Partner Piece – Preparing to sell your company: 10 common legal pitfalls

March 10, 2017

Preparing to sell your company – 10 common legal pitfalls

 

         As any Bluebox client will know, pre-sale planning is key to a successful deal. In this piece Penningtons Manches look at 10 common legal pitfalls that in our experience as legal advisers on private company sale transactions can cause real problems for a buyer and the deal, but which can usually be resolved relatively simply by you as seller taking action before the sale transaction starts.

 

  1. Company registers – who are your shareholders?

Every company is required by law to keep and maintain share registers, showing a complete and up to date record of all transactions involving ownership of the company’s shares. Any buyer will want to know who owns all of the shares in the company, and that the “chain of title” to those shares (the record of share issues and transfers) is full and accurate. Legal title to shares is evidenced by a formal entry in the share registers (not by share certificates), and the buyer will want to see and check those registers to ensure it is buying the shares from the legal owners, and that no-one else has any possible rights over shares. Registers are not to be confused with a “cap table” which is usually a spreadsheet file of share and/or option holders kept in whatever form the company finds most useful.

 

In the early days of a company’s life maintaining the registers is often not a priority and as the business grows it can be overlooked, and accordingly incomplete or even a complete absence of registers are not uncommon. However, this can usually be fixed relatively easily by reviewing and completing the registers with supporting paperwork wherever possible before the buyer asks to see them.

 

Review and update your registers…

  1. Share buy-backs – were they done correctly?

The Companies Act allows for the return of cash to shareholders of private companies in some circumstances by a “share buyback”. This is a relatively simple and convenient process and consequently is quite commonly used. However, it is crucial that the formalities set out in the Act are followed absolutely. If they are not, the buyback transaction can be void, with the result that legal title to shares are in fact still held by the person who is meant to have sold their shares back to the company (often a departing shareholder). If this comes to light only when the buyer reviews the share capital it can cause real problems with needing to track down former shareholders and ask for signatures…

 

Check any share buyback paperwork…

  1. Ownership of intellectual property – do you have the rights you think you have?

If any intellectual property rights are material to the value or operation of your business, the buyer will want to ensure that your company has all the ownership or other legal rights necessary for the business. Companies commonly assume that any IPRs produced for them by external or internal consultants or contractors (website content, branding, software, designs etc) are automatically owned by the company because it has paid for them. However, the agreement with a contractor, particularly if provided by the contractor, will often seek to retain the IP ownership, or will be silent on ownership, and of course there may be no written agreement at all. The buyer will want to see a paper trail evidencing the company’s rights, including that employment agreements have an appropriate IP ownership clause. These problems can usually be dealt with by drawing up and entering into the appropriate documents before a sale process starts, but if it’s in the context of a sale where the other party knows that you need their signature in order to get the sale through, it can make things more difficult (and expensive).

 

Check that you own your IP…

  1. Employee terms and conditions – are your employment contracts in good shape?

 A buyer will want to know that all key employees are properly contracted to the company, with sufficiently long notice periods, enforceable restrictive covenants (non-compete and non-solicitation clauses) and other terms that protect the position of the company they are buying. Equally, if the buyer’s plans include removing any employees they will want to be sure of the cost and terms for doing so (any enhanced redundancy pay terms for example), and that the employment contracts are properly compliant with employment law. It is much simpler to negotiate and sign the right employment agreements before employees get wind of a possible sale.

 

Review your employment agreements and documentation…

  1. Share option schemes – do they work?

 If you have granted any share options, the buyer will want to be sure that all options will either be exercised or lapse on (or as a result of) completion of the deal, and will want to know that there is a set and binding process for that to happen. If your option scheme documents are incomplete or unclear (or options have been “promised” but not formally granted) it could cause real delays and expense in the sale process. Accordingly it’s best to ensure that all the option documentation is reviewed and completed, and the practicalities of ensuring exercise or lapse on the sale are worked out, well in advance.

 

Check and complete your share option paperwork…

  1. Change of control clauses – will your contracts transfer to the buyer?

 You shouldn’t assume that because you are selling your company as an entity, rather than transferring the business and assets, you won’t need the consent of any of your customers or suppliers to transfer their contract to the buyer. Change of control clauses, whereby the consent of the other party to the agreement is required in order for the contract to continue after a change of control of your company, are not uncommon, and only sometimes will there be a requirement for the other party to act reasonably in deciding whether to give consent. It’s therefore important to identify all material agreements (ones that could have a significant impact on the business if they were to terminate on sale) and check whether or not they have change of control provisions so you can plan how you need to handle the consent process as part of the sale.

 

Check your contracts…

  1. Tax planning – will you pay too much tax?

 For individual sellers this is generally a fairly simple one these days because of Entrepreneur’s Relief, but it’s always worth checking that shareholdings and the deal consideration are structured so that you do qualify for ER if possible, and otherwise in the most tax efficient way – for example ensuring earn-outs are properly structured can result in a tax saving.

 

Get some tax advice…

  1. Finance arrangements – what happens on sale?

Buyers may or may not want finance arrangements to stay in place following the sale, but of course there can be penalties for prepayments, consents may be required in order to sell the company and a sale transaction can constitute an event of default. It’s important that you as buyer understand the constraints and requirements of your finance arrangements before agreeing a deal with a buyer.

 

Review your finance terms…

  1. Drag along – can you guarantee all your shareholders will sell?

In almost all circumstances a buyer will want to acquire 100% of the issued shares of your company. If you have minority shareholders not closely involved with the company, or other shareholders who you cannot be sure will either sign a sale agreement or a power of attorney allowing someone else to do so for them, it is possible to provide for a compulsory sale mechanism whereby minorities can be forced to sell on the same deal terms as the majority sellers. This kind of “drag along” is usually included in the company’s Articles and it is much easier to ensure that you have a binding and effective drag along in place before a sale process starts. It’s also important to check for any hidden or forgotten restrictions on the transfer of shares that could impact on a deal.

 

Check your Articles of Association…

  1. Advisers – have you got the right ones?

Clearly you have the right corporate finance advisers in Bluebox, but it’s also a crucial factor in the success of a deal to have the right lawyers and accountants on your team. This can mean taking a difficult decision to work with someone other than your regular advisers if they don’t have the right experience of handling the sales of companies like yours. A lawyer who is inexperienced, or experienced at doing different kinds of deals, can be a very significant factor in the time taken to close a deal, the levels of risk you as seller accept under the sale documentation and the fees you have to pay for getting the deal done. The Corporate team at Penningtons Manches has many years’ experience of handling company sales, and we’d be very pleased to have a no obligation discussion with you about any of the issues outlined above, or how we could work with you on a sale.

 

Talk to Penningtons Manches…

 

Justin Starling

Corporate Partner, Penningtons Manches LLP
E: justin.starling@penningtons.co.uk

T:  +44 (0)118 982 2646 M: +44 (0)7808 777720

 

The above is necessarily a brief summary of the issues described and is for guidance only. It is not and should not be relied upon as legal advice. Please contact us through the above if you do require legal advice or for any further information.

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