Partner Piece – Faegre Baker Daniels LLP
October 9, 2019
Selling Your Business – Are You Ready For The Legals?
By James Ellis-Rees of Faegre Baker Daniels LLP
A great deal of preparation goes into selling a business so when the stars finally align and you and your buyer are ready to do the deal you will want the legal transaction to go as smoothly as possible. There is a lot you can do ahead of time to avoid bumps in the road and here we look at some of the issues which you can anticipate. Good preparation will help avoid the uncertainty and heartache of an inefficient legal process, and could even make the difference between the sale going through and a painful collapse.
Price Structure
Fixed price or adjusted price? A price adjustment could be attractive if there is the potential for you to realise more than with a fixed price but the adjustment mechanism would need careful thought.
An earn-out is not uncommon and has the attraction of increasing your upside if the business delivers a good performance. One concern with earn-outs is whether the buyer might constrain the business’s ability to deliver during the earn-out period. There can be a lot of negotiation around the details of these mechanisms but this needn’t be a problem if the principles are agreed at an early stage.
Are you going to receive cash, loan notes or shares? This will naturally be a significant issue for you and driven to a large extent by your tax position. Loan notes or shares will involve extra transaction documentation, although it needn’t be problematic if the consideration structure is agreed upfront rather than being left until the deal gets underway.
Payment Terms
Full payment on completion would be ideal but you should think about whether you can live with deferred payments or an escrow arrangement as these are often required by buyers to give them security in the event of a warranty claim emerging. If you are not prepared to go along with some form of retention this may come at the cost of a lower overall price.
Retention terms can be complex and time-consuming to agree, and if an escrow is used an allowance will need to be made for bringing an escrow agent on board and negotiating the escrow terms. If an escrow is agreed at the outset the details can be comfortably managed as part of the process, but if it is only brought up part of the way through the transaction there are likely to be hold-ups.
Warranty and Indemnity Liability
You will need to consider your attitude to potential liability under the warranties and indemnities that you will invariably have to give. They will leave you exposed to risk for a period after the deal is done and you will want to minimise that risk by ensuring there are as few potential issues as possible in the business and also by negotiating reasonable liability caps and claims periods with the buyer.
However successful you are in doing this, some level of risk will remain and buyers sometimes take an aggressive approach to pursuing warranty and indemnity claims.
You could be sanguine about this possibility but it might also be worth building warranty and indemnity insurance into the deal. This insurance is usually written to cover the buyer but is often agreed to by both parties as it can benefit both sides. For you the advantages are that it can give you a clean exit by eliminating the need for an escrow and also enhancing the valuation by strengthening the warranty package for the buyer. The decision to take this insurance should be made early on to allow time for the underwriters to give an initial indication of cover and then review the documentation during negotiations before providing their final terms.
Consents and Approvals
You should consider early on whether you will need consents or approvals for the sale from any third parties as these can take some time to obtain. If you need approvals from regulators or the competition authorities you will know these are significant exercises and will no doubt have already built them into your planning.
More commonly, you should think about your major customers or suppliers. There may be assignment or change of control provisions in your contracts with them but, even if there aren’t, you may well need to talk to them to keep them on board.
If you are selling the business rather than the company you will need consents from your landlords to assign your leases and this often takes many weeks. Consents from lenders and leasing companies can also take some time to obtain.
Realistic timescales for all this should be built into the transaction timeline to avoid you coming under pressure as you near completion.
Due Diligence
Be prepared for the due diligence process to take up significant management attention, particularly at the start when the bulk of the information needs to be assembled and replies given to the buyer’s initial round of information requests. You should however use as small a team as you can to preserve confidentiality and minimise disruption to the business.
It is well worth investing the effort of making a thorough job of the due diligence at the outset as it can smooth the progress of the deal by building the buyer’s confidence.
You should decide where to draw the line about providing some types of information. For example, granular information about margins earned by individual divisions or product lines or from individual customers may well be too commercially sensitive to disclose until later in the transaction process. Personal data about employees should also not be disclosed, although a lot of staffing information can be provided without identifying individuals. If the buyer is a competitor you should be particularly careful in case the transaction does not go through.
If there is a particularly significant matter to disclose, for example a sizeable dispute or an investigation, you should consider discussing it with the buyer rather than just leaving it for them to spot in amongst the rest of the due diligence information.
Employees
You should give some thought early on about how and when to inform your employees about the sale. Too soon or too late will both risk disruption, as will giving too much or too little information.
If you are selling the business rather than the company, you will have obligations under the transfer regulations (TUPE) to inform or consult with the employees within a particular timeframe about the transfer of their employment to the new owners.
For a share sale the TUPE rules do not apply, but timing announcements about the deal will nonetheless be a sensitive matter. If left too late, the rumour mill can be disruptive and could force your hand for you.
Sale Agreement
The sale agreement, whether for a share or asset sale, will usually be a substantial document often requiring a great deal of negotiation. Depending on the price structure, consideration and payment terms, there can be complex mechanics which need careful attention. Your obligations under the warranties and indemnities will often be a focus for extensive negotiation. Post-completion non-compete restrictions are usually expected and may also be a significant area of negotiation if you are continuing in business after the sale.
Finally
The legal transaction for a business sale will often proceed fairly smoothly with seller and buyer and their legal teams sharing a willingness to get the deal done. The chances of your sale working out like this will be all the greater if you have given some thought beforehand to the issues we have outlined. Even so, sometimes even the worst-prepared deals still manage to struggle across the winning line, although in our experience it is well worth avoiding the heartache!
This document is for information purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.
James Ellis-Rees (Associate) Faegre Baker Daniels LLP 7 Pilgrim Street London, EC4V 6LB Email: james.ellisrees@FaegreBD.com Tel: +44(0)2074504528
