Inside Out – Buying a business
2 August 2019
The chances are that during your years of hard work growing your own business you will have identified one or more target businesses as a potential ‘good fit’ with your own enterprise. Ideally you will have spent time courting the owners of your target to feel confident about the synergies that the target will bring to your business.
The ‘pros’ of buying a business are usually obvious. No doubt your main concern is ensuring that you have identified all the ‘cons’ so that you do not compromise your business success to date. There may be a myriad of matters to consider but there are common themes which your solicitor will be very familiar with.
Take advice at an early stage to ensure that you are concentrating on all appropriate issues and ensure that your advisers understand your motivation and the risks as you perceive them.
Buying a business is time consuming and can be a major distraction from your day to day business activity. You need to plan for the time commitment involved and ensure that your own business is not neglected in the process.
Business valuation and source of funding
Most advisers will say that valuing a business is an ‘art rather than a science’ but there must be justification for the price. The seller will no doubt have a ball park figure in mind as the starting point for negotiations.
You should seek advice from a suitably experienced valuer and ensure that your financial and legal enquiries (referred to as ‘due diligence’) will stand up to the scrutiny of your lender or business investor.
If you need to borrow money to finance the purchase or you are relying on third party investment make sure you appreciate the lender’s / investor’s requirements fully. This is especially important if you need to move quickly and there is another buyer in the wings. A buyer will ask questions to assess your ability to proceed and anticipate the likely hurdles.
It may be appropriate to seek advice from corporate finance specialists who will be able to look at options available to you. Depending on the transaction you may use a mix of borrowing and third party investment with a view to giving up some equity (shares) in your company to an angel investor. The latter will entail an investment agreement or shareholders agreement and changes to your company’s articles of association.
You will need to take time to properly understand these documents and the limitations which you will need to operate the business within.
Financial and legal due diligence on the target business is essential. This entails asking a suite of standardised or bespoke questions which the seller must carefully answer. The seller will expect you to sign a confidentiality agreement to ensure you do not use any sensitive business information if the purchase does not proceed. You should have this checked by your solicitor before signing.
If the due diligence process reveals any issues of concern it may be appropriate to renegotiate the price and or seek an indemnity from the seller in respect of any liability arising from that issue. You may also want to retain a sum from the purchase price for a fixed period of time as security in case of a warranty claim.
Share purchase or asset purchase?
Assuming the target business is carried on as a limited company you can either buy the shares from the shareholders of the company (‘share purchase’) or buy the business as a going concern from the company itself (‘asset purchase’). Various factors need to be assessed to ascertain which method is best depending on the facts in each case.
A share purchase means that you acquire the target company ‘warts and all’ (i.e. you inherit control of the company and its trading history and the entirety of its liabilities and tax affairs).
An asset purchase allows you to cherry pick the elements of the business you wish to acquire and leave behind liabilities and assets which you do not want (albeit with some exceptions, most notably concerning the protection of employment of the target’s employees). If you wish to take over any significant live contracts then you will need to specifically address the transfer of each one.
Your solicitor will be able to advise on whether an asset or share purchase is most appropriate. Each method has various pros and cons but generally speaking share sales are more common. If the business is a partnership or limited liability partnership then a different approach is required.
Timing for payment
It is often very helpful if the buyer retains the seller (especially if the sellers comprise the management team of the target) for a period after completion to help the buyer successfully integrate the business into their own. To incentivise the seller the share price can be structured to include an ‘earn out’ which depends on the performance of the business during that post sale period.
Deferred payment arrangements and earn outs deserve careful attention. There are a variety of ‘ifs’ and ‘buts’ to consider, e.g. what happens if one of the sellers cannot work the entirety of the earn out period for whatever reason?
Consider holding back some of the purchase price for a period of time as security for any warranty claim you may need to bring against the seller. Your solicitor can hold money in an escrow account for this purpose.
This represents a flavour of just some of the considerations to be given and which your legal adviser will help you navigate.
The content of this article is from the summer 2019 edition of Inside Out and is for general information only. For further advice, please contact a member of Birketts’ Corporate Team.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at August 2019.