For many, buying a company can be a frightening prospect and those looking to make their first acquisition will undoubtedly have many questions. There are a number of complexities and nuances which can arise, particularly on larger transactions. Here then, is your guide to the principles which apply to all transactions.
Q: Should we acquire the shares or just the assets of the target company?
A: Usually the shareholders of the target company wish to dispose of their shares in order to take advantage of taper relief and substantial shareholding exemption for CGT. From the buyer’s perspective there are sometimes tax losses in the target company which can be utilised, and there are issues such as stamp duty which could be significant if the assets include a land or buildings with substantial value. However, one major consideration in the acquisition of shares in the company, is that the buyer would normally be taking on all the liabilities of the company and it is essential that a very thorough due diligence exercise be undertaken. This is why it can often be attractive to a buyer to try to cherry pick certain assets and leave behind the liabilities in the company. However there may be some liabilities which will pass in any event, in particular, if the essence of business is being acquired and the TUPE regulations will apply in respect of employees.
Q: How do we calculate the price?
A: There are various accounting methods of valuing shares but inevitably you will have the financial position of the company assessed by your accountant. There are intangibles such as the goodwill of the company which may be more difficult to value and as with most other transactions the matter ultimately comes down to how much you are willing to pay and how much the seller is willing to accept. There can also be a certain element of ‘earn out’, where the final amount payable to the seller depends on the future performance of the company.
Q: What if figures cannot be finalised until after the intended completion date?
A: It is not uncommon for there to be adjustments to the price depending on the financial position of the target company on the completion date. This may be on the basis of the value of a single asset such as stock which will need to be valued or it could be of a more general nature with an accountant certifying the financial position of a company once all relevant information is to hand. The share sale agreement will specify a formula by which any adjustments to the price are to be calculated.
Q: How do we pay for the company?
A: There are three basic means of payment - shares, loan capital and cash. Whilst there is nothing to prevent an unlisted company from issuing shares for an acquisition, in practice sellers are not normally willing to accept such shares as there is no ready market for them. Also the buyers may not wish to have their controlling position in the company diluted. Therefore the issue of shares as payment for the acquisition of a private company is uncommon.
Q: Can we use company funds or assets to fund the purchase?
A: The general rule is that it is illegal for a company to give financial assistance for the purchase of its own shares. There are some exceptions to this rule which apply in limited circumstances and which require detailed procedures to be followed. Great care needs to be taken as a breach of the rule can be a criminal offence and breaches can be triggered inadvertently as even indirect financial assistance is prohibited.
Q: What is meant by due diligence?
A: This is a term commonly used to describe the investigation into the affairs of the target company. Whilst this is primarily a financial and legal investigation, it may also be a business one eg. checking out the quality of the company’s customer book, and also a physical one on the condition of assets such as buildings, plant and machinery. The extent of the investigation will depend on the circumstances of the transaction, for example on a management buyout the buyers may not feel the need to carry out such a thorough investigation because of their familiarity with the company. Short cuts on due diligence is generally a false economy.
Q: Is there any way of protecting ourselves against future problems?
A: It is usual to require warranties which are written representations given by the seller on various matters relating to the company’s position. These may be simple ones such as representing that the company has no actual or threatened litigation against it, to complex ones relating to the company’s tax affairs. The warranties are often qualified by reference to a statement signed by the seller setting out the material information disclosed to the buyer. If within the warranty period a liability arises which is covered by a warranty but was not disclosed by the seller then a claim will arise. Warranty claims are often limited by both time and amount.
Q: What happens to the employees?
A: If it is the shares of the company which are being acquired the employer, which is the company, will not change and the employees will continue to be employed. If assets are acquired then if there is a transfer of an ‘economic entity’ the TUPE regulations will apply and the employment contracts of the relevant employees will be automatically transferred to you. Employees can be made redundant but only on technical, organisational or economic grounds, but if this is envisaged great care needs to be taken particularly as any dismissal purely by reason of a transfer of ownership is automatically unfair. As part of the due diligence exercise investigation should be carried out into the position of staff and, for example, whether key staff will remain after the takeover and whether there are any existing or potential claims. You would probably also wish to make sure that the employees have suitable contracts with the relevant restrictive covenants where appropriate.
Q: How do we aid the smooth transfer of control of the company’s business?
A: Apart from the usual business skills in making sure that key staff and customers are treated correctly you might also want to consider continuing to employ the seller on the basis of a consultancy/service contract, assuming that they have been involved in the day to day management of the business. These contracts are normally on a fixed term basis although it is not uncommon for a seller to get itchy feet and look to leave before the contract expires. It is important to note that a seller as an employee of the company would have usual employment rights.
Q: Can we prevent the seller from competing with the company?
A: Yes, provided that any restriction imposed on them is reasonable to protect the company’s interest. It is usual to include restrictive covenants in the share sale agreement and they would be defined by reference to time, geographical area and type of business, the extent of which depends on the factors such as the type of company, the nature of its operations and the area which it serves.
Q: What if there are a number of buyers acting together by way of a joint venture?
A: It is usual for there to be a shareholders/joint venture agreement to regulate relevant matters between the buyers/investors. As to what is covered will depend upon the particular circumstances, but typically would include matters relating to the provision of funding share allocations and whether there are different types of share carrying different rights; if there are minority shareholders, provisions which prevent the majority shareholders from abusing their dominant position; and if there is a sleeping or venture capitalist type partner, requirements for the provision of information and for board representation. It is also common for there to be pre emption rights giving other shareholders the right of first refusal should one of them wish to sell their shares, and to restrict circumstances under which the shares can be sold to third parties.
Q: What tax issues arise?
A: Of course there are plenty of tax issues to consider, but that’s another story on its own.
Christopher Sykes is a senior partner specialising in Company Commercial at Sykes Anderson LLP
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