Buying a business
- Helen Curtis
- Updated: Mon, 21st Nov 2016
When buying a business you risk paying too much, as problems emerge long after completion. We reduce those risks, by identifying, quantifying and catering for them in the legal agreements. Otherwise the long established rule of “buyer beware” applies and you have little recourse.
The steps in buying a business
To achieve value for money there will be some steps to work through. Which steps are essential to you will depend upon the particular business you are buying. We work to streamline the process drawing on past experience.
Our buying a business service includes but is not limited to:
We focus mainly on private company transactions. We act for either the buyer of the entire business or the acquirers.
We use our corporate law, share valuation, intellectual property (IP), and tax expertise to put you in the best position. Our team of solicitors who specialise in dealing with buying businesses is small enough to be cost-effective and large enough to meet your deadlines for completion.
We also support minority shareholders buying a stake in a business. Our skill is managing the process of buying a business – often a daunting task without the right support and advice. We apply our knowledge to all transactions with a degree of proportionality ensuring that your legal costs are reasonable.
Our buying a business track record
Some recent transactions include the purchase of a:
- Bicycle manufacturer: a well known brand with a celebrity sportsman’s endorsement agreement. The due diligence on the business’s intellectual property proved crucial, the value being in the target’s use of the celebrity’s name and image.
- Franchised business: to add to an existing portfolio of franchised businesses, the sole purpose to expand the territory of the franchise.
- Media agency business: acquired by a larger group, with all employees placed on incentive schemes to stimulate growth.
- Credit card business: which required new terms and conditions of use to be drafted in light of reforms to the financial services industry. Our due diligence revealed outstanding claims. We negotiated a full indemnity from the seller for all and any damages due on these claims from completion.
Confidentiality and exclusivity
Our confidentiality agreements enable you to manage a variety of concerns, e.g. that the seller:
- Has no obligation to keep anything confidential.
- Could speak to other purchasers about your interests or plans for the business. This might be price sensitive information, market know-how, or trade secrets that you wish to bring to the target business.
- Could waste your time and money. An exclusivity agreement specifies a period during which the seller agrees to only discuss the sale or investment with you, which encourages the seller to commit to a deal. This is also known as a lock-out.
Heads of terms for buying a business
The heads of terms set out the basics of the deal. You’ll reduce your total costs, if you take time and care over the heads of terms agreement. The heads of terms include:
- The parties: to the investment or purchase.
- The agreed price: which should be subject to due diligence and completion of the share purchase agreement – this is where we add value with our share valuation expertise.
If the price can be adjusted for developments taking place during the process of buying a business then the mechanism for adjustment should be dealt with.
- The timeframe: for completion of the acquisition.
- Targets and earn-out terms: which often include requirements that key players remain employed after the acquisition for a defined period, for example a finance director. This helps protect your investment in the target company.
- Details of shares: if you will gain new shareholders, then set out the basic requirements for holding shares e.g. the share valuation if a shareholder leaves the business. Distinguishing between good and bad leavers is always advised.
- Financing requirements: which might set-out for example:
- If completion depends on the purchaser’s bank approval,
- The terms on which other shareholders inject share capital to finance the acquisition,
- If the seller has to pay down existing bank borrowing and sell debt free.
On what promises are you investing or purchasing when buying a business?
Every business has key reasons for success. Most buyers want the current shareholders to promise these key reasons won’t change. The current shareholders will doubtless endeavour to limit these terms. You should ensure you are comfortable with these limitations. Common limitations are:
- Time periods for claims;
- Cap on the value of any claim;
- Disclosures already made: meaning the buyer or investor already knows the risks and buys the business with these risks.
Due diligence when buying a business
There are many types of due diligence which broadly fall into legal and financial due diligence:
Legal due diligence
The due diligence varies according to the business sector and the acquisition price, we work to scale. There is no template. The trick is to avoid irrelevancies. For instance, if the business is, for example:
- Technology or IP developed by the seller: we would check if the seller:
- Has IP rights;
- Whether these IP rights are registered, and if they are not, whether they should be; and
- Could face third party claims.
- Software: we would test for bugs and scalability, and seek user feedback.
- People-based: we would focus on employment documentation;
- Past claims often indicate how the workforce was historically managed and what claims are potentially latent.
- Product based: we would review customer contracts to ensure they can be validly assigned to the purchaser.
- Regulated: we would focus on what consents are required, e.g. FCA regulation for a business involved in the provision of financial services, or health and safety records for businesses in hospitality.
Usually, a business combines many elements e.g. a product based company probably has great design engineers. There will often be intellectual property rights in the product, for example a patent, and intellectual property rights in the designs, such as copyright. Our review encompasses enough core details so you can see the whole picture, and proceed to ask the seller to warrant for any risks discovered through our due diligence.
We can set up and run a data room for you and recommend suppliers of virtual data rooms. Data rooms hold the due diligence documents on an electronic base to streamline the process.
Financial due diligence on buying a business
A buyer of a business will want to review the company’s financials. We have accounting expertise, but most clients prefer to use their accountants and financial advisers. We ensure the findings from the financial due diligence are included in the legal documentation.
Purchase terms for buying a business
Our suggestions and experience adds value, especially in the ways to spread the risk and payment terms. For example:
- Warranties: as to the state of the business.
- Indemnities: in relation to known business liabilities.
- Withholding: retaining part of the purchase price during the warranty period.
- Price reduction: the more the seller discloses, the weaker the buyer’s warranties become.
- Perhaps consider using these weaker warranties to negotiate a price reduction.
- Practicalities: for an outright purchase, e.g. the mechanics of hand overs, access to the banking, websites, client databases, and customer review platforms etc.
- Restrictive covenants: to prevent the seller setting up again in competition. Without such covenants the seller, and those connected with the seller, are not restricted – damaging the investment. The restrictive covenants will need to be tailored to the industry, location of the target business, and plans for growth. For example, if you’re buying a business with plans for expansion in the EU, then the restrictive covenants should cover that territory to prevent the seller from taking a slice of the market, in turn, damaging your investment.
Investment in the business
If you’re investing in the business, rather than acquiring the whole business, check two key documents. These determine how everyone will get along, once you’ve invested.
Key documents: articles of Association and shareholder agreement
If you do not deal with the point and in some cases require changes to the articles as a condition of investing or buying a business you may find that the articles restrict you. Another area for potential restriction on your activities may arise under the shareholders’ agreement. Common matters to check when investing include:
- Rules on dilution of existing shareholders;
- Appointment of directors;
- Management decisions and dealings at directors’ meetings, e.g. the quorum, voting;
- Share transfer rules and rights of first refusal, i.e. rights to purchase a departing shareholder’s share, or on a new share issue;
- Departing shareholders good and bad leaver provisions; and
- Dividend policy.
How to buy a business
Commonly, there are two types of business acquisitions:
- Share purchase; or
- Asset purchase.
Here the buyer acquires an entity complete with its assets, rights and liabilities, both past and present. There may be change of control provisions in the business’s contracts, particularly with customers. Otherwise, the change of ownership should not affect trading.
As a buyer, if you do not secure warranties from the seller you will be exposed. The exposure under UK law stems from the principle of caveat emptor, i.e. buyer beware, which applies when purchasing a company’s shares or assets.. The precise warranties the buyer needs vary from business to business but typically include warranties on the targets:
- Finance & banking;
- Commercial contracts;
- IT; and
The buyer may want some but not all of the business. Under an asset purchase agreement the buyer takes the assets and liabilities it wants and leaves behind parts of the trade not required. As with a share purchase agreement, you should secure warranties on an asset purchase to protect the buyer from inheriting more than it plans to inherit. In some cases warranties are not practical and the acquisition price reflects the buyer’s risk.
The general principal under English law is “caveat emptor” or “buyer beware”. This means a buyer accepts the business’s risks. Warranties are statements about the business, given by the seller to the buyer. These statements comfort the buyer as to what they are purchasing. Warranties typically cover the business’s:-
- Assets, e.g. intellectual property;
Warranties are usually limited to:
- Facts: within the seller’s knowledge, not disclosed to the buyer;
- Caps: on the amount buyers can claim under the warranties; and
- Time: to give notice of warranty claims and/or initiate legal proceedings in relation to those claims.
If the warranties do not turn out to be true, the buyer can claim for breach of warranty, i.e. sue for the damage suffered. Selling shareholders usually have personal liability for a breach of warranty. You could see warranties acting as a form of retrospective price adjustment in a business sale.
Sellers avoid giving warranties. Sellers argue that warranties are redundant if the buyer and their advisors undertake adequate due diligence. If forced, sellers try to limit the warranties’ scope and cap their liability. Sellers usually retain the opportunity to remedy, i.e. fix, any breaches of warranties, providing they can do so within a specified time.
The use of warranties in practice
The seller’s liability under the warranties is invariably limited to the extent that problems were properly disclosed. So sellers use disclosure letters to limit warranties. This letter defines the warranties that are incorrect. Clearly, the disclosure letter is an important document.
Tactically, warranties encourage the seller to disclose known problems. Thus, warranties often flush out potential problems.
Warranties versus Indemnities
Warranties and indemnities are different. An indemnity is:
- An undertaking, by the seller, to meet a business’ specific potential legal liability;
- Entitles the person indemnified to a payment if the specified event occurs;
- Unlike a warranty claim, the buyers is:
- Not required to show a loss;
- Not obliged to mitigate their loss.
Claiming on warranties
Often, to close the deal, sellers give warranties that later appear to be untrue, false, or misleading. For instance: a seller warrants that current debts are recoverable within 60 days. The buyer later discovers that all debts were written off as “bad debts”. No sums are recoverable.
What can be done? Buyers who were well advised can usually do something. However, if the buyer knew about the issue, he cannot claim. Hence sellers disclose as much information as possible to reduce liability under warranties. Most sellers negotiate to limit the period during which a claim for breach of warranty can be made.
Buyers should tailor provisions related to warranty claims to the acquired business. We identify the risks, and tailor warranties appropriately.
Without express warranties in the share or asset purchase agreement, buyers have little recourse. There might be implied rights under common law. However, usually these rights are weak and fails. When things go wrong for a buyer, we hear the following questions:
With hindsight, the time restriction for bringing claims is impractical
On this issue, pre-planning before drafting the purchase documentation is important. All businesses differ. The period for assessment of a claim should be appropriate for your business.
When does a “buyer become aware of the claim”
This issue is a fact finding exercise. Some authorities say the buyer actually becomes of the claim when there is a “proper basis for the claim on an assessment of the merits”. This means when the buyer consults a solicitor, who advises the claim has merit.
Employment law issues
If you want to retain employees and/or avoid claims then you will need to deal with employment law issues arising on the purchase. We will report to you on the position and enable you to make decisions. For example we can:
- Review existing employment contracts: and highlight any onerous terms which may impede you, such as variations to the terms and bonus entitlements;
- Review restrictive covenants: to ensure you can enforce them. We can suggest changes to cater for the new business and often this requires the creation of new roles;
- Draft retention bonuses: to tie employees into their new employer;
- Manage re-organisations or redundancies: which may flow from buying the business and the review of the current employees’ restrictive covenants, as above; and
- Issue shares or options: to incentivise the newly acquired workforce.
Case study – acquiring a portfolio of retail toy shops in London
We recently acted for an investment company on its share acquisition of a business running four retail children’s toy shops in London. The business manufactured its goods for sale. Our client incorporated a special purpose vehicle, separate from its main undertaking, incorporated for the sole purpose of the acquisition. The due diligence was extensive, and as a result of our due diligence:
- Our client reduced the purchase price;
- Our client understood the nature of the business and its risks;
- Our client was able to retain key employees post-acquisition; and
- Our client was able to minimise future risks and liabilities of the business.
We have since been instructed to act as the sole solicitors for the newly constituted business, advising on the core business areas.
The terms of the deal
We prepared the heads of terms after receiving instructions from our client. We drafted a base purchase price, which was subject to variation either way, no more than 10%, to protect our client on any due diligence findings warranting a reduction in the purchase price. This proved to be important.
The heads of terms were confidential and exclusive. Again, this was important given the seller’s competitive market – children’s toys. If word of the transaction got out, then the seller’s reputation could be damaged, having a knock-on effect on our client post-acquisition.
The due diligence and the warranties
Following the initial round of due diligence, it became apparent that the seller overstated the value and strength of the business. The business is product and people based. Some of the key issues which were discovered were:
The business was fraught with intellectual property issues, firstly with many smaller businesses providing similar goods in competition, and secondly with larger businesses claiming that the seller had breached their intellectual property rights through the manufacture of the goods sold.
The business had mixed relations with its suppliers. The majority of the business’s suppliers provided materials on credit. Using our accounting expertise, we reviewed the business’s financial accounts and flagged up the outstanding and continuing liabilities to be acquired on the share transfer.
The business had recently begun trading online, selling products direct via the business’s website. We reviewed the standard terms and conditions to ensure compliance with applicable consumer regulations. The terms and conditions were outdated – another risk.
After additional enquiries, it was apparent that the business was faced with employment tribunal claims for the handling of dismissals. There were three outstanding unfair dismissal claims. Another liability that we had to factor into account and report to our client.
We asked for warranties and indemnities on all of these matters, which were rejected. Therefore, we were in a strong position to ask for the purchase price to be reduced by 10% as drafted under our heads of terms to factor for such risks. Our request was accepted.
Keeping key employees post-acquisition
Post-acquisition, our client wished to retain a number of the business’s key employees, one being the marketing director and the other the financial director. This was to ensure that our client could understand the operations of the business post-acquisition and obtain the appropriate know-how to stimulate future growth.
The key employees were to acquire shares in the business. We prepared two documents for each employee:
To cover the employment of the two directors. Both had outside interests and we sought to restrict these so that the directors gave the business their full attention. The employment could be terminated twelve months post-acquisition: a fixed term. A bonus was to be paid six months post-acquisition, providing the business hit certain targets – an incentive for the directors to comply with our client’s business plan.
This regulated how the directors were to deal with our client post-acquisition. Our client had voting control. However, some protection was given to the directors on matters requiring their votes. If employment ended, then our client could buyback the director’s shares at market value, market value being no more than the price paid for each respective share under the share purchase agreement – protecting our client.
The two documents run parallel to one another. Therefore, the terms had to agree to prevent conflict and confusion.
The success of the business post-acquisition
The directors have stayed on since the acquisition and beyond the twelve month period, believing in our client’s business plan and working towards targets. Post-acquisition, we advised the business on how to settle the outstanding unfair dismissal claims, so that attention could be focused elsewhere – this being the plans for growth and the recoupment of the investment made. As a result of this, we have reviewed and revised the business’s internal employment policies to prevent wasted costs in defending future tribunal claims.
In addition, we have reviewed and revised the business’s terms and conditions for online sales, opening up additional revenue streams.
Without due diligence, our client would have missed out on the opportunity to understand the strength of the business. There was also the chance of missing the opportunity of using any weaknesses to negotiate a reduced purchase price. We asked the seller the key questions to solicit the answers our client needed. The result was that the client was not caught out on liabilities post-acquisition – this is where we added value to the transaction.
When buying a business or investing into a business you need to know what you are getting into. Our experience in having run many corporate acquisitions and transactions will help you make decisions quickly and to secure the best deal on the most favourable terms – this is our expertise.
Our commercial law team and will take you through all of the stages involved in buying a business. We have managed many acquisitions and know all the tricks of the trade. We are good at drafting and negotiation.