In last week's article we discussed the benefit of a prospective seller preparing for a sale a year or two prior to an exit to and the practical steps you can take to resolve matters that could put buyers off.
This week, we will focus on a prospective seller who has put together their team of professional advisors and is starting to formulate their sales strategy.
Your corporate finance advisor, alongside your accountants and tax advisor will assess and advise you on key matters such as the sale price and the best method of sale for your business (e.g. private negotiation, auction or management buy-out). You will also need to identify the best legal structure for the sale. There are two primary ways to sell your business:
- If your business is held by a limited company, you can sell the shares to the buyer (a 'share sale'). The buyer will acquire the whole company along with all of its assets, liabilities and obligations that it owes. The company will continue to operate the business and it is only the owners of the shares that will change.
- You can sell the individual assets which make up the business (an 'asset sale'). Only those assets and liabilities which a buyer agrees to purchase are sold. The rest remain with the seller or the seller's company.
Your decision will be influenced by a range of factors with the ultimate goal of achieving the optimum sale price for your business. A seller and buyer will probably have different objectives and it is unlikely that these can all be met within the same structure. This in turn will impact on pricing and you will therefore require assistance from both your corporate finance advisor and solicitor during any negotiation regarding structure.
Tax can be an important and sometimes determining factor. Generally, a share sale is more likely to be tax advantageous to the seller than a buyer. Conversely, asset sales historically have often been more tax efficient for a buyer. However, this is less so the case nowadays. You will need to seek advice from your tax advisors in any event in order to ascertain your optimum tax position.
From a legal perspective, the main issues that tend to influence the structure chosen are as follows:
Sellers generally prefer share sales as they can shift all of the liabilities of the business onto the buyer. Your liability post-sale will usually be limited to the extent of any warranties and indemnities (discussed later in this series) given to the buyer, the full ambit of which can be negotiated. However, the scope of the warranties and indemnities included in the sale agreement are often wider in a share sale and therefore there can be increased risk of claims by the buyer against you.
Share sales are usually less attractive to a buyer. They will be concerned about inheriting certain liabilities in the company; such as claims from clients or employees or other unquantified or unknown liabilities. The business is acquired 'warts and all'. Buyers may therefore, prefer an asset sale and 'cherry picking' assets and only assuming the known and quantified liabilities.
The actual legal mechanics of transferring title in a share sale are simpler. This is an advantage to a buyer looking to minimise disruption to the business when taking over. From an outsider’s point of view very little will have appeared to have changed.
Likewise, if your business has employees, the transfer of the employees on a share sale is simpler as there is no change of employer.
If your business relies on key contracts with third parties (e.g. suppliers, industry regulators or customers) then these do not need to be transferred in a share sale. In an asset sale, the buyer will need to take over the contracts so will need agreement from the third party concerned.
Approval of third parties may still be required in a share sale depending on the terms of the contract. We discussed last week the importance of checking that no material contracts can be terminated on a change of control. Consideration will need to be given as to which third parties may need to be approached for approval and whether the transaction is likely to be challenged.
As a consequence of the potential liabilities the buyer will acquire in a share sale, the due diligence process undertaken is usually more rigorous. We will discuss the due diligence process in more detail later in this series; however, the salient point for you to consider is that a more detailed due diligence process is likely to increase both parties' costs and the length of time of the transaction.
In a share sale the buyer will be acquiring the risk on the company's tax liabilities. Therefore, the seller could be subject to extensive and complex tax warranties and indemnities in the sale agreement. In an asset sale there is no need for these for the simple reason that most contingent tax liabilities will remain with the seller.
Once a buyer has been identified and a structure agreed, a seller will start negotiating the key terms of the sale. These are often set out in a 'heads of terms' document or 'letter of intent'. In next week's article we will consider the importance of this document and some of the key legal matters that will be negotiated. We will also look at the sale process as a whole and the key stages involved in a sale.