HOW TO BUY OR SELL A PRIVATE COMPANY

Exerpts from the full version (available to subscribers)

 

By Christopher St Cartmail, B.Com (Auck)

with thanks to Adrian Shipwright, Barrister-at-Law,
and Lance Blackstone, Blackstone Franks
© Copyright Business Data International 1997, 1999, 2007

 

CONTENTS

Chapter I To Buy or Not To Buy?
Chapter II How to Identify a Target Company
Chapter III Evaluating and Wooing the Target
Chapter IV Negotiating Techniques
Chapter V Valuation
Chapter VI Tax Considerations for Buyers and Sellers
Chapter VII Legal Aspects of Buying and Selling
Chapter VIII Paying the Price
Chapter IX Financing Private Company Acquistions
Chapter X Preparing a Business for Sale
Chapter XI Post-acquisition Integration
Chapter XII After the Sale

This web page is designed to provide a summary of aspects of the subject-matter and does not purport to be comprehensive or to render legal advice. Whilst every effort has been used to ensure the accuracy of the contents, no responsibility can be accepted by the publishers, their employees or agents for any error, factual or otherwise, contained herein.

 

CHAPTER 1

TO BUY OR NOT TO BUY?

Recently there has been an improvement in the market for buying and selling unquoted companies. This guide will deal most specifically with companies which have a turnover in excess of £1m. 

Reasons

Companies are continually bought and sold for a wide variety of reasons: to increase market share, achieve economies of scale or product synergy, diversify risk or to ensure supplies or outlets. Sales may result from the retirement of an owner, sometimes from the forced sale of a struggling or insolvent business and sometimes so that a successful owner can make a well-earned profit from an enterprise. The acquisition of a company can be for personal reasons: the purchaser may simply want to find a business he can manage successfully and become a Captain of Industry.

Purchasing and making the final decision as to whether or not to acquire a company may take a considerable amount of investigation and research. Different industries have varying growth rates and even within the same industry,these can vary enormously. Acquisitions are easier to finance than start-ups. Finance can be obtained from sources such as venture capital firms, from family funds or close friends.

Growth

Acquisitions can facilitate or permit rapid growth: if a company has no proprietary technology, no unique product and is not in an industry characterised by enormous growth, rapid growth can still be achieved through acquisition. Acquisition is a method of overcoming inherent difficulties in business such as marketing problems; customers may already be well-served by a particular supplier and difficult to lure away; looking for facilities to lease can be time-consuming and building a new facility is often problematic because of limited availability.

Acquisition can encourage rapid geographic expansion. Because of well-established customer-supplier relationships in many industries it is often difficult to extend a product line. Suppliers may be wary of supplying a competitor to their existing customers and in times of shortage only established customers may be assured of supply. Product line expansion may be difficult because customers' requirements can be hard to learn and for a customer to do successful business with a new supplier there is usually a 'carrot' such as lower price. Acquisition can overcome problems such as these; the acquirer can inherit the expanded product line and its benefits.

Serving the customer

Acquisition can lead to a firm being able to offer a more comprehensive customer service. Many customers believe it is best to be serviced by one supplier as this simplifies order entry, billing and inventory control. The customer-supplier relationship is likely to be most successful if a customer's requirement can be satisfied wherever he is located and acquisitions are often a good way of obtaining facilities to enable a company to service large accounts. Growth through acquisition can help keep down investment costs associated with techniques such as just-in-time delivery, quality control, paperless order entry and bar-coding that seek to enable companies to remain competitive in local and international markets.

Strategic considerations

Sometimes a company or a division is up for sale because it is a poor performer or no longer fits in with the strategic direction of a parent company. This can result in an opportunity to acquire a business at a reasonable price and to make a profit, provided its operations are improved.

It is not impossible

Finding an acquisition may not always be a nightmare. Even in an economic downturn there is usually funding available for an appropriate acquisition. Lenders like to see a company acquiring another business. Loans can be secured by the assets being acquired and lenders can project interest coverages and amortisation schedules based on past performance. In some instances the lender may even perceive that the loan is virtually risk-free.

Corporate growth, personal wealth

The ultimate yardstick of corporate success is growth and most executives and directors will spend a great deal of effort trying to expand geographically, extend product lines and obtain greater purchasing power through greater size. Internal growth is often perceived as preferable to acquisition but this entails obtaining facilities, equipping and staffing them, learning the peculiarities of a new geographic area and securing new customers. Internal growth can be a lengthy and expensive process; the acquisition of an appropriate company can achieve all of the corporate objectives of growth and personal objectives of wealth-creation.

Considerations of management

Correct management of a company will ensure success. The management of an acquiring company must therefore evaluate whether it can run the target company effectively. Considerations will therefore include similarity of 'culture' and style and whether it is a mature or relatively young business; there should be a 'skill-fit', a common language and some shared experience. It is important to have sufficient information to be able to understand the target. Key areas to understand when assessing an acquisition include industry structure, the strategic position of the target, its quality and correct valuation. Although valuation is important, it is vital to ensure that an acquiring company has the necessary management skills and capacity to run the new business. Retaining key individuals with core competencies is likely to facilitate this.

 

EVALUATING TARGETS

CHECKLIST

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

ACQUISITION CHECKLIST

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

 


 

CHAPTER II

HOW TO IDENTIFY A TARGET COMPANY

Usually there will be four stages involved in an acquisition: identification, wooing the target, execution and post-acquisition integration. In order to identify and correctly woo the target company, key activities should be undertaken which include:

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

Small and medium-sized companies usually make acquisitions in their own or closely-rated business areas. A common way of finding an acquisition is through knowing a company or an individual in the same sector. This can mean reduced risk in that the company and its products are likely to present few surprises but can also mean the acquisition may be made without sufficient exploration of the alternatives. There are many other sources of data that are useful for identifying acquisitions targets, including:

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

The Business Sale Report by Business Data International Ltd., Tel: 0181 875 0200 details medium to large companies for sale in the UK valued from around £200,000 to over £50m and costs £135 for an annual subscription.

External advice is helpful when looking overseas for an acquisition. Companies should be able to identify overseas businesses that have useful technologies or interesting products that can be licensed for the UK market. Sometimes this approach can be more viable than an acquisition.

Internal sources of acquisition opportunities may include:

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

Small and medium-sized businesses can also be purchased through third parties such as company brokers, administrators, receivers or accountants and merchant banks.

INTERMEDIARIES

Strengths

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

Consultancies

A consultancy may be useful in the search for an acquisition when the strategic rationale for making an acquisition is unclear. A consultancy can also assist when too many options exist or there are no affordable or attractive targets in obvious sectors or when the search includes overseas initiatives, or when rapid post-acquisition integration or implementation of change is required and management resources are likely to be stretched.

Objectives

Objectives sought by acquiring businesses may include:

  • Gaining access to new customers or market segments
  • Realising economies of scale
  • Introduction of new management approaches
  • Reduction or elimination of a competitive threat
  • Gaining access to a new product or technology

The ideal target will depend on the importance of these criteria. A strategic audit prior to the acquisition search will introduce new dimensions into the identification of a target and will assist management in focusing on the goals and criteria in making an acquisition. A strategic audit will look at the external market position and the internal capabilities of a company and will endeavour to evaluate key trends, issues and risks and assess the main strategic challenges facing the acquiring company:

(AVAILABLE IN FULL SUBSCRIBER'S VERSION)

 

Properly conducted, the process will ensure that sufficient analysis is undertaken to identify the role of an acquisition in the growth of a company. It will permit the company to look outside its traditional markets and broaden its list of potential candidates.

 


 

CHAPTER III

EVALUATING AND WOOING THE TARGET

A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBER'S VERSION)

 

Having identified a target or made a shortlist, the acquiring company will have to woo the target if that target is not 'on the market'. It is important to establish a process for monitoring changes in the situation of the target company: these could include a change in market position, management change or the entry of an aggressive competitor into the market-place.

Regular progress meetings should be scheduled during the wooing stage.

Communication is essential to build up trust between the parties and to develop a mutual understanding of each other's businesses. Logic supported by analysis is essential to convince targets of the advantages of selling. During a protracted process of negotiation it is sometimes easy for corporate attention to wander: it is advisable to keep the process alive and to maintain high interest levels.

Approaching the target and negotiating

Having identified a potential acquisition, decide how to approach the target. A decision will have to be made whether to make a direct approach or go through a third party and once a foot in the door has been established, negotiating tactics that will ensure the best chance of completing a satisfactory deal should be adopted. The importance of research As much research as possible should be carried out on the target.

Planning an approach

 

Dealing with the vendor

Set parameters and goals initially so you know what you want to get out of the negotiation. Knowing your goals prevents the other party from setting the tone and pace of the negotiations. Stick to major objectives: a good negotiator wins the important issues and allows the other party to win minor ones. Good research will prove invaluable in the process: for example, if you have discovered weaknesses in the target company, you may be able to reduce the price. Make sure that your position can be justified: if you are trying to lower the price then you will have to present reasons for it. If the vendor wants a higher price, ask him to justify it. Professionalism It is a good idea to have competent professionals on your team who understand your objectives. Try to make sure they understand your style and brief your team thoroughly and if necessary, role-play the negotiations beforehand.

 


 

CHAPTER IV

NEGOTIATING TECHNIQUES

A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)

 

Negotiating should, ideally be a win-win situation, not win-lose, so try to find creative solutions where both parties can be winners but if you are unable to satisfy the objectives you have set, be prepared to back out; there are always other fish in the sea. The opening position in negotiation is important because you want the other party to believe that you mean to settle at or very close to it. Therefore, it needs to be credible in both content and delivery; this will include being realistic and it is unwise to opt for an extreme opening position.

 


 

CHAPTER V

VALUATION

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBER'S VERSION)

 

There is no 'correct' price for a business. The 'right' price is one that a willing buyer is prepared to pay and a willing seller is prepared to receive. 'Value' is to a large extent dependent upon who is doing the valuing: for example, a distributor of electrical goods may find that he is of more value to a related manufacturer than to an unrelated buyer.

Some outdated valuation techniques

It is not common these days to value companies on a net asset basis unless the bulk of the assets are readily realisable at book value, for example certain property companies and investment trusts. The book values of assets reflected in published accounts are usually drawn up on a 'going concern' basis. These values are often significantly higher than the values that can be realised if a business fails. In addition, other costs associated with the failure may arise such as redundancy costs and lease termination payments.

Accounting techniques that use net assets as a basis for valuation are problematical because they do not value intangible assets such as goodwill: net asset valuation does not value what most purchasers are really looking for - a stream of operating cash-flows.

Investment appraisal techniques

Capital investment appraisal techniques include payback provisions which basically calculate the number of years it will take to earn sufficient profits to equal the purchase price and is known as the Accounting Rate of Return (ARR). This is similar to the concept of Return on Capital Employed (ROCE) which calculates the future profits earned and expresses them as a percentage of the purchase price. The two techniques above have some limitations as valuation tools. However, they can and do act as a useful rough and ready check on valuations derived from more complex and theoretically sound methods, in particular in industries that tend to be volatile and those in which a buyer must be wary of any investment that does not have a short payback period and as a rough estimation as to whether the continuing profitability of a business is likely to justify its purchase price.

Comparison-based valuation techniques

The P/E basis of valuation (price/earnings) is perhaps the most commonly-used method of valuing unquoted companies. Choosing the appropriate company may also prove problematic and it should also be remembered that many small companies will, by virtue of size, make apparently more risky investments than otherwise similar but larger companies.

Yield basis valuation

A similar valuation approach is sometimes achieved by substituting the dividend yield per share of a comparable company for the P/E ratio and applying this in an adjusted form to the maintainable dividend per share of the target company - the 'yield basis'.

Discounted cash flow

One flaw in the comparative-based valuation techniques is that, in effect, they only achieve the valuation of another company and not the target company. The only satisfactory basis of valuing an unquoted company is one that projects its own future profits using discounted cash-flow techniques.

Two new discounted cash-flow based techniques have recently emerged as a practical way to value companies. The shareholder value method values the business as the sum of its discounted future estimated operating cash-flows less debts or plus cash. The future estimated operating cash-flows are discounted at a rate equivalent to the firm's opportunity cost of capital. This is usually calculated on the capital asset pricing model which combines the time value of money, the risks involved in investing in shares as opposed to cash and the risks inherent in the business of the target company.

Internal rate of return

The Internal Rate of Return calculates the price a financial institution might pay for the target with reference to the re-financing of the company so that it is optimally geared. The correct value will be a purchase price which achieves the required IRR. It may be interesting to compile a comparative company ratio analysis. None of the techniques of the corporate valuer are perfect but all have their use. Valuation will also depend on other accounting and non-accounting factors and differentials such as pre-acquisition or post-acquisition values, open market value and value to the business. Be careful when working out the value to you or your business that you have taken into account factors such as non-competition covenants and intellectual property rights such as royalties, copyrights, patents and licensing rights.

 


 

CHAPTER VI

TAX CONSIDERATIONS FOR BUYERS AND SELLERS

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)

 

TAX CONSIDERATIONS FOR BUYERS AND SELLERS

When considering any transaction, start planning as soon as possible as it gives the best chance of avoiding tax pitfalls and decreases the Inland Revenue’s opportunity to argue that measures are artificial and aimed at tax avoidance. It is essential to seek the advice of tax experts wherever possible.

Tax planning for vendors
The planning alternatives depend on two factors - what the vendor hopes to achieve and whether the sale is one of shares of the business or just its assets. The vendor may want to retire and live off the proceeds, reinvest in another business or remain active in the business after the sale. If a seller wishes to retire he is more likely to want to sell the company outright and factors such as Capital Gains Tax entrepreneurial relief, enhancement of pension benefits, non-residence, the use of trusts and pre-sale dividends become relevant. If reinvesting in another business, he may wish to transfer assets as the target company may be able to claim roll-over relief on the proceeds thereby deferring tax perhaps into retirement. If the vendor remains in the business, issues such as share-for-share exchanges and deferred consideration will become important.

Tax issues for vendors of share
Capital Gains Tax will normally be payable on any gain made by a vendor on the sale of shares. The chargeable gain which forms the basis of valuation for tax purposes is basically the difference between the proceeds on disposal less the allowable expenditure. Allowable expenditure is the aggregate cost of the asset and enhancement expenditure (called the base cost).

 


 

CHAPTER VIl

LEGAL ASPECTS OF BUYING AND SELLING COMPANIES

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)

 

A company is separate legal person and if a purchaser acquires all its share capital, it acquires a complete entity, with the possibility that it has greater actual or contingent liabilities than envisaged. By purchasing a company the buyer acquires not just a collection of assets and liabilities which is what would happen if a business was purchased but a legal entity or 'person' with attaching rights and liabilities. The main question that faces a buyer, then is whether to buy the shares of the target or the assets instead (and therefore assume certain liabilities of the target business). On the sale of assets by a company, tax will generally be payable by the company on any gain made and it is likely that further tax will be payable by the company's shareholders when any surplus proceeds are distributed to them. Generally, the only safe way for a buyer of assets to ensure that it is obtaining the benefit of a particular contract will be to seek the express agreement before proceeding with the acquisition. This kind of problem does not arise when shares are acquired.

Experts can help

The involvement of a legal expert or team from the outset can be especially favourable when negotiating the acquisition of a medium size or large private company.

First things first

The parties may wish to draw up heads of agreement initially: this can be useful but unless there is an urgent need to get the seller contractually bound, the buyer should not try to make such a document legally binding. However, a preliminary contract may be acceptable and a seller may insist on the buyer signing a binding confidentiality agreement before he starts his investigations to protect himself.

Buyer and seller should consider whether any consents or similar action are needed before proceeding. If the party is a company, it may need the approval of shareholders under the Articles of Association.

Stock Exchange Requirements

There may be Stock Exchange requirements if either party is a listed company: the listing rules or Stock Exchange 'Yellow Book' require shareholder's approval to be obtained if the transaction is a Super Class 1 or reverse take-over or if the other party is a 'related party' and in a case where the seller or the buyer is a listed company the provisions in Chapter 10 and 11 of the Yellow Book may indeed be relevant.

(FURTHER DISCUSSION AVAILABLE IN FULL SUBCRIBERS VERSION)

Reverse take-overs

The final class covered by Chapter 10 of the Yellow Book is known as a Reverse Take-over. If it does fall within the reverse take-over class an announcement must be made to the Announcements Office but there are also implications relating to the listing of the company's securities. Upon the announcement of a reverse take-over the exchange will suspend the listing of the company's securities. The company must send a circular to its shareholders to obtain their approval and must prepare listing particulars as though the company were a new applicant.

Related party transactions

Where a listed company proposes to enter into a related party transaction it must make an announcement, send a circular to its shareholders explaining the transaction and obtain shareholder approval.

The City Code on Take-overs and Mergers

The Take-over Code or 'City Code on Take-overs and Mergers' is mainly applicable in relation to the take-over of listed companies and is a voluntary Code so therefore does not have the force of law.

Monopolies and Mergers

The main legislation dealing with monopolies and mergers is the Fair Trading Act 1973. The provisions of the Act are administered by the Office of Fair Trading (OFT).

EU Merger Regulation EU

Merger Regulation can apply to UK acquisitions and it can sometimes be worthwhile applying for an advance consent or clearance. The regulation may apply where there is a merger of two previously independent businesses and control is not the only criterion - the regulation may also apply where one party acquires the ability to exercise a decisive influence over another. The regulation will only apply, however, if there is a 'Community Dimension' to the transaction. If the target trades in a regulated industry such as gas, telecommunications, etc. the regulator may need to be notified and clearance obtained.

Some considerations

If the deal assumes the form of a sale of share it may be relatively straightforward but it may be advantageous to reorganise the share capital before the sales takes place or move assets in or out of the target and the seller may also wish to take a pre-tax dividend. Tax planning advice at this stage including advice on liability for Stamp Duty is advisable. A private company is usually sold through a share sale agreement or share acquisition agreement. Completion in this case may be when formal transfers of the shares are handed over, sometimes immediately after signing.

If the freehold or leasehold property of a target company is an important item, as well as asking lawyers to investigate the legal title, one should consider having it surveyed. Environmental liabilities can be enormous these days as the UK has a body of law similar to that of the US which can expose the occupier of a property to substantial claims for pollution.

Investigations

Investigations will usually be carried out by an accountant although the seller may be reluctant to allow the buyer's representatives to examine it before the buyer has made a commitment. The result of such enquiries will almost certainly affect the price the buyer will pay and will enable the legal team to decide what warranty protection to seek.

Due Diligence

It is extremely probable that the prospective buyer and advisers will want to put all the aspects of the company under the microscope. This is what is called due diligence exercise. A due diligence exercise is carried out to validate strategic ideas and to provide an independent review and support for assumptions underlying the investment appraisal. It identifies negotiation points and can help determine practical solutions for the tactical implementation of a strategy. It may also form the basis of the sales memorandum. Where no investigating accountants have been instructed the purchaser's lawyer's should raise full enquiries at an early stage to flush out unexpected liabilities or other problems. Most law firms with acquisition experience will have standard 'ready-made' preliminary enquiry lists but it is up to the client to alert them to any particular concerns or issues so that the list can be tailored to suit the circumstances.

There are several areas of a due diligence exercise which are of particular concern to a prospective buyer:

It is important to find out what the employment terms of employees are in relation to senior management. Pensions are another area that require some investigation. Although there are now less under-funded pensions schemes than there used to be, one might inadvertently acquire a substantial hidden liability if, having acquired a company, it is discovered that its pension scheme is seriously under-funded.

Special requirements

It may also be necessary to obtain consents needed under covenants given to lenders and financial institutions. In certain circumstances the provisions contained in s320 of the Companies Act will be relevant. Another area of importance is the terms of contracts to which the target company is party. In some sectors of industry there may be special requirements.

 


 

CHAPTER VIII

PAYING THE PRICE

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)

 

The price of an acquisition is often paid in cash but, subject to the rule which prohibits a private company from offering shares or debentures to the public, a purchasing company may be able to satisfy part or all of the price by an issue of its own shares as loan notes. The price can also be paid by the transfer of any other assets.

The seller's position

The seller should endeavour to ensure that the acquisition agreement includes provisions which prohibit the buyer from asserting set off rights. If shares are issued in consideration of all or part of the purchase price if those shares are listed or publicly traded in any way, it will be necessary to consider placing restrictions on the sellers in terms of disposal.

Vendor placings

If the purchaser is a limited company it may use a method of giving the purchaser the proceeds of the shares issued through a 'vendor placing'. This is a mechanism whereby an acquiring company can use its own paper to fund an acquisition whilst providing the sellers with immediate cash.

Earn-outs

In any deal where the price has been calculated by reference to profitability the buyer may consider it a good idea to structure the deal so that the final price is dependent on profitability levels being maintained or enhanced.

Conditions

It is possible to make a sale and purchase conditional upon certain events. It is important in this instance to ensure that all the necessary pre-conditions have been identified and agreed early on in the negotiations. If conditions are included to benefit a particular party then that party should be permitted to withdraw from the deal if the conditions have not been satisfied within a certain pre-agreed time scale.

Timing

Timing of the payments may be an important factor. The buyer may wish to pay for the shares by instalment, either fixed in advance or varying by reference to the post-completion performance of the target ( an earn-out).

Contracts of employment

Contracts of employment between the target and its executive directors and employees will not normally be affected by the sale of the target's shares.

Intermediary fees and expenses

These are usually a combination of a Retainer and a Success fee. A Retainer is usually paid monthly over a three to six month period plus expenses. Thereafter, it is negotiated on a per diem (day-by-day) basis. A Success fee is payable on completion according to the Lehman scale (full details of the Lehmans scale available on the subscribers' site).

Warranties

The transfer of a business as an on-going concern will involve quite a complex sale agreement whereas the mere sale of business assets such as plant or equipment may involve little more than an invoice. In practice, it will be difficult for the buyer to obtain all the information about the company that he needs and he will probably have to rely on assurances by the seller that he has been informed about everything he needs to know. It is customary to include in the agreement a range of warranties by the sellers about the target and its operations. Conversely, the seller will normally seek a series of vendor protections to limit his liability. These comprise limits on the time within which claims can be made and on the seller's maximum aggregate liability. Warranties are statements about the business and affairs of the target company which the sellers are required to confirm/warrant as being correct. If the buyer then discovers later on that any of the statements was not correct he will have a right of redress against the sellers - a claim for a breach of warranty. A buyer has a duty to mitigate any loss suffered as a result of a breach of warranty by the seller and the burden of proof is on the plaintiff (usually the buyer) and proving to a court that there has been a breach of warranty can be difficult.

Indemnities

An indemnity claim differs from a warranty in that it is usually for a specified amount, whereas a warranty leading to a claim will usually be for the loss suffered.

Limitations

A claim under English law will automatically become statute-barred after the expiration of the relevant period. The period varies depending on whether the document from which the claim arises is a simple agreement executed under hand or a deed executed under seal. Claims for tax under warranties will usually be treated differently to those in relation to non-tax warranties because the Revenue has the right to retrospectively re-open tax assessments for a period of 6 years.

Disclosure letters

A seller will sometimes have to qualify warranties and these exceptions will usually be listed on a separate document called a disclosure letter which the seller gives the buyer when the contract is signed. Disclosure letters, written by the Solicitors acting for the sellers will generally try to include a string of general items which are stated as being deemed to have been disclosed. If a buyer does become aware of a problem concerning a target company, it is not acceptable practice for a buyer to pursue a claim because it is not referred to in the disclosure letter. A court will not look kindly at a claim in relation to a matter of which the buyer was aware even if the warranties have apparently been breached.

Retentions

Normally, once the deal has been completed, the possibility will remain that the buyer will subsequently have claims against one or more of the sellers because of the warranties, indemnities or other undertakings obtained from them in the acquisition agreement. Retention provisions do have some problems but, from a buyer's perspective, they should be considered.

Guarantees

If the seller is a subsidiary company the buyer may expect the holding company to guarantee the seller's obligations under the agreement. In the same way, the seller would probably ask the buyer's parent company to guarantee if, for example, the full price was not paid on completion.

General checks

No two company sales are alike and what is crucial in one deal may not be important in another. There are, nevertheless, certain points that need to be considered at the outset in order to prevent delays later on. For example, the buyer may wish to investigate the target's title to freehold or leasehold property or be given certificate of title. It is also advisable for a buyer to elicit whether the target has unencumbered use of patents, trademarks, registered design copyrights and other intellectual property it uses in the business.

Restrictive covenants

There may also be issues regarding UK and EU competition law if it is intended that the seller of its directors be prohibited from competing. Where substantial amounts are being paid for goodwill, any buyer should consider at an early stage the restrictive covenants he should seek from the seller as to their activities once the sale has taken place. If the people who built up the target company over a number of years were to set up a new competitive operation, they might inflict damage on the target.

The Restrictive Trade Practices Act 1976 imposes requirements that agreements containing restrictive covenants be registered with the Office of Fair Trading. If registration is not made within the required time period, any restrictions contained in those agreement will be void and enforceable. It is necessary, therefore, to obtain advice as to whether or not there is a need to register the agreement with the OFT.

Further considerations

With regards mortgages, guarantees and other obligations it will be necessary to establish whether the target has entered into any of these kinds of obligations and whether they will be discharged at completion. If a floating charge is current, a certificate should be obtained from the bank to the effect that it has not yet crystallised. The parties may wish to adopt a common policy over any public announcement that may be made. If any of the parties is not based in England or Wales a provision will need to be made to define the law of the country governing the transaction and the courts which will have jurisdiction in the event of a dispute unless an arbitration clause is present in the agreement.

Share sale vs. a business sale

Employees' contracts of employment are automatically transferred to and become the responsibility of the buyer under the provisions of the Transfer of Undertakings (Protection of Employment) Regulations 1981 (TUPE) when a business is sold. Pensions are excepted. TUPE imposes duties to inform Trade Union representatives. Liability to PAYE and National Insurance contributions remain with the seller.

A share sale will not, except where there is a change of control clause, affect contracts with employees, customers, suppliers and lessors of the target company but a business sale does and therefore a buyer should check that the seller is free to transfer the benefit of contracts which will not automatically be transferred by operation of law. In a share sale a target's pension scheme arrangements will be unaffected but this is not so in the case of a business sale unless the purchaser becomes the principal employer of the seller's scheme.

There may be commercial significance in the amount of any transfer value paid from the seller's scheme to any scheme of the buyer's which the seller's employees are transferring. VAT may sometimes be payable on a business transfer and the parties should decide whether the sale price is inclusive or exclusive of V.A.T.

The point in time at which the risk in the assets transferred is to pass should be established and agreed so that the buyer can arrange insurance cover from then.

Confidentiality

When contemplating the sale of a company, before releasing any information about it, the prospective buyer should really be required to enter into a confidentiality undertaking agreement that he may not use or disclose any of the information which he is given other than purely for the purposes of evaluating the proposed acquisition.

Completion

Advance thought and planning should be given to completion arrangements especially as they can be time-consuming and involve delays. Where individual sellers are involved it is a good idea to obtain powers of attorney from each of them in advance to avoid delay if any of the sellers is unable to be present.

 


 

CHAPTER IX

FINANCING PRIVATE COMPANY ACQUISITIONS

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)  

Development capital is the most active area of venture capital investment but almost two thirds of the money is invested in the management buy-out or management buy-in market. The acquirer will usually have existing advisers who can assist with the acquisition and it is important for them to have the appropriate 'corporate finance' experience. In particular, the adviser should be familiar with the process of raising equity finance. To avoid wasting time and effort the acquirer should, with the help of an adviser, narrow financiers to a short-list of three or four.

Presenting to financiers

The business plan should make clear the commercial logic behind the proposal requiring funding. It is important that the financier understands the motivation of each of the parties involved including why the owner of the target company is selling and what the shareholders of the investing company want in the long term. The financier will be particularly interested to understand how quickly he will receive his money back after the transaction and to determine what degree of downside protection there is in the business.

Equity vs. mezzanine vs. debt

The senior debt provider usually takes security over the company's assets. The level of senior debt available must first be established before the remaining financial structure can be agreed. Mezzanine debt will not have full asset security and will rank behind the senior lender. The mezzanine debt provider will take a view about the company's cash flow and the ability to sell the company in the event of a level of under performance. Equity finance ranks behind all other instruments and generally takes the form of preference and ordinary shares. Interest cover, cash flow and net worth covenants will be required by the debt provider. Failure to repay interest or capital will constitute a breach whereas failure to pay a dividend or redeem preference shares will give the equity provider certain rights but will not immediately risk the company's future.

Equity finance reduces the financial risk of the business and allows the management to concentrate on running the business; it is permanent and unsecured, does not tie up the asset base and its servicing costs are dependent on the level of profit. Financing the acquisition with debt leaves no room for under performance and as a considerable amount of uncertainty is involved in an acquisition, debt financing should not be a first choice option.

 


 

CHAPTER X

PREPARING A BUSINESS FOR SALE

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)  

Once a seller has decided to sell a company, the next step to choose is the method of sale and identify potential purchasers. This raises questions such as whether flotation is an option or should there be a trade sale and if the latter, should trade buyers be sought.

Management buyouts and buyins

Another possibility is that the management team may be a potential purchaser and a management buy-out may be on the cards. A management buyout can be described as the acquisition of an existing business by a group consisting of some of the existing managers of the business and institutional investors, the latter providing most of the equity financing.

Flotation

Flotation may be an option if the main objective is not just to realise an investment but to raise cash to finance growth. A stock exchange listing can provide the most cost-effective dilution of owners' equity, but companies have to be a reasonable size, usually making pre-tax profits of at least £2m with good growth potential. As well as providing a cash injection, flotation enables managers to continue to participate in the business but the Board of Directors may need to be strengthened in order to conform to the standards of disclosure and accountability required of public companies.

Price expectations

In most sales, price expectations are of paramount importance. Whatever price the seller decides to opt for, it should be tested against the opinion of professional advisers. Often, sellers will like to think their business is worth more than it really is and it is not in their best interests to try to market the business at an unrealistic price. If the price is initially pitched too high a seller will lose credibility in the eyes of potential purchasers if he subsequently tries to reduce it. A seller may also risk wasting his own time and disrupting the business.

Having agreed a realistic price expectation the next stage will be to develop the rationale behind it and to be able to justify the price to a potential purchaser. Vendors who are looking for some sort of strategic alliance may prefer not to take professional advice and to draw up a short-list of possible purchasers of their own. In this instance, it is advisable to establish a good commercial relationship before broaching the subject of a strategic alliance as this will increase the changes of creating a harmonious atmosphere without any formal negotiation or disclosure of confidential information to the market or to employees.

The sales prospectus

The seller and his advisers should construct a clear sales prospectus describing the background to the business, the market in which it operates, future trading prospects, product opportunities and details of its financial position. The prospectus is an important document and may take up to two months to prepare and finalise.

Listing prospects

A seller and his advisers may need to analyse lists of hundreds of companies in order to select those to which the sales prospectus will be sent. Typically, a prospectus might be sent to 30 or 40 potential buyers together with a confidentiality letter.

Look far afield

Restricting the search for buyers to the UK can be a mistake. A great deal of interest in UK company sales now comes from abroad, particularly from the EU and the USA. If an independent adviser is used, it is wise to ensure he has the scope to attract international interest.

Good grooming

The process of grooming a business for sale and endeavouring to attract potential buyers begins by reviewing its origins and assessing the future needs of stakeholders including employees. The history of the company is likely to influence the exit strategy and the negotiating stance. It is useful to be clear on the reasons for a sale: if looking just for the best price either flotation or a sale to a management buy-out team might be an option. If the development of the business will be best achieved as part of a larger group then a trade sale might be favoured. It may be that a fire-sale is the impetus behind disposal and speed is of the essence.

Good housekeeping

Basic housekeeping procedures can reduce on-going costs and increase profitability but cost-cutting should be done carefully because cost-cutting that damages the business in the future will be spotted by a sensible buyer and if the sale falls through, the seller will be left with the consequences.

Timing the sale

The background to the sale will affect timing. A fire sale will allow little time for planning but if selling in order to realise an investment in a healthy business, setting a timetable can help maximise objectives. An important issue is whether the sale will be based on historic or prospective earnings. This can make a huge difference to the final price gained. By delaying a sale until perhaps two months before the end of a trading year, it may be possible to secure a sale price based on improved current year earnings compared to a lower price if the sale is based on historic earnings. Seasonal fluctuations in working capital can also affect the face value of a company and the timing of the sale.

Presenting financial information to potential buyers

When presenting financial information to potential buyers, try to ensure that it is sufficient to satisfy them but avoid giving away confidential information to a competitor. Try not to bombard a potential buyer with too much detail in the early stages of negotiation and be accurate and truthful at all times. Buyers will not be impressed by inaccurate or inflated figures and may lose confidence and interest in a deal as a result.

Intelligent negotiation

If the business is strong and there are many potential buyers the ultimate price is likely to be higher and a seller will be able to dictate the pace and direction of negotiations more easily. If the business is struggling, a seller should recognise that he is in a weaker negotiating position. Understanding the buyer's position is vital in negotiations: financial buyers such as management buy-out teams are likely to require detailed, forward-looking financial reports of their own but trade buyers who will primarily be looking for operational advantages may accept historical financial information and be more concerned with synergy.

 


 

CHAPTER XI

POST-ACQUISITION INTEGRATION

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)

 

To integrate almost any acquisition, a management team is needed who know each other well and understand each other's methods. The period immediately following an acquisition is a one of enormous uncertainty and is one of readjustment that can be fraught with problems. The problems can vary enormously depending on the situation of the target and the abilities of the new management.

A description of ten of the most frequent strategy implementation problems that can be encountered is available on the subscribers' site.

In many cases, the use of a culture audit or portrait of the company undertaken well in advance of the take-over will be beneficial.

 


 

CHAPTER XII

AFTER THE SALE

(A FULLER DISCUSSION ON EVERY HEADING IN THIS CHAPTER AVAILABLE IN FULL SUBCRIBERS VERSION)

 Considerations for the seller after completion of the deal will depend on whether or nor he will retain an interest in the business, whether through a share holding, working for the business or an earn-out.

Tax planning in this respect is important and the seller should take advice on the most tax-efficient means of extracting the proceeds from the sale of the business. Forward planning may also be necessary with regards to Inheritance Tax (IHT) and Capital Gains Tax. For the purposes of Inheritance Tax, the first £200,000 of an estate is tax free and the rate is at present 40% for transfers on death Most lifetime gifts made more than seven years before death will be free of IHT as are most transfers between husband and wife or on death. Spouses have separate IHT bands and savings can be made by ensuring that the nil rate band is utilised. An annual exemption of £3,000 applies to lifetime gifts made by the donor each year and there are other exemptions on other kinds of gifts. With careful planning and expert tax advice, IHT can be reduced and the use of trusts can assist in this. Spouses should try to make use of all appropriate income and capital gains tax allowances and reliefs, including use of spouse's lower and basic rate band. Use should be made of tax efficient investment vehicles such as personal equity plans (PEPs) and tax exempt special savings accounts (TESSAs).

Where there's a will

Sellers should make a will and take advice to ensure that assets are distributed as desired and as tax-efficiently as possible. The will should be reviewed regularly to take account of any change in financial position. The seller and his family should have sufficient life cover in the event of his death to cover any IHT liabilities. Any policy designed to cover IHT should normally be written in a suitable form of trust so that it does not fall into the seller's estate for tax purposes and thus defeat its own object because tax will be due on the insurance money itself.