What is the procedure for buying and selling private companies?
Mergers and Acquisitions of companies has increasingly become an intrinsic part of the constantly evolving commercial environment in which many companies operate. There are numerous reasons as to why companies and their owners may be looking to buy or sell. From the seller’s perspective, the sale of a company can represent an opportune exit strategy, paving the way to retirement or new endeavours. From a buyer’s perspective, the acquisition of a company can be a means to bring about new talent, new products and innovation, a platform to enable access to new markets, and ultimately can be a very successful strategy to develop and manage growth of a commercial enterprise.
Just as most company owners will want to ensure the company is sold to prudent purchasers who will take the business from strength to strength, purchasers will generally want to ensure they are buying a business that is or is likely to be profitable, and has as few liabilities as possible.
You may already have a willing purchaser who you wish to sell your company to, or you may have spotted a prime company to purchase and invest in. Alternatively, you may be able to find interested parties through your own business circle, or through commercial agents or brokers.
Whether a small family owned company or a global corporation, there are numerous issues that can arise in the sale or acquisition process. To successfully navigate the sale or purchase of a company, it is important to appreciate the mechanisms of the transaction and issues that can arise.
Structure of the Transaction
There are two main ways in which a business can be acquired, and each method has its own characteristics that lend themselves to the overall transaction.
One route is by buying the shares in the company that runs the business. This is known as a share sale. The other route is by buying the assets of the company which make up the business and is known as an asset sale.
Under a share sale the purchaser is buying the shares of the company itself, and by virtue of the shares, the assets and liabilities of that company. The company itself will continue as it is, but the owners of the company will change due to the transfer of shareholding.
This can be quite a seamless and effective way for the outgoing sellers to step away from the company entirely, and the incoming purchasers to take over the reins with minimal disruption to the day to day operations of the company. There will typically be no need for new contractual arrangements to be entered into with the employees, landlords, suppliers and clients as company entity itself remains intact.
In an asset sale, the company sells the assets which comprise the business. For example, the machinery, intellectual property, stock, inventory, investments, vehicles, know-how, real estate, equipment, patents etc.
Instead of the company itself changing hands, certain assets and liabilities will change hands. An asset sale may be a suggested mechanism for the transaction because the seller may wish to retain particular roles of the business or sell them at another time to maximise value. Alternatively, the purchaser may wish to purchase the business by way of an asset sale as they can ‘cherry-pick’ the assets they wish to buy and subsequently take on whilst leaving out certain liabilities or unnecessary assets.
In an asset sale, the incoming purchasers will usually have to enter into new contractual arrangements with clients, suppliers, landlords and other relevant third parties who are relevant to the business operation of the selling company. This can mean that there is a substantial amount of additional work required to ensure a smooth transition to the new owners. For example, an assignment of the lease from the selling company to the purchasers would need to be negotiated and agreed with the landlord. Clients and suppliers of the selling company may need to agree to the transfer of their existing contractual arrangements to the purchasers and may use this as an opportunity to negotiate better terms.
Notably, the contractual arrangements and liabilities in relation to employees of the selling company do automatically transfer to the purchaser in an asset sale. Under the Transfer of Undertakings (Protection of Employment) Regulations (‘TUPE’), where a business transfers from one owner to another the employees will often transfer automatically with the business to the purchasers. After the transfer, the employees will be employed by the purchaser as if the purchaser had always been their employer and any pre-existing liabilities will be transferred to the purchasers.
Another factor that differs between the two methods of the transaction is the respective tax positions. Usually a share sale is quite favourable for shareholders as they will have single tax liability on any capital gains arising from the sale of their shares, and they may be able to reduce their tax liability to 10% if they are entitled to entrepreneurs’ relief. Purchasers may be liable to pay stamp duty reserve tax on the shares that they are purchasing.
In an asset sale, the selling company may be liable to corporation tax on the profit made from selling the assets, and then the shareholders may also be subject to a tax liability when they withdraw the sale proceeds from the company.
Valuing the Business
There are several methods of valuing commercial enterprises, each of which can bring about drastically different valuations to the other. Some valuations amalgamate elements of various other valuations to arrive at a valuation. Generally speaking, most sellers tend to overvalue the business they wish to sell, and most purchasers tend to undervalue the business they wish to purchase. Quite often it falls to an independent expert to value the business and provide a set of valuations that the parties can seek to agree or negotiate.
Put simply, due diligence is the process by which the business’s assets and liabilities are thoroughly appraised and the information gathered during the due diligence process will typically build a picture of the commercial potential of the business.
Companies and businesses are often a sum of their parts, and these respective parts often include key legal documents, business arrangements, human resources, financial issues and liabilities.
The purchasers will raise various enquiries of the seller to enable them to evaluate amongst other things, what exactly they are buying, whether they should proceed with the purchase, and the maximum price they are willing to pay.
The due diligence process will also be used to identify how a transaction may be best structured, identify any third party consents that would be required, identify areas where the purchaser may seek additional protection by way of warranties and indemnities, and identify how the business will change hands to ensure a smooth and efficient handover.
The due diligence process can be quite involved and in-depth and can often last for months. Indeed, one enquiry raised by a purchaser and answered by the purchaser can create several additional enquiries. To this end, preparation is key to prevent any delays. Sellers should be able to provide documents relating to the company or its assets promptly as and when requested. Delays in finding and sourcing documents can be the bane of the transaction and a deal can break down due to frustrations in communication.
Ideally, once a deal is agreed and the purchaser is satisfied with the outcome of the due diligence exercise, they would pay to the seller the agreed price in full and take over the business. However, more often than not (especially in troubled financial times) it is common for the parties to agree to pay the sale price in instalments (earnouts).
Earnouts can come with various conditions and although can be used to bridge any valuation gap between the parties, can often be a way of deferring disagreements about price to a later date. As such it is important for the seller to be acutely aware of any provisions attaching to any earnout agreement or payment terms as a whole. If an earnout arrangement is acceptable to the parties in principle, then consideration should be given to the requirements attaching to them which can be tailored to metrics and conditions to enable them to be more predictable.
For sellers trying to sell their business, it can be overwhelming to ensure that all the components making up the sale from the initial discussions to the due diligence process to the purchase agreement are proceeding smoothly whilst ensuring that they continue to run the business at peak efficiency up until the moment they hand the keys over.
For purchasers, the acquisition process can be a daunting process fraught with paperwork, legal jargon, negotiations and emotion. Not only is it time consuming but it can be mentally and physically taxing.
Having a team of professional advisors in your corner takes the stress off the parties so they can focus on the business itself. Your team should work with you to ensure that the end goal of the sale or purchase of the business remains viable within the timescale and budget, and that your objectives whether as seller or purchase, are achieved in the most effective way possible.
Asim Arshad, Solicitor within our dispute resolution and commercial teams.
Please get in touch if you have any questions that we can help with: 01273 775533