Tracy Evans, Corporate Solicitor, discusses six things that you need to consider when you decide to sell your business.
There are two main methods of selling a business; each subject to advantages and disadvantages. This article provides a succinct analysis of key issues in the sale of a business.
In deciding the best route to take, the seller must consider the type of sale which is relevant to the business. The two main ways of selling a business are asset sales and share sales. Both variations have pros and cons and the most effective type will very much depend upon the financial and tax position of the business. It is therefore essential to liaise with your accountant and solicitor on this issue before committing to what could be a tax inefficient process!
SALE OF ASSETS
Asset sales provide the opportunity for the seller to sell off/retain chosen assets only. Buyers will often prefer this method as it will not automatically take on unwanted liabilities. The seller will, after selling the relevant assets, be left with all liabilities that are excluded from the sale to resolve or pay.
SALE OF SHARES
Share sales allow the seller to rid itself of all liabilities within the company, subject to the terms of the share purchase agreement. The buyer acquires all the assets, liabilities and obligations of the business by operation of law.
HEADS OF TERMS
The parties may wish to enter into heads of terms which have the effect of setting out the framework as to how the sale will take place.
Care must be taken so that the actual heads of terms are not constituted as being the actual agreement. It should be stated that they are strictly subject to contract, with the exception of any confidentiality or exclusivity provisions which are to be legally binding. Tax and potentially, competition issues should be considered prior to entering into heads of terms.
As the seller may own significant intellectual property or know how or other valuable assets, the heads of terms may include a confidentiality agreement to be signed by the buyers to ensure that any disclosures made to them in response to their enquiries are kept secret.
The main consideration of the seller is how they are going to be paid. Advice should be sought on this point as early in the transaction as possible and agreement should be sought between the parties.
Consideration can take many forms; from payment on completion, to it being deferred or it may be combined with loan notes or shares. Increasingly deferred consideration is conditional upon the company performing to a certain agreed level at a date in the future. This is known as an ‘earn out’. In such circumstances, provisions should be made to ensure the buyer does not deliberately sink the business in order to pay less at the end of the day. This could be by way of continued employment or extensive covenants.
Unless stated in the agreement, the seller is not obligated to disclose any information. The seller must therefore be prepared for the buyers to ask extensive questions and request reams of paperwork relating to the company or assets in question. This process is known as ‘due diligence’.
The buyers will provide a list to the sellers detailing the information required. Despite not being obligated to do so, it would be prudent for the seller to oblige the buyers. The seller in response will provide extensive answers to these enquiries. Some areas of concern to be covered will be: property, pensions, material contracts, employees, environmental issues, competition, compliance, supply contracts, pending litigation, intellectual property and tax. The seller should pre-empt such enquiries and collate all material information concerning these areas.
The seller should not hide problems. Warranties, covenants and indemnities will be used in the agreement to make the seller responsible and liable for any undisclosed or misrepresented happenings. Early disclosure is therefore imperative.
The buyer’s solicitors will draft the share sale agreement as there are more liabilities that must be warranted against.
The major part of any agreement is the warranties. A warranty is effectively a contractual promise that a certain state of affairs exists. Any breach entitles the buyer to rescission or damages for breach of contract to the value of the diminution in value of the shares attributable to the breach of warranty (i.e. difference between price paid and price buyer would have paid had he known of the breach).
In some instances, the buyers could seek indemnities instead of warranties. Indemnities will be sought for high risk and foreseeable concerns.
To save the seller from being liable he can disclose against the warranties. The disclosure effectively voids the effect of the warranty as the buyer becomes aware of the situation and cannot therefore claim that he was not aware of the situation when entering into the transaction. Advice to sellers is to disclose as much as possible!
The selling process is complex and requires patience. In order to maximise the value of the Company and ensure suitable protections are built into the terms of the deal from the outset it is advisable to prepare early and seek relevant professional advice.