Welcome to Thomson Snell & Passmore’s legal guide to acquiring a business. The decision to buy a business is a major one for a company or individual and for many people, it will often be unfamiliar territory.
Although the process of buying a business is very similar to the sale of a business, there are a number of very different considerations when deciding to buy another business.
We have prepared this guide from the buyer’s perspective to provide an overview of the main stages involved in the acquisition of a business. We hope that it will help you understand the buyer’s role and alleviate some of the concerns and uncertainty that you might face when making the decision to acquire a business.
The key is to seek professional advice at the earliest possible stage. This will enable you and your advisers to plan the purchase process and identify any issues well in advance. This proactive approach should hopefully be rewarded in terms of both a smooth transaction and potentially a better deal for you.
We hope you like the Guide and find it useful. If you would like further information please contact a member of the Corporate Team.
Step 1: Initial considerations
There are many reasons why a company or individual may consider buying another business including:
- Expanding your existing company’s reach or customer base
- Eliminating a competitor
- Rescuing a failing company
- To enter into a new market.
Most buyers when acquiring a business hope to accelerate future growth in the hope of a return on their investment in the future.
When it comes to buying an existing business, there are a number of other benefits that may arise including:
- Immediate access to the existing clients and customers of the target business
- Existing employees (access to key employees who may be the linchpin of the business)
- Immediate income
- Depending on the nature of the target business, an established brand along with the goodwill, assets, contracts etc. of the target business.
What should a potential buyer do next?
It is important to appoint experienced professional advisers to help you with the acquisition process as early as possible.
Your professional team may consist of some or all of the following people:
- Corporate finance adviser/business advisers
- Legal advisers (in-house and external)
- Accountants/tax advisers
- Specialist due diligence advisers.
It is also useful at this early stage to review the financial resources available for your purchase (whether this is your own financial position or that of your company).
Do you or your company have the surplus cash to fund an acquisition? Although it is likely at this stage that you will not know the exact purchase price, it can save you the cost of trying to locate a target business if you establish at this stage that your company is not in a strong enough financial position to fund any acquisition.
It may also be useful to consider at this stage whether you can raise funds for the purchase through bank funding, or teaming up with other investors. In particular, if your purchase is going to be funded by bank funding it is useful to get this arranged and started as early as possible.
How can Thomson Snell & Passmore help?
We have many corporate finance contacts and can point you in their direction and give you recommendations; we also have knowledge of the market and legal issues in different sectors.
Step 2: Finding a target
When trying to find potential businesses to acquire, it is important to consider your reasons for the purchase. In particular, if your company wishes to diversify you may want to try and find a business which operates in a different market or perhaps you want to increase your market position and purchase a business which exists in the same market as you. Establishing your motivations will help you to narrow down potential target businesses.
Your corporate finance adviser may help you to locate potential target businesses and can assist you in the valuation process.
If you find a company which is already on the market for sale, it is likely that the sellers or their advisers will have prepared an information memorandum about the target company or business.
The information memorandum will usually contain details on the target company’s major assets, its business, its financial information (both historical and future projections) and potentially anonymised details about employees, major customers and contracts.
It may be useful to review any potential information memorandums with your professional team to utilise their expertise. Your professional team may be able to highlight any potential issues and help you avoid any further costs if the issue is a deal breaker.
Once you have found a target business that you would like to acquire, you will need to consider your acquisition strategy. This will include a decision on whether you want to structure the purchase as a share or asset purchase.
A share purchase involves you acquiring the shares of the company which owns the target business or assets. Whereas, a business/asset purchase is where you purchase each of the individual assets that make up the target business.
If shares in the company are purchased, all of the company’s assets, liabilities and obligations are acquired too. This highlights the importance of careful due diligence to ensure that you are fully aware of any historic liabilities and obligations of the target business as you will take these over upon completion. Whereas in an asset purchase, only the identified assets and liabilities that you agree to purchase will be acquired. This effectively allows you, as the Buyer, to “cherry pick” which items of the target business you wish to acquire.
The major disadvantage of an asset purchase is that the consent of the suppliers and customers of the target company are likely to be required. With a share purchase, the consent of the suppliers and customers is not usually required unless there is an express change of control provision in long-term contracts.
However, the decision to proceed with a share or asset purchase may be dictated by the seller. For example, a seller of a company may only be willing to sell to you a particular part of the overall business which would dictate that an asset purchase is the way to proceed.
Step 3: Negotiations
When starting the negotiation process with a potential target business, it will be important to decide on a valuation mechanism. There are many different valuation mechanisms and your corporate finance adviser will be able to discuss the various options with you and help you decide on a mechanism.
As explained in step 1, it is very important that by this stage you have considered your financial position and if necessary spoken to your bank or other investors about their funding towards the purchase price. If a bank will be lending funds for your acquisition, it is likely to take a debenture (a legal charge) over either your company or the target company’s assets to ensure that its money is secured.
The next step (once you have formulated your valuation and considered your financial position) is to make an offer for the target business. Again, your corporate finance adviser will be able to help you with structuring such an offer.
Head of terms
Once your offer has been accepted a comprehensive set of heads of terms will need to be created and signed by both parties. The heads of terms document usually sets out the key terms of the transaction including:
- The calculation of the purchase price – will the final purchase price be dependent on the level of assets and liabilities of the target company on completion?
- The payment of the purchase price– will the whole amount be paid on completion or will some be deferred until a later date?
- If deferred, will the amount be dependent on the target’s performance (an earn-out)?
- The structure of the acquisition – is it a share or asset purchase?
- The estimated completion date
- Any other important matters agreed between the parties.
A lot of time is often spent negotiating the heads of terms to ensure that the deal makes commercial and financial sense. It is also very important that fundamental commercial points are agreed at this stage to avoid future arguments down the line.
For the buyer, it is essential that the heads of terms contain exclusivity provisions. Exclusivity provisions prohibit the seller from negotiating with any third parties in relation to the sale of the business for a set period of time (e.g. 6 months) whilst you try to complete the purchase. This is important protection for the Buyer as it will want the comfort that the seller is not negotiating with any other party before incurring time and money carrying out the due diligence process.
Step 4: Due diligence
It is vital that a buyer investigates the target business to ensure that it is fully aware of what it is purchasing. This is even more important with a share purchase as the buyer will be inheriting all of the assets and liabilities of the target company so it is important that the buyer knows as much as possible.
The process by which the buyer carries out its investigations on the target company is the due diligence process. There are typically three types of due diligence; legal, financial and commercial:
- Financial due diligence - this consists of investigations into all of the financial elements of the target; accounts, loans, financing and tax
- Legal due diligence - this consists of investigations into the target company’s legal contracts, property, corporate structure, share capital and various other matters
- Commercial due diligence – this focuses specifically on the trade agreements and contracts of the target.
There are specialist firms who can help advise you on financial and commercial due diligence and Thomson Snell & Passmore are experienced in assisting our clients in the legal due diligence process.
Legal due diligence
This process starts with a detailed legal due diligence questionnaire which is exchanged between the solicitors for the buyer and seller. The legal due diligence questionnaire asks a number of detailed questions on a wide range of topics including:
- Corporate structure and records
- Share capital
- Finances, accounts and security granted to third parties (such as banks)
- Intellectual property
- Contracts and trading
- Litigation and disputes
The seller will complete the questionnaire and provide the responses and accompanying copies of relevant documents to the buyer. The supporting documents are usually uploaded onto a virtual data room set up by the sellers. The buyer and its solicitor will then be able to review all of these documents. These responses and supporting documents should hopefully highlight some of the key components of the target business and any issues.
Once the buyer’s solicitors have reviewed all of the documents and information provided by the seller, they will usually prepare a legal due diligence report for the buyer. This report will set out the key issues and points for the Buyer to consider before proceeding with the purchase. If there are any specific issues that have been highlighted, the buyer’s solicitor may advise that specific protection is sought in the acquisition agreement to cover this risk.
We have set out below two examples of common due diligence issues:
- A key contract containing a change of control clause. A change of control clause in a contract gives either party the right to terminate the contract if the ownership of either party changes. This could be detrimental to the buyer if a key contract is terminated as a result of the change of control of the target company resulting from the purchase. It may be very difficult to predict whether a third party is likely to terminate the contract after the purchase given that the purchase is likely to be kept confidential until completion.
- As a buyer, you will be particularly interested in issues that may affect the value of the target company, for example, large potential pension or environmental liabilities.
If an issue is spotted during the due diligence process, the buyer usually has three options:
- The buyer can seek to insert an indemnity in the acquisition agreement. This will require the seller to reimburse the buyer on a pound for pound basis for any loss it suffers in relation to the specific risk identified
- The buyer may seek to use the issue as a bargaining tool in trying to seek a reduction in the purchase price for the target business
- The buyer can withdraw from the transaction altogether. This is the most drastic option but depending on the nature of the issue and the seller’s response to any issues, it may be the only option.
Step 5: Legal documentation
As the due diligence process progresses, the parties will begin the negotiation of the legal documentation to implement the purchase. The range of legal documentation required varies for each deal.
The first draft of this document is traditionally prepared by the buyer’s lawyer and can range in length from 40 to 100 pages.
Typical provisions include:
- What is to be sold (the shares of the target company or specific assets such as the business itself)
- Details and terms of the purchase price
- Conditions to be fulfilled (if any)
- Completion requirements
- Warranties and indemnities
- Seller limitations on claims
- Restrictive covenants
- Pension arrangements (if applicable)
- The terms of any ongoing relationships between the parties.
One key consideration for the buyer is tax. As a buyer you will require protection against potential tax liabilities. Such protection is usually provided in the form of a tax covenant and tax warranties in the acquisition agreement. The tax covenant is relevant only when shares are being acquired and will not be applicable where the buyer is purchasing the business or assets as the buyer will not be taking on the tax liabilities of the selling entity. The tax covenant also helps to ensure that the buyer acquires any relevant tax reliefs of the target company.
The seller will prepare a Disclosure Letter that contains both general and specific disclosures against the warranties contained in the acquisition agreement.
A warranty is a statement of fact about the affairs or “state of health” of the target company. By giving a warranty, the sellers are confirming to the buyer that the statement is true and accurate. Within the acquisition, the seller will be providing a number of warranties on a number of different aspects including corporate structure, share capital, litigation and disputes and property. If a warranty turns out to be untrue, the buyer, will have a claim for breach of contract for any matters not disclosed to it in the Disclosure Letter.
It is important that the warranties in the acquisition agreement and the Disclosure Letter are carefully considered from the buyer’s perspective as a warranty claim is the buyer’s main contractual protection.
Most ancillary documents are required to perfect the transfer of assets; for example the transfer of legal title to shares to a buyer, property transfers and/or lease assignments, assignments and/or novations of contracts, assignments of intellectual property etc.
Other ancillary related documents include board minutes, shareholder resolutions authorising the transaction (if necessary), releases from charges, resignation letters, consultancy agreements, powers of attorney, indemnities for missing share certificates etc.
Step 6: Completion
Once the parties have reached agreement on the final versions of the legal documentation the deal will then move into the final stage of the process; completion.
Usually, the signing of the acquisition agreement and completion of the transaction will take place simultaneously. However, in certain circumstances, it may be necessary for there to be a gap between exchange of contracts and completion. An example of this will be where there are conditions which need to be satisfied before completion can take place, including the granting of planning permission or where the consent of the Competition & Market Authority is required.
If the buyer and seller are both corporate entities, their respective boards of directors will hold board meetings to approve the terms of the acquisition and the execution of the transaction documents before the acquisition agreement is signed.
A board meeting will also be held by the target company (and any subsidiaries) at completion to approve, amongst other things, the transfer of the shares or assets to the buyer.
The terms of the acquisition agreement will require the seller to deliver a number of documents to the buyer on completion. On completion, the buyer will pay the completion payment for, and will become entitled to, the shares or assets in the target company.
Step 7: Post completion
Following completion, the buyer will need to undertake various post completion tasks.
The buyer will be required to pay stamp duty on the purchase price for the shares or assets. If the transaction is by way of a share purchase, stamp duty may be payable on the purchase price (so long as it is over a particular threshold). If the transaction proceeds by an asset purchase, stamp duty land tax may be payable in relation to any property elements of the acquisition.
Companies House filings
The buyer will also need to ensure that the Companies House records for the target company are updated post completion. Some of the various filings include:
- Appointment of new directors of the company
- Appointment of a new secretary of the company
- Updating the PSC register of the company
- (if applicable) change of registered office
- (if applicable) change of accounting reference date.
Other post completion matters:
- Updating the target company’s statutory registers
- Making any necessary staff and customer announcements
- Dealing with various administrative matters
- If applicable, dealing with any completion accounts.
When buying a business there are a number of considerations and clients will benefit from our vast experience and contacts, including with corporate finance contacts to guide a buyer through the acquisition process and explain the key concepts and risk areas, at each stage. We advise on finding a target, negotiations, due diligence, legal documentation, completion and post completion.
This guide to buying a business is written as a general guide and is not a substitute for professional advice. You are recommended to obtain specific professional advice before you take any action. Please contact a member of the Thomson Snell & Passmore Corporate Team if you would like further information.
This guide to purchasing a business is written as a general guide and is not a substitute for professional advice. You are recommended to obtain specific professional advice before you take any action. Please contact a member of Thomson Snell & Passmore Corporate Team if you would like further information.