions” by competitors.
DUE DILIGENCE
Due diligence basically means an investigation of a business by a prospective buyer before entering into a contract. There are a number of advantages to a buyer of a due diligence investigation. These are:-
- It picks up undisclosed liabilities: The general principle of English sales law is “caveat emptor” or “buyer beware”. If you buy shares in a company, you buy the company with the liabilities that are in it. This is the main reason behind the due diligence exercise and the subsequent warranties and indemnities that will be based on that due diligence and will appear in the Share Purchase Agreement. This is also relevant on the sale of a business, although to a lesser extent, as the buyer will only inherit the liabilities that are specified in the Sale and Purchase Agreement.
- It helps with price negotiation: Initial prices are often negotiated with the buyer making a number of assumptions. Due diligence can assess whether these assumptions are valid. If not, the quality of the due diligence exercise will reflect the strength of argument in the re-negotiation of the price.
- Assists drafting of Sale and Purchase Agreement: Due diligence by the buyer should be done prior to the drafting of the main Sale and Purchase Agreement, so that the lawyer knows what conditions, warranties and indemnities to draft in the contract. Due diligence helps identify the particular liabilities in respect of which warranties and indemnities are being sought by the buyer and, in essence, allows the lawyer drafting the contract to understand the issues surrounding the relevant business and to draft the contract accordingly.
SUMMARY
From a seller’s view point there are 3 keys rules to follow:-
(i) Be professional at an early stage – look at the best structure to maximise proceeds and reduce liabilities.
(ii) Prepare for due diligence: review all documentation and collate it in an orderly fashion.
(iii) Use Heads of Terms and Confidentiality Letters to protect your business and assist the sale process.
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