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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
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