Transactions - what to plan for

Due diligence before buying or investing into a company

If you are contemplating a significant transaction, whether buying a company, securing private equity investment or undertaking an MBO, experience shows that time spent planning and preparing for the transaction can pay off.

To help you manage the transaction process, we set out some of the key initial steps you should consider.

Start with a confidentiality agreement

Confidentiality and exclusivity agreements deal with a variety of concerns. Without a confidentiality agreement :-

• There is no obligation to keep anything confidential unless there is a specific agreement. Even with an agreement, enforcing a breach of confidentiality can be difficult and expensive in practice, so it is important to take care over what you disclose.
• There is an increased risk of a wasting your time and money. An agreement can limit this risk by specifying an exclusivity period during which a seller agrees to only discuss the sale or investment with the buyer, encouraging the seller to commit to progressing the deal.

Before you get to heads of terms stage

Most buyers, once they have signed the NDA, want to see an overview of the business. It is therefore helpful to have the following information ready:

• Key employees;
• Key customers;
• The split revenue for the last 3 years at least;
• Funding rounds;
• Latest management accounts;
• Approvals required from landlords, banks, contractual releases, majority shareholders, etc., so that the buyer has a clear understanding of what they may be getting into.

If you are a small private company, the chances are the buyer will be a larger company with teams of HR professionals and financial specialists equipped with resources you may not have. You need to make a good impression, so it pays to prepare in advance. A good broker can help you put together an information pack in readiness. Alternatively, talk to us and we can help you prepare.

Heads of terms

The heads of terms set out the basics of the deal. You’ll reduce your total costs by taking time and care over the heads of terms, as this can reduce the amount of subsequent drafting and help identify potential problems at an early stage. Heads of terms should be prepared at the beginning of the transaction and are a good way of flushing out issues before the parties become more heavily committed to the deal.

The heads of terms typically include:

• The agreed price: which should be subject to due diligence and completion of the share purchase agreement. If the price can be adjusted for developments taking place during the process of buying a business, the mechanism for adjustment should be agreed at this stage.
• 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. Deferred consideration is linked to post acquisition performance. This helps protect the buyer's investment in the target company.
• Shares: if you will gain new shareholders, then set out the basic requirements for holding shares.  Rights can be covered in the articles or a shareholders agreement. Distinguishing between good and bad leavers is always advised.
• Financing requirements: which might set-out, for example, whether completion depends on the purchaser’s bank approval, the terms on which other shareholders inject share capital to finance the acquisition, or whether the seller will be required to pay down existing bank borrowing and sell the business debt free.

Data room

Once the buyer and seller are happy with the outline heads of terms, the data room is created. There are various products available to manage the data, but care is needed as, in prolonged transactions, the costs can mount. The information provided through the data room will feed into the disclosure process, including preparation of the disclosure letter, which is an important stage for sellers.

In simple terms, if information is properly disclosed, the buyer will not be liable for matters covered by that disclosure, subject to the terms of the share purchase agreement. The data room will contain many of the documents the buyer will acquire. Buyers may also use information identified during due diligence or disclosure to seek a price adjustment or renegotiate other terms of the transaction.