Buying and selling companies and businesses is a routine process. The buyer and the seller will enter into a contract, which contains the following elements:

  • A methodology for calculating and paying the purchase price
  • Restrictive covenants preventing the sellers from competing with the buyer and taking the client base back
  • Provisions dealing with prior advice liability and how this is to be dealt with after completion
  • Warranties
  • Indemnities
  • Costs.

If the purchase price has been agreed, calculating it and ensuring it is paid is generally straightforward. However, there are elements of the transaction which are more heavily negotiated.


Warranties

Most business and share sales involve the seller giving warranties to the buyer. Warranties are contractual promises about the business and its operation prior to completion. There are two reasons for warranties.

Firstly, they allocate risk between the parties. Some risks are taken by the sellers under the warranties whilst others remain within the target company or business and will, therefore, be borne by the buyer.

Secondly, the warranties allow disclosure. This is where the sellers have the opportunity to disclose where any warranties are not, in fact, true. Where disclosure is made formally to the buyer the sellers will be excused of liability in relation to the matters disclosed.

A very common warranty is that the business is not involved in any litigation or similar process and the sellers know of no reason why it may become involved in litigation.

Warranties are generally limited in time (seven years in relation to taxation warranties and between two and five years, in relation to commercial warranties).  They may also be limited in amount and in other ways under the business or share sale and purchase agreement.


Indemnities

Unlike warranties, where the buyer has to show that it has suffered a diminution in value of the company or assets as a result of the breach of warranty, indemnities provide for a pound for pound reimbursement if any of the indemnified events take place.

Effectively, indemnities are a promise of payment should specified events happen. They can be broken down into two types.

Firstly, in any share sale the buyer will expect to obtain an indemnity in relation to taxation arising prior to completion. Therefore, if the tax affairs of the target company have not been dealt with properly the sellers will be liable for the tax not paid.

Secondly, the buyer may require that indemnities are given on specific risks. For instance, if claims have been made against the target business prior to completion then the buyer may wish to obtain an indemnity in relation to dealing with such claims.


Costs

Usually, the buyer and the seller pay their own legal, accounting and other professional costs for drawing up the contract.

Brokers’ fees should be taken into account as part of the deal cost. Most brokers will only take fees from one side of the transaction, depending on whether they are acting for the buyer or the seller. Broker fees can range from 1% to 5% of the purchase price.

Legal fees are potentially in the range of 1% to 3%, depending on the size and complexity of the transaction.


Heads of terms

Often buyers and sellers enter into a preliminary document known as a heads of terms, heads of agreement or a term sheet.

These set out what the parties have agreed in terms of price and other key terms of the deal. They tend to be non-binding at this stage.

There is a danger of spending too long negotiating heads of terms, rather than getting on with the main transaction.  It may be better to get on with the actual transaction documentation and negotiate the points as part of this, rather than dealing with them at heads of terms stage.

One part of the heads of terms which may be legally binding is an “exclusivity” period. This enables the purchaser to have certainty that the sellers are not trying to run competing transactions.


Restricted covenants

It is usual for the sellers of a business to undertake not to compete with the new owners after the sale.

It is understandable that buyers would not want to pay significant sums to a seller who might set up a competing business and take all the clients back. Restrictions are designed to legally prevent the seller from competing with the business, soliciting clients or poaching staff, and come in two forms:

  • The buyer will usually expect a restrictive covenant in the business or share sale agreement. Courts usually enforce a longer restriction in a business sale and restrictions of between 3 and 5 years are usual
  • If you stay on with the business, the purchaser may expect you to enter into either an employed or self-employed contract, and include a restrictive covenant of up to 12 months after termination of the contract. The shorter term of the restriction reflects the fact that the courts are less likely to enforce a long restriction in an employment contract or self-employed agreement.

The business and its employees

There is a distinction between share and business sales in relation to staff.

If shares are being sold, the staff will continue to be employed under their current contract of employment unless the buyer and the seller agree that a change should be made. However, on a business sale, the Transfer of Undertakings (Protection of Employment) Regulations 2006 will apply. These regulations make any redundancy in connection with the transfer of business automatically an unfair dismissal.

Changes to employee contracts and redundancies should therefore generally not be made at the time of a business sale. However, most buyers will reassess the staffing needs of the business they are buying, and it is unusual not to make changes to staff. This can be done prior to or after completion.


Payment

The payment or consideration offered by the buyer is a fundamental part of any transaction. The simplest form is cash paid upfront or on a deferred basis. There are, however, other options:

  • Loan notes. The buyer can issue loan notes, these are evidence of indebtedness and are repayable on agreed terms.  A buyer might accept loan notes because they can help create a more tax-efficient position. However, loan notes are not common in sales of financial advisory businesses
  • Shares. Shares in the buyer’s business are more common than loan notes. A buyer might offer shares to sellers for a number of reasons

Firstly, shares reduce the need for the buyer to find cash. It can simply issue more shares giving the sellers a stake in the purchasing company.

Secondly, issuing shares (particularly if the buyer is a private, unlisted, company) may be a mechanism to bind the sellers into the buyer. This is particularly useful if you are staying on and working for the buyer and gives you some control over the buyer. However, ensure that the shares that are issued give sufficient rights to income and management control. Sometimes shares are issued as a token of value, and have no value until a defined event, such as a trade sale or listing on a public market. If these events never happen, you have received consideration in a format with little value.

Thirdly, if the shares are listed on a public market they can be translated into cash by selling them in the market. Sellers often take a view that they may increase in value, thereby increasing the overall consideration. However, listed companies tend to have a lock-in period during which consideration shares cannot be sold. This is to stop sellers dumping shares into the market and depressing the share price.

Want to explore your options with us?

Speak to our professional acquisition team

Enquire now