Mergers and Acquisitions: issues for buyers

16/01/2010

By Nicholas Gabay, Partner in Corporate & Commercial. Featured in Kent on Saturday.

Buying a business involves many risks. If a buyer is not careful, he may end up paying more than just the agreed purchase price. However, with careful planning and proper advice, these risks can be reduced.

The most important factor is to know what you are buying. This may seem an obvious point, but if you are buying shares in a company, you are buying all assets and liabilities of that company, whether known or unknown, actual or contingent.

Due diligence is vital, therefore. This will involve scrutinising the target's financial and tax records, cash-flows and budgets, business and employment contracts, properties and other assets.

The price will probably be agreed with the seller before due diligence takes place, but a buyer must not be afraid to renegotiate if due diligence throws up issues or liabilities which were not expected. 

The price payable for the business can be structured in many ways. It is rare nowadays for a buyer and seller to agree a fixed price, all of which is payable on the date of the acquisition. The price can be payable in instalments and occasionally the value of the instalments are calculated by reference to the profits or turnover of the business during the intervening period (known as an earn-out). It is also quite common for the price to be adjusted by reference to accounts of the business which are prepared as at the date of the acquisition, so the buyer is paying for the assets and liabilities on the balance sheet at that date.

If the target business is a company, the buyer may choose to buy the shares or the assets from the company. Buying shares is generally more risky for a buyer. It means buying the company "lock, stock and barrel" and inheriting any skeletons in the company's cupboard.  It is actually a much simpler structure and likely to be favoured by sellers. Buying assets may be more tax-efficient for the buyer and it allows the buyer to cherry-pick the specific assets it wants, but it will involve the complexities of transferring individual assets and having to renew or assign contracts with customers and suppliers.

The principle method for a buyer to protect itself against unknown liabilities post-acquisition is to obtain warranties from the seller. Warranties are statements of fact relating to the business which are relied on by the buyer as being true. If a warranty subsequently turns out to be untrue, the buyer will be able to claim damages for breach of warranty. The warranties often take up a significant proportion of the purchase contract and a lot of time is often spent negotiating their terms and application.

The warranties serve two useful purposes. Firstly, they force the seller to disclose any information it knows about a warranty which is untrue, so the buyer has a full picture of what it is buying. Secondly, the warranties serve as a price adjustment mechanism by enabling the buyer to claim compensation for any damages, losses or liabilities arising from a warranty being untrue, effectively reducing the price paid for the business.

Employees are often key to a business, but sometimes a buyer will not want or need all of the seller's employees. However, a buyer will inherit responsibility for all of the seller's employees, so careful consideration is necessary before any redundancy decisions are made, either by the buyer or the seller. 

The acquisition of a business should be a stepping stone for greater success and profits for a buyer. Buyers must ensure that the terms of the acquisition fully protect them against it being an expensive mistake.