Partner Piece – Practical Issues Surrounding The Sale Of A Company
November 28, 2017
When one is considering selling a company it is never too early to start planning for the process. It is vital to have an exit strategy in place if the shareholders wish to maximise the value of their company. An exit strategy is not just a decision to sell the shares at the highest possible price as soon as possible. A potential seller needs to consider when is likely to be the optimum time to sell, do they wish to sell all or part of the equity, are they prepared to take shares in a purchaser company, do they want an all cash deal are they prepared to consider an earn out or deferred consideration and do they want a quick sale.
Perhaps the most important consideration is price expectation and this is something that should be discussed with a competent corporate finance adviser as soon as a decision has been taken to exit.
Careful planning well in advance of a purchaser being identified is very important. This is particularly so in relation to the due diligence exercise which a purchaser will carry out. In this article I concentrate only on legal due diligence, but a purchaser will typically also carry out financial and commercial due diligence. Legal due diligence is a process that the buyer’s lawyers will conduct and it will be deep and detailed. It is a process of eliciting information relating to the company in order to understand and identify any legal risks associated with that company. It is an essential part of the M&A process and enables the potential buyer to understand the company prior to its acquisition. The information that is discovered on due diligence will enable the appropriate legal documents to be drafted and may, if it discloses something significant, call for indemnities from the sellers and/or a reduction in price. It can also identify issues which need to be resolved before any deal can close. Any potential sellers should be discussing with their lawyers and corporate finance advisers any major areas of concern that they are aware of so that preparation can be made in advance of the due diligence process commencing to alleviate these concerns. Normally an electronic data room will be established into which all relevant documents will be placed and which will be made available to potential purchasers after the entering into of a letter of intent or heads of agreement. It is unusual for the due diligence exercise to discover issues which are likely to stop the deal going ahead although I have known this happen on one occasion. The reason why this is unlikely is because any sellers know of such issues if they exist and will take steps to deal with them in advance. Alongside the request for documentation and its examination by the buyer’s lawyers there will be warranties given by all or some of the sellers in the sale and purchase agreement. The buyer will typically ask for all sellers to give warranties but this will be resisted by sellers who are not involved in management of the business and who do not have knowledge of the day to day activities. Certainly, financial shareholders for example a private equity company never agree to give warranties relating to the business. In a significant number of M&A transactions warranty and indemnity insurance is put in place. This will indemnify the insured for loss resulting from a breach of warranty or tax covenant in a sale and purchase agreement and is typically taken out to protect the sellers against claims. Typically a policy will offer coverage that matches the liability under representations and warranties in the same as the sale and purchase agreement. The cost of such insurance is usually around 1% of the transaction value. These warranties will be qualified by disclosures in a “disclosure letter” and the main purpose of these warranties is to produce information alongside the due diligence investigation. If however there is a breach of warranty then the buyer will have a remedy and will be entitled to claim damages. The damages will be assessed as being the difference between the value of the company if the breach had not taken place and its actual value. This is different to an indemnity which would entitle the buyer to recover the total cost of a specific liability. Indemnities are frequently sought when specific issues are identified as part of the due diligence procedure.
In relation to a food business there will be certain specific items of due diligence which will be carried out including are the premises properly registered, are the products properly and correctly labelled, is the food safe to eat and does it contain additives and if so are they approved. If food has been imported are health certificates and/or import licences needed? These are unlikely to be needed if imported from the EU.
I have referred to heads of terms/letter of intent. These are documents which will set out the main principles of the transaction and will only be binding in relation to confidentiality and exclusivity. However, it is agreed between the parties that these main principles, including price, will be adhered to unless something material is discovered during the due diligence process. It is important that this document encapsulates and records the main commercial terms agreed between the parties with clarity.
Other matters that may be relevant are such things as anti-trust issues and specific issues that may arise from cross border transactions. Tax structuring is important as proper advice in this field can add significant value to the transaction. This is both for the selling shareholders and for the acquirer.
If the company is being sold under an auction process then it may be sensible for the seller’s lawyers to prepare the sale and purchase agreement and for any offer to be accompanied by a mark-up of that agreement. In that way the seller is able to assess the value of the offer knowing the legal requirements of the buyer.
By Clive Garston, DAC Beachcroft
