Are you buying a limited company or the right to business?
Acquiring the shares in a company involves the acquisition of a legal entity in its own right and accordingly inheriting all the legal liabilities and obligations that the company has incurred since the date of its incorporation. Acquiring a business allows a purchaser to “cherry pick” the various assets and ring fence the liabilities it is prepared to take on board. For those selling their business they have the same choice, to sell shares in the company that owns the assets of the business or to procure that the company itself sells its assets. Factors that are often considered when deciding which route to take include:
Tax
A sale of shares will normally give rise to a capital gain for an individual shareholder, but if a company sells its assets, the company will pay corporation tax on any net gains and it will be difficult to pass the proceeds of the sale onto individual shareholders without further taxation. Sellers will typically wish to sell their shares in the company rather than procure the sale of its assets and as a purchaser you may wish to preserve the benefit of tax losses available on an acquisition of shares rather than assets.Liabilities
A company is a legal entity in its own right and capable of incurring contractual, tortious and even criminal liability all of which will need to be evaluated before any purchase. A purchase of assets allows you to select only those assets and liabilities you wish to inherit (with the exception of employees and certain property and environmental liabilities). So an assets acquisition is more favourable where the trading history of a company is uncertain or there is some doubt about the liabilities it has incurred.Non Transferable rights
In many circumstances (for example the transfer of a leasehold property) the rights in certain contracts or licences cannot be transferred without the consent of a third party. There may be a significant contract with a major customer which contains a similar clause. The business may benefit from significant intellectual property which is owned by a third party. In these situations the acquisition of the shares in a company doesn’t change the entity which has the benefit of such contractual rights whereas the acquisition of assets may trigger such pre-emptive rights which could scupper a disposal.
Partial Disposal
It may be that sellers only wish to sell a share of a business. In this case a purchaser may acquire a percentage shareholding in the company which would give certain rights to participate in profits in the company by way of dividend. You would typically put in place an agreement between the shareholders protecting your investment and giving certain contractual protections in the form of veto rights depending on the percentage shareholding you acquire. If the sale is of a particular division of a company an asset sale may be the only practical choice.While all these factors will affect the structure of the deal typically one or more will often be compelling but agreeing the principal form of acquisition structure at the outset is important as it will dictate the structure of the legal documentation that is put in place to eventually complete the deal.
Due Diligence
Whatever the structure of the deal you will want to carry out your own commercial, financial and legal investigations to ascertain to the greatest extent possible what assets the company or business purports to own and what liabilities it has incurred which may or may not transfer to you, the purchaser. Call for all the trading accounts, audited accounts (and management accounts since the last set of audited accounts), stock inventories, balance sheets, profit and loss accounts, bad debt policy and policy for depreciation. Instruct an independent accountant (not the accountant who has produced the accounts) to review them and raise any issues as soon as they become apparent. Any irregularities could affect the purchase price or the decision to proceed at all.In terms of legal due diligence you will need to instruct a solicitor to raise a whole host of questions concerning the business, what property it owns, are there any charges registered against the company at Companies House? Will these be discharged at completion? Who are the shareholders? Are the shares freely transferable? Is the business a subject of any litigation or under threat of the same? Are there any bad debts? Are there any employees that will transfer over to you by operation of law? Do any of them have any grievances against their current employer?
Although investigation will go some way to establish whether or not the target owns the assets it purports to own, the most intensive and searching enquiries cannot conclusively establish the extent of the liabilities which the target owns. It is therefore customary to include a comprehensive set of warranties or contractual statements about the target and its business in the legal documentation which if they subsequently prove to be false will permit the purchaser to sue the seller for the loss it has suffered as a result.
Valuing a business
Probably the biggest concern for a purchaser is paying too much for a business. Whilst this is understandable it has more to do with misinformation and your approach to the due diligence process than being an expert at valuations. What someone is prepared to pay for a business is entirely subjective. Whilst there may be cases where a purchaser may not have negotiated the best price payable for a good business it stands to reason that no price is cheap enough if you buy the wrong business. In time a good business will always justify the purchase price whereas a bad one may never allow you to recover financially.There are two main valuation methods which could be the subject of a separate article in their own right. These are asset based valuations and cash flow multiples. In the former a value is attached to all the assets of the business (machinery, equipment, property etc.) and you purchase the the assets accordingly (possibly subject to a completion accounts adjustment mechanism to verify the value). For cash flow based multiples a formula is used that combines the targets profits, owner benefits, adds back certain expenses and then applies a multiplying factor (possibly based on the industry sector) to this number to establish a purchase price. This is the method that is most commonly used and a general understanding of accounting principles is required to make this calculation. As a rule of thumb the multiple is typically equal to three times the cash flow.
Structuring the purchase price
Is the purchase price to be paid in full on completion? Is this going to be funded from your own cash flow or is there bank funding required? If so, what will the bank want to see in terms of its own due diligence before it sends the proposal to its Credit Committee to approve the loan? Will it want security over the assets of the target going forward? Will it look for a personal guarantee from the individual purchaser over their personal assets (most importantly the family home)?If there is any doubt over the value of the assets of the target that is being acquired you may wish to incorporate a completion accounts mechanism whereby the assets are valued by an independent accountant at completion and the purchase price adjusted accordingly by reference to an agreed benchmark figure.
If it’s a company purchase and there is some doubt over certain as yet un-crystallised liabilities you might consider paying a proportion of the purchase price into a separate escrow account pending the happening of certain events or the or the lapse of an agreed period of time during which the perceived liability may or may not come to fruition. This method ensures the purchaser is protected should the perceived liability materialise and the seller is given the comfort the money is available provided the liability does not arise) and the purchaser is not just making up spurious reasons for reducing the purchase price.
Do you want the key stakeholders to remain in the business?
It may be the case in a small family business that a lot of the goodwill, know-how, customer relationships etc. rest in the hands of certain key shareholders or employees. Whilst you want to acquire the target and have free rein to run your business as you see fit following completion you might wish to retain certain individuals for a short period of time to enable that knowledge base to be transferred for customer or supplier relationships and other key contacts to be embedded with you as the new owner of the business.Similarly if part of the purchase price has been structured by way of deferred consideration or earn-out (where a proportion of the purchase price is calculated by reference to the future profitability or turnover of the business) the seller may want to remain with the target for that period of time to ensure the target’s performance in order to maximise their subsequent payout.
For more information on mergers and acquisitions, buying or selling a business, follow this link: http://www.orj.co.uk/corporate.php or contact Partner Lorraine Smith on 01785 223440, Lorraine.smith@orj.co.uk
