How can I prevent the seller setting up in competition after the sale?
Restrictive covenants can be inserted into the sale agreement. These normally specify that:
- the seller will not be involved in a competing business.
- the seller will not solicit customers or key employees.
To be enforceable these clauses will need to be reasonable in terms of business covered, duration and geographical area.
Often there will be negotiated “carve-out” exceptions to allow the seller some scope post-sale, particularly where it is a sale of part-only of a business.
Asset Sale You will be left with the liabilities, including tax. Additionally there may be warranties that will not expire for say 2-years.
Share sale It is easier, in one sense, to achieve a clean break in so much as you will no longer own the company, ie, all assets and liabilities have been transferred. However, if you have agreed to various warranties and liabilities then you will have to wait for the claim periods to expire before finally “sleeping easy”.
When can I sleep easy as a seller?
You can relax once the time period for enforcement of warranties / indemnities has passed. That is assuming that full payment is made on completion and there are no post-completion provisions whereby, for example, the final sale price might depend on how the business performs in the future (eg earn out provisions). In these circumstances, you will not be able to rest easy until full and final payments have been made and, even then, not until the time period for enforcing warranties and indemnities has also passed.
As a Buyer can I defer some of the purchase price?
It is possible to negotiate deferred payments. This mechanism is used where the buyer is uncertain that targets can be achieved, for example, turnover for the purposes of an asset sale. It is much more common in a sale of shares, however, and is usually used for “earn-outs”.
What is an earn-out?
An earn-out clause stipulates that the sale price is to be based on the company performance after completion. For example, it might be stipulated that if the business makes net profits of £X after one year then the buyer will pay the seller a further £Y consideration.
Completion accounts are accounts that are produced at an agreed time after the formal completion date. They can be a useful tool in situations where the initial purchase price was produced by use of “old” Profit and Loss and Balance Sheet information. It is of particular use in situations where a business or company is experiencing changeable trading conditions. It might be that a set payment is made at formal completion and then an adjustment is made once the completion accounts are produced.
They nearly always form part of a share sale to calculate a net asset value which prompts a balancing payment.
Our Top Tip: involve your solicitor and accountant at an early stage in working out how the completion accounts will be calculated and taken into account in the drafting of the sale agreement.
What is a Warranty?
Let’s take an example:
All information contained in this agreement, all matters contained in the Disclosure Letter and all other information relating to the Business given by or on behalf of the Seller to the Buyer, its advisers or agents are true, accurate and complete in every respect and are not misleading.
You can see that the buyer requires the seller to confirm that the information given is true, accurate and complete. If, subsequently, the buyer finds that a piece of information is patently incorrect and that, as a result, expense is incurred, s/he can sue the seller. Nevertheless, the buyer must prove the loss and this may lead to court proceedings if the seller does not consider the information to be incorrect or false. This is the difference between a warranty and an indemnity.
What is an Indemnity?
An indemnity is a form of guarantee. It is a protection against a specific liability that the buyer’s solicitor has isolated as a potential (lawyers call it “contingent”) liability that the buyer is not prepared to pay for. Indemnities are more frequent in an SPA, where it is usual, for example, to have a tax indemnity deed covering any unpaid tax liability of the company before the completion date. The selling shareholders have to give the indemnity personally.
In a Business Sale Agreement or Asset Purchase Agreement an indemnity would cover a specific liability, for example, a defect in the seller’s title to property or a debt owed but unpaid to a supplier.
In both cases, the seller will want to provide as much information to the buyer as possible, to minimise the risk of a claim. In addition to the documentation and replies to enquiries given by the seller during due diligence, the seller may also set out any particular concerns, real or potential, in a “disclosure letter”.
A Disclosure Letter is a method of limiting / qualifying the warranties made by the seller. If a disclosure is made against a warranty then it means that the buyer will generally (subject to whether disclosure was sufficiently full and accurate etc) not have a claim under the particular warranty in question.
The Disclosure Letter will contain general disclosures that the seller would expect the buyer to be aware of / find out for itself, for example, information available to the public such as that at Companies House.
The other type of disclosures are specific disclosures that will be made against specific warranties. However, because of the overlap, the disclosure letter often states that the specific disclosures apply against all of the warranties, rather than just specific warranty X, Y or Z.
The purpose of the Asset Purchase Agreement (APA) or Business Purchase Agreement is to set out the assets that are being bought and sold and the price payable for each asset class, that is, the total purchase price is “apportioned” between each asset class. One of the reasons for this is capital gains tax. Some assets are chargeable to tax, others not. The price payable for each class is negotiated between the buyer and the seller.
The BSA and APA also set out the way in which any property is transferred, whether freehold or leasehold. In a share purchase agreement (SPA) this is unnecessary because the property stays in the company.
Next, the BSA and APA deal with the transfer of employees under the Transfer of Undertakings protection of Employee Regulations – known as TUPE. It is important to remember employees pass across to the buyer of a business automatically. This, of course, requires careful thought in all businesses and close attention is paid to the employees, their age and their length of service during due diligence.
Finally, the buyer will want the seller to warrant the accuracy of the information given. The buyer may also require indemnities for specific liabilities.
The structure of the SPA is a little different. As the assets stay in the company the body of the SPA is shorter, but the extent of the warranties covering both the business, the assets and the tax affairs of the company is considerably longer.
See also our FAQ on Warranties.
If it is a BSA or APA then normally the seller’s solicitor will produce the draft (although there is no set rule on this). If it is an SPA then, by convention, the buyer’s solicitor produces the agreement, but again, there is no set rule on this.
At Truelegal we usually volunteer to draft the main agreement regardless, in order to control the timing of the transaction and to take the initiative.
Let’s deal with the SPA first, because it is a completely different transaction. Here, the individual shareholders are selling their company, whether the company runs a small coffee bar or a large engineering business. It has to be a share sale. Once the selling shareholders have sold out, they no longer have anything to do with the business.
Both the BSA and APA are two kinds of agreement dealing with the sale of assets. Often the terms are used interchangeably. Occasionally they are differentiated as follows:
- The BSA is used for the sale of businesses, whether owned by an individual or a company, where the main asset is goodwill and that goodwill is dependent upon the location of the business premises. For example, a coffee bar, public house, or retail shop fall in this category. The premises may be freehold or leasehold and if the former, the value will be higher.
- An APA is used where there are a number of assets, for example, intellectual property rights (patents, trademarks, copyright and the like) or plant and machinery as well as goodwill and property. These transactions usually require greater degree of investigation and are therefore more complex. Value is a consideration but by no means the only one.
Due diligence basics
When you buy a business, whether assets or shares, you will want to be satisfied that the business is worth the price you have agreed to pay for it. This involves a thorough examination of the business and its assets and liabilities.
As a seller, you will hopefully have already spent some time making sure the business is in good order. Instructing us to help you prepare a business for sale will shorten the investigatory period and make sure there are no issues which might give the buyer the opportunity to re-negotiate the price.
As a buyer, you will need to be meticulous in your scrutiny of the relevant information and documentation to make sure you fully understand what you are buying, whether good or bad. We can guide you through this process and ensure any issues or irregularities are identified and appropriately addressed.
It is normal for the seller’s solicitors to prepare and send the due diligence replies with the business sale agreement (“BSA”) to the buyer’s solicitors where the business being sold has a large property element to it. For example, public houses, cafes and restaurants, hair and beauty salons or retail shops. In other words, due diligence is carried out in fairly quickly. For engineering businesses, the process takes longer as there is usually more information to gather. The buyer’s solicitors will make the enquiries and obtain replies, so that the buyer can assess them before sending out an Sale Purchase Agreement (“SPA”).
What does legal due diligence cover?
Different kinds of business have different types of asset. A pub business will have different compliance issues to an engineering business. There are of course many common features to both. A list of the “tangible” assets/liabilities will usually include:
- Employees;
- Property – freehold and/or leasehold;
- Fixed Assets – those attached to the property;
- Moveable Plant and equipment, including computer hardware;
- Stock;
- Intangible Assets;
- Debtors/Creditors
See our Due Diligence 101 FAQ for more detail.
How long does due diligence take?
If the seller has the information ready then it will normally take three to four weeks for the buyer’s solicitors to go through everything, so that they can advise their client what more is needed and what they still need to see. The buyer’s solicitors will prepare a due diligence report, highlighting the various concerns they may have. If the seller is not ready to supply the information required by the buyer, it can add at least another month to the process. Having a HoTs in place is very useful at this point. The buyer will be able to go back to the seller, pointing out any matters of concern which may justify a reduction in price.
What follows due diligence?
The buyer’s solicitor will report on all the information received from the seller’s solicitors. If the information discloses no hidden difficulties or other contingent liabilities that could affect the purchase, the buyer’s solicitor will prepare and send a Sale and Purchase Agreement to the seller for approval.
If, on the other hand the due diligence process has thrown up hidden difficulties or contingent liabilities, the buyer will want to re-negotiate the deal. The adjustments may only be peripheral to the price the buyer has agreed to pay. Sometimes, however, the due diligence investigation throws up more serious problems, leading to a re-negotiation of the deal in its entirety. It is at this stage that either party may pull out.
Let’s look at each in turn…
Employee Due Diligence
Under the Transfer of Undertaking Protection of Employees Regulations (known as TUPE), employees are almost always automatically transferred from seller to buyer on the same terms and conditions those employees enjoyed immediately prior to the sale, whether or not they have contracts of employment.
This means that the buyer assumes the liability for the employees whether they are wanted or not. For example, X has been employed in a business for 20 years but the buyer does not need him. That employee is entitled to look to the buyer for full redundancy entitlement. The buyer will need to calculate this liability before buying the business and reduce the price paid for the assets to compensate for it.
On a sale of shares, of course, it is the company that is the employer and the employees’ contracts continue as a matter of course. Clearly, the same principles will apply to redundancy and price adjustment may have to be made.
Property Due Diligence – freehold or leasehold
On a sale of assets, the property housing the business may be of vital importance to the buyer – if it is restaurant or public house, for example, where location is a key factor. On the other hand, if it is, for example, an engineering company, the buyer may already have premises nearby or wish to relocate.
If the property is leasehold, the seller will normally want to transfer it as one of the assets to avoid liability for paying the rent after the sale. In such cases, the landlord will have to consent to an assignment of the lease and this will be subject to satisfaction that the tenant will be able to continue paying the rent. This will all involve the landlord’s solicitors and is an expense the seller, as tenant, normally has to bear.
If the property is freehold, the seller may be quite happy to sell it separately. If it is part of the deal, the buyer’s solicitor will need to investigate ownership of the property.
Fixed Assets
This covers all plant and machinery that is “fixed” to the property and cannot be removed without spanners or screwdrivers. This becomes more important when the property is leasehold. These fixtures may belong to the landlord and remain in the property for the buyer but have little or no value for the purposes of the transfer of the business.
Moveable plant and equipment
An engineering business may have valuable plant and machinery the buyer is keen to purchase. If so, the seller will need to supply particulars of the machine, if it is owned outright or on finance, hours worked etc. Normally, the seller will have prepared an “asset register” for this purpose.
Every business will have equipment it uses for trading purposes. For example, a restaurant will have kitchen equipment, a hairdressing salon scissors and more sophisticated hair dryers. Normally this is all disclosed and contained in a schedule to the Sale and Purchase Agreement.
Stock
Stock represents the “consumable” items in a business. It also includes work in progress. In a restaurant or public house it will include beer, wine and spirits. In a restaurant, it may also include items such as flour, spices etc – “dry” goods that are still usable in the business following the sale. The hairdressing salon will probably have shampoos, conditioners and beauty products.
An engineering business will not only have stocks of nuts and bolts and the like, but also “work in progress” – part finished products that have to be valued and are payable for on completion of the sale.
Stock and work in progress are all normally valued on the completion date of the sale of the business. Sometimes a seller will want money on account before the sale takes place. Often the value can be agreed between the buyer and seller. In case they cannot agree, stock is valued by an expert in the particular trade and the cost covered jointly by both parties.
“Intangible” Assets/Liabilities
By far the most important intangible assets are the contracts with customers that the buyer will be anxious to scrutinise. As the business is being bought as a “going concern”, these customers are its lifeblood. Any contract that accounts for over 10% of the turnover of the business is called “material”. The risk of losing it may mean the difference between profit and loss. Some businesses have very few customers. Their value will be of very great importance to buyer and the risk of losing them will play a large part in determining the price for the business. On a sale of assets, these contracts have to be formally transferred and the sale may be conditional on this happening. On a sale of shares, the contracts stay with the company.
This may not be of great consequence in other kinds of business. Restaurants and pubs, for example, may have established very good reputations, but the seller will have no contracts normally to pass to the buyer. It will be up to the buyer to maintain the standard, particularly as the seller will be looking for a substantial payment for goodwill.
Other intangible assets could include intellectual property. For example, internet and IT companies may have developed their own software. Graphic design companies may hold substantial copyrights for their designs. Engineering companies may hold patents for products they have developed. All of these businesses may have registered trade marks. Intellectual property rights can have a substantial value. The buyer will want these rights to be checked out and ensure they are properly registered.
There may also be contracts with suppliers that the buyer wants to continue. These could include computer software licences, banking card machines and the like. Furthermore, some of these supplier contracts may be in the form of a lease. The buyer may or may not want them. On a sale of assets the seller will have to terminate those contracts before completion. On a sale of shares, of course, the buyer is buying the company “lock, stock and barrel” and so will have to adjust the price for the shares if a contract is not desirable.
Debtors and Creditors
If the sale is of business assets, the seller will normally keep the debtors and creditors of the business up to the completion date. The buyer will start from Day 1 with no inherited debts to collect or bills to pay.
In a share sale, on the other hand, debtors and creditors these are included in the sale to the buyer.
In either case, the buyer will want to know how much is owing to the business and how much the seller has to pay to creditors, in order to build a proper picture of the seller’s business activity.
Additional due diligence information for share sales
For share sales, the buyer will need to know the seller has complied with the requirements of the Companies Acts and to see the minutes book, recording the decisions of the directors/shareholders.
The buyer will also want a complete history of the company and will want a rigorous examination of the company’s accounts. In addition, the buyer will want warranties and indemnities against all taxes outstanding prior to the purchase.
Business Accounts
For both asset and share sales, the accounts of the business are crucial. The buyer should request at least five years’ accounts for the business and any management accounts available during the current financial year. They show how well the business is trading, how cyclical it is, whether there are outstanding debtors and creditors, the amount of any bank overdraft, other third party borrowings, leasing and other finance liabilities etc. From this, the buyer’s accountant can provide the buyer with a pattern of the trading history of the business and highlight any cost savings which might be available. The accountant will form a view about whether the business, assets or shares, is worth the price.
There can be, but normally these provisions are contained in the Non-Disclosure Agreement (NDA) that is signed up at the same time as the HoTs.
An NDA is essential to protect against the damage that would be caused to the seller should the buyer allow secret information about the seller’s business fall into the wrong hands.
The NDA is strictly enforced. In larger share/asset sales/purchases, information is sometimes given to certain designated employees of the buying company or business, who can only disclose it to the managing director/proprietor.
We would always recommend that an NDA is considered before detailed data is shared. In some circumstances it is good practice to enter into a more detailed NDA to supplement a short form one provided by some brokers. Get in touch with us for a draft NDA.
What are the usual terms and conditions of a HoT
The HoT sets out:
- The shares/assets the buyer proposes to buy. For shares this is straightforward; for assets, there will be a list – goodwill, plant and machinery, stock etc;
- The assets and liabilities the buyer does not propose to buy. This is relevant only to assets, for example, book debts and creditors;
- The employees passing across are normally listed;
- The amount the buyer proposes to pay for the shares or assets and how it is to be paid. Part of the purchase price may be retained against future claims against the business or, alternatively, on an “earn-out” basis where the seller has to reach certain targets before he gets the rest of his money;
- How the buyer has calculated the price, which is normally based on the limited information provided at this stage. These are called “the Assumptions” and the buyer lists what documents have been given by the seller, together with any particulars of sale prepared by a business transfer agent;
- The conditions the buyer attaches to the proposed price. This is where due diligence comes in. The buyer will want to test assumptions made about price against a thorough review of the business. Conditions may also require the seller to agree to a “non-compete” clause after completion, so that the buyer gets the full benefit of the goodwill;
- Agreed time limits for the due diligence process. This is called the “exclusivity period” and will depend on the size and complexity of the business. It can be anything up to six months. A well-organised seller can supply the information quickly and show the buyer that this is a well-run business;
- The buyer will require the seller to give an indemnity for costs and expenses incurred in investigating the business during the exclusivity period should, for example, the seller negotiate with another potential buyer during this period.
The HoTs is a document drawn up by the seller’s solicitor or broker once an offer has been accepted for the business. It details the business’ profile, strengths, financial information, premises details, employees, reasons for the sale, key opportunities etc.
The purpose of a HoTs is to show that the seller is willing to sell and the buyer is willing to buy at an agreed price, subject to a number of important terms and conditions. No money usually changes hands but, notwithstanding that, it is a very useful and important document. It usually gives the buyer exclusive access to the seller’s business for a fixed period of time. This is because a buyer will be reluctant to part with any money at all until a “due diligence” investigation of the business has been carried out. Equally, a seller will be reluctant to part with any sensitive information about the business, unless there is a guarantee that it will be handled in strict secrecy buy the buyer. For this purpose, the HoTs is normally accompanied by a “Non-Disclosure Agreement” (NDA).
Signature of the HoTs shows that both seller and buyer are serious in their intentions. It means that some provisions of the HoTs will be legally binding on the parties.
The seller, or sometimes the business transfer agent, may ask you to pay a deposit. This is unusual, but the seller may want to be satisfied the buyer really wants to the business. In other words, that you are acting in good faith.
On the other hand, in these early stages, you will only have seen a page or two of business sale particulars. Why should you pay a deposit when you know nothing about the business?
If you do pay a deposit, make sure that you are clear as to the terms under which the deposit is being paid. For example, is it non-refundable if the deal collapses? Get the terms agreed in writing so that the repercussions are clear to all, should the deal fall through.
There is, however, a much better way of handling this. The seller and buyer can agree to enter into a Heads of Terms Agreement (known to us as a HoT).
Generally, they all charge a percentage of the sale price (the “success fee”). This might be in the region of 5–10 %, although precise figures will vary from one transaction to another.
Some agents may agree to be paid hourly or on the basis of a retainer. They may also ask for an upfront listing fee for advertising your business for sale.
We recommend that you speak with us before you commit to a particular broker’s signed terms of business and we can give you our opinion on whether they are suitable for you.
Remember though that once you sign up to a broker you are committed to pay their fee which will usually be paid directly by the seller’s solicitor from the sale proceeds.
Yes, you should you use a business transfer or broker expert to help sell your business
Is the short answer! Using a good business transfer agent will save you time, money and hassle. The bigger firms of business transfer agents have a national reach. They are able to market your business across the country but also have the local expertise to value your business. In addition, most can help you negotiate your price and will play an important part in screening prospective buyers to weed out time wasters.
The national firms include Adams & Co, EM&F Group, Business Partnership, Turner Butler, KBS, all of whom can be accessed quickly over the internet. There may be more than one in your area. It is important to meet them all and choose the one you get on with and whom you feel will do the best for you. Some of the more specialist brokers may be more suitable.
Truelegal has longstanding relationships with a number of transfer agents and brokers whom we would be happy to recommend. If you would like us to point you in the direction of who we believe are the betters ones, then please contact us.
How is a business valued?
Valuing a business is not a precise science. Much will depend on the experience of the valuer. Your accountant is probably your first port of call. Even if s/he does not do this sort of work, s/he may know valuers in your area. In addition, business transfer agents specialise in business valuations. There are a number of national firms in this market, all of whom have local offices in the major cities. They combine a national reach with local knowledge.
Alternatively, give us a call; we have contacts in this field throughout the country to whom we can refer you. We would be able to do this for you as part of our pre-sale service.
Common Valuation Considerations
The valuer will need to look at a wide range of factors to come up with a value. These include:
- The history and development of the business;
- Details of shareholder agreements (and rights attached to classes of shares);
- The price or value agreed for any previous share transfers;
- All information circulated to shareholders by the company;
- Details of a company’s/business’s market share, main competitors, contracts with customers and dependence on specific customers;
- Audited and management accounts;
- Trading prospects, including budgets and forecasts;
- Details of claims or litigation against the business or contingent liabilities such as environmental matters.
Most of this information is necessary for both business (asset) sale and share sale, save for items 2 and 3. Obviously, information about the company will not apply in an assets sale. Some of the methods that might be used are mentioned below. The valuer will also take into account the values achieved on recent comparable business sales in your industry and location.
How do I value the assets of my business?
The “tangible” (physical) assets of a business are not so difficult to value, for example, machinery, vehicles and property. Some intangible assets, for example, intellectual property rights (patents, trademarks and the like), can also be valued by a specialist valuer. The question is: what are they worth in the open market?
Goodwill is more difficult to value. The gap between what the seller believes the goodwill of the business is worth and the amount the buyer is prepared to pay can be a wide one.
The valuer may take an average of previous years’ profits and select a multiplier appropriate to the kind of business to arrive at a figure. What is “appropriate” depends on the kind of business it is, for example:
Business type X / size Y x location Z
The figure for goodwill is then added to the value of the other assets to arrive at the sale figure.
How do I value the shares in my company?
Most share valuations are “earnings” based, where a valuer has to estimate a company’s future profits and then apply a multiple to this profit.
Estimating future profits requires a review of the trend of past and current performance, with adjustment for items which may not have been incurred for the benefit of a company’s business or are “one-off” items.
This is the “p/e” (price/earnings) method. In addition:
- Net Asset Value (NAV) – the Balance Sheet is assessed to see how much is owed to the shareholders i.e. Fixed Assets + Current Assets minus (Current Liabilities + Long term liabilities). The resultant figure is the NAV.
- Profits/earnings calculation – an average figure for, say, 3 previous years’ profits is taken and then multiplied by a suitable industry multiplier.
- Discounted Cash Flow – sometimes it might be appropriate to calculate the projected cash flow for the next, say, 10 years and then to apply a suitable discount.
As you sell the company, “warts and all”, share sales are likely to take more time and effort to complete and so are likely to be more expensive than business sales. On the other hand, there are definite tax advantages and, once the shares are sold, you are free of it.
The additional costs usually relate to:
- more comprehensive due diligence
- more extensive warranties, in particular tax related
- more completion ancillary documentation
At Truelegal we always offer a fixed quote.
A sale of assets may well require the consent of a third party, for example, a landlord in the case of a lease transfer. This can take time and cause delay. After the sale, you have the expense of collecting the debts due to the company and paying any debts owed by it.
As a rule, buyers will usually prefer asset purchases, while sellers will prefer sale purchases.
We can talk you through your own personal circumstances and make early recommendations before you make or accept an offer.
Buying Shares
Advantages
- You step into the seller’s shoes. There is no third party involvement so it is more low key
- Warranties and indemnities are given by the seller personally
Disadvantages
- You take over the company’s problems, “warts and all”
- The risk is consequently greater and the transaction more involved
Buying Business Assets
Advantages
- There are fewer risks involved
- You are not liable for any debts before the date of purchase
Disadvantages
- Each asset has to be transferred to you, often involving third party consent
- The selling company gives the warranties/indemnities, not the seller shareholder. You may want him or her to guarantee those warranties and indemnities
