Step by Step Guide to Buying and Selling a Company - Terminology Used and the Transaction Process
We have set out below some of the main issues involved when buying or selling a company. Before you buy and more importantly when you sell a business the most important thing is to remember that no matter what assurances you are given, the deal is not complete until all parties sign the legal documentation and the business has been transferred. It is not unusual for a deal to collapse at the late stages of negotiation and therefore it is crucial that as a seller you do not run the business down by assuming that the business will be sold.
If the transaction is a straightforward sale or purchase of shares, there will usually only be three entities as follows:
(a) Target (the company whose shares are being purchased);
(b) Sellers (the holders of the shares in the target);
(c) Purchaser (typically a company, purchasing the shares being sold in the target).
(a) Heads of terms – this document can be useful in order to outline the deal that both parties have agreed. It should not be a detailed document because the detail will usually be dealt with as the negotiation proceeds. Ideally the heads of terms should not be legally binding.
(b) Confidentiality agreement – this is something that a seller will want the purchaser to enter into. This document provides that the information disclosed to the purchaser about the target during the due diligence process remains confidential.
(c) Exclusivity/lock out agreement – these are agreements which are used to try to ensure that the seller solely negotiates with the purchaser for a period of time. This aims to give the purchaser some protection from another party outbidding him and the purchaser wasting costs in preparing documentation and due diligence.
Before the purchaser commits himself to the purchase he will want to undertake an exercise to uncover all of the potential risks and drawbacks of the deal. This is called a due diligence exercise and is carried out in respect of the legal, business, tax and financial affairs of the target. The due diligence process can usually result in further negotiations in relation to the price.
Structuring the deal
The structure of the deal will largely be driven by tax considerations. Tax advice should be sought from an accountant and this should be taken from the outset of the deal.
(a) Share purchase agreement ("SPA") and tax deed.
The purchaser's solicitors usually produce the first draft of the SPA and the tax deed and the seller’s solicitors then produce a ‘mark up’ setting out their proposed amendments.
The SPA is likely to contain amongst other things:
- Commercial terms – These set out the key elements of the deal including the terms of payment and what is being sold.
- Completion - A list of the things that must occur at completion.
- Warranties – The warranties are contractual promises made by the seller but which are subject to the vendor protection referred to below. You will probably hear your legal adviser talking about warranties and indemnities quite frequently as these are typically the most heavily negotiated aspects of the SPA. In any sale the principle of "caveat emptor" applies (i.e. "let the buyer beware"). The law provides no statutory or common law protection for the purchaser as to the nature of the assets or liabilities he is acquiring. However in an SPA the purpose of the warranties is to provide the purchaser with contractual protection and a remedy if the statement made within the warranty about the company later proves to be incorrect and the value of the target is reduced.
- Indemnities – These provide the purchaser with a pound for pound remedy for any loss he may suffer as a result of a breach and are not usually subject to vendor protection provisions.
- Restrictive Covenants – These are used by the purchaser to prevent the seller from entering into a competitive business or from soliciting customers or employees from the target.
- Vendor protection – These are used to limit the rights that the purchaser has in respect of the warranties and includes clause such as; the purchaser must make any claim within a limited period of time and the purchaser cannot make claims for trivial amounts. The seller will also insist upon a monetary limit to any liability it may incur under the warranties. How much ‘vendor protection’ is given will depend upon the bargaining powers of the parties.
- Tax Deed – The seller is usually expected to give the purchaser an indemnity against any unforeseen tax liabilities that may arise.
This document allows the seller to limit its liability under the warranties by disclosing to the purchaser all matters which are not as warranted. The seller will not be liable for breach of warranty to the extent that he has disclosed against it in the disclosure letter. Therefore, the seller should make sure that any problems be they past, present, future or only potential, are fully disclosed to the purchaser (i.e. selling a company is not like selling a second hand car, a seller needs to ensure that all of the target’s faults, shortcomings and blemishes are fully disclosed.)
The disclosures within the disclosure letter will usually be backed up with documents and these documents form the disclosure bundle.
Completion is the day when everything comes together and all of the documents are signed. Completion arrangements can be difficult if there are a number of parties to sign the documents. The original signed documents must be in the hands of the lawyers to complete. Often it is easier to hold a completion meeting where all of the parties attend.
After completion all of the original documents are sent to each party which requires it. The filings are made at Companies House, company books are updated and stamp duty is paid by the purchaser.
Posted on 03/12/2014 by Ortolan