If you are thinking of selling your company, which events in recent years and the high prices being paid for businesses have caused many to decide to do so, it is highly advisable to prepare your business in advance of that sale.
Any potential buyer is likely to want to carry out an extensive investigation of the company which will include financial and legal due diligence exercises.
The financial due diligence will be key to the buyer’s assessment of the value of the business and the price it is willing to pay for the shares in the company, but the legal due diligence will also seek to flush out details of any potential liabilities or expenses which might be incurred by the buyer in relation to the company and so which might also affect the price to be paid.
This note is concerned with legal due diligence and highlights some key areas of a business where putting the house in order before a company is marketed can help sellers to avoid the risk of price chips and difficulties when share sale documentation is negotiated.
Statutory books: While the sellers are running a business, the statutory books and registers will rarely see the light of day and it is not unusual for sellers to forget all about them or even where they are located (quite possibly gathering dust in an old cupboard or in a dark corner of the accountant’s office).
When the time comes to sell the company however, they will become extremely important because it is the register of members, rather than any share certificate, which in law determines ownership of the shares in a company.
Depending on the history of the company, the books may record issues and transfers of shares and perhaps purchases of its own shares by the company. The advisers of the buyer will want to see the relevant registers and scrutinise the transactions recorded in them to confirm that the seller is, or sellers are, in a position to sell all the shares in the company. Was the correct stamp duty paid on any share transfers? Were all the necessary authorities in place for any issue of shares? Has any purchase of its own shares been carried out in accordance with the relevant laws so that it is not void?
If there are any problems with the records, it is infinitely better to identify and seek to resolve them before a buyer is involved.
At the same time, it may also be worth having the articles of association of the company reviewed to ensure that there are no provisions in them which give rise to difficulties, for example, in relation to the ability of the directors to hold quorate board meetings.
Finance and Accounts: There is some overlap between legal and financial due diligence. The legal due diligence questionnaire will also request copies of recent accounts, accounting policies, management accounts, bank accounts, security given to lenders, loans to or from the company or its directors or shareholders.
In preparation for a sale the opportunity should be taken to tidy up any loose ends and generally to get to a position which demonstrates the strong financial position, management and prospects of the company.
Debtors, creditors and stock will constantly fluctuate and so any issues in relation to these can only really be addressed as at the time of the sale. Policies regarding them however can be considered and reviewed at any time. If current policies are inappropriate or may be unfavourable, it is easier to change them beforehand than to argue for this at the time of a sale.
Contracts and trading arrangements: The sale documentation is likely to require the seller to produce copies of a range of contracts, including contracts with key customers and suppliers, hire purchase or lease agreements, agency and distribution agreements, long term agreements and a host of other types of contracts or of contracts which include different types of provision.
A buyer will be particularly interested to know, for example, whether any of the contracts include provisions entitling the other party to terminate the contract on a change of control of the company. It may be very helpful for a seller to carry out an audit of its contracts in preparation for a sale to identify issues which may be of concern to a buyer, any missing or incomplete contracts and generally to be ready to respond to the buyer’s requests for information.
Where the business trades with customers generally, without contracts, a buyer will want to know that the business has appropriate and enforceable terms of sale in place, and to be assured that the procedures in place for taking orders ensure that these are also effectively incorporated into contracts with customers. If the business sells to consumers for example through a website, do its terms comply with all the legislation regulating such sales?
Employees: The buyer will want to see full details of the arrangements in place with employees of the business and of their rights and entitlements. They will be interested in any employees who are key to the running of the business and in understanding how well it can function without the involvement of the sellers. Do the company’s employment contracts include suitable protections for the business and does the company have in place and maintain appropriate and compliant employment policies, procedures, handbooks and records?
Pensions: The buyer will want to see that the company has complied with its obligations in relation to pension schemes. If the company has a final salary pension scheme or any scheme which has a final salary element, this is likely to be of significant concern and the parties will probably need to take specialist pensions advice early to understand the nature and extent of the company’s obligations under the scheme.
Data protection: Unless exempt, businesses which control personal data are required to pay an appropriate annual fee to the Information Commissioner’s office. Even if exempt, businesses should have in place privacy policies and other documentation and records regarding their use of personal data. They should have a good understanding of what personal information they collect, how they use it, the legal basis for doing so, if any information is transferred to other parties and whether any such transferees are outside of the EU. If the business has a website, it will need to consider if it complies with current law regarding the setting of any cookies through the site.
If a business has not considered and addressed data protection compliance in advance of a sale, it will be very difficult to address it and respond satisfactorily to the buyer’s concerns during the sale process.
Intellectual Property: Intellectual property which encompasses trade marks, copyright, designs and patents is another area which is very important to many businesses. Where the IP is an important element of the value of the company, a buyer will want to confirm that the IP is properly owned by the company (as opposed perhaps to a contractor or employee) and assurance also that the right in question is valid and enforceable. Unless it has been specifically assigned to the business, it is common to find for example that copyright in a website is retained by the website designer with the business using it under licence.
Patents need to be registered. Copyright arises automatically on creation. Trade marks and designs on the other hand may be either registered or unregistered. A buyer may expect to see that trade marks or designs which are of value to the business have been registered and maintained, do not infringe the rights of third parties and, if necessary, have been defended when infringed.
The company’s IT systems may be important. Are all necessary software licences and appropriate back-up and security arrangements in place?
Assets: Of primary importance will be the ability of the sellers to demonstrate that there are no issues in relation to any property owned or leased by the Company. Aside from this, does the company have an up to date asset list and own and maintain all of the assets necessary for the running of the business?
Litigation: Any actual, contemplated or likely litigation by or against the company will be important to a buyer. They will want to understand the likely value of any claim, the stage of any proceedings, the prospects of success and perhaps what the litigation says about the business generally. If any litigation is going to cause an issue with a buyer, it may be better to seek to resolve it before the company is marketed.
Environmental and Health and Safety: A seller should look to ensure that it can demonstrate compliance with EHS law and that it has in place all necessary policies, records and procedures to this end. If there have been problems with EHS law, the aim should be to show that these have been resolved and that action has been taken to prevent a re-occurrence. The presence of any asbestos and risk of related claims is likely to be of considerable concern to a buyer so should be addressed early with appropriate advice.
Insurance: As a minimum the buyer will want to see copies of the company’s insurance policies and later in the share sale agreement will seek warranties regarding the arrangements and cover in place. It may be worth reviewing insurance arrangements with a broker.
Compliance: Compliance requirements vary according to the nature of a business. They may relate to licences or consents required to operate the business, product safety regulations, competition law or anti-bribery and corruption. The latter is an area where many businesses have not put in place policies and procedures and this often comes up as an issue on a sale.
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In summary, the advantages of preparing for a sale early are numerous. It means that areas of potential difficulty are identified and addressed before a buyer is involved so that the buyer is less likely to have cause to argue either for a reduction in the price or an indemnity to recover part of the price paid after the sale in the event of a claim made subsequently by a third party.
Also, because much of the information required to respond to the buyer’s questions has already been gathered the sale process is likely to be easier, more straightforward, quicker and less costly.
The fact that more time is available to collate and confirm information reduces the risk of a warranty claim being made by the buyer after the sale in relation to any inaccurate or incomplete information provided during the sale process.
In the case of any issue identified which requires work to investigate or address or which may require input or assistance from third parties, dealing with it in advance will mean that there is more time, less pressure and perhaps also that there may be more options available for dealing with the issue.
In the case of other matters which may be intrinsically more straightforward and inexpensive to address such as putting in place policies, doing this early means that the new policies can be bedded in and shown to be already in operation when the sale takes place.
Even if ultimately the sale of the company is postposed or reconsidered, taking time to work through some or all the matters highlighted in this note will in any event help the business to be more resilient, prepared, organised, efficient, compliant, profitable and ultimately valuable.
If you would like assistance or legal advice in relation to preparing your company for a sale or any of the matters highlighted in this note, please contact a member of our Corporate Team.
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