You are a business family or owner-manager; you are dynamic, self-made and entrepreneurial. You have worked tirelessly to create a business that is successful, sustainable and the market now wants. The time has come to realise your investment.
Aside from being both exciting and emotional on a personal level, selling your company is a time-consuming process, the demands of which will need to be managed whilst ensuring the day-to-day operations of the company continue as “business as usual”. The demands of a sale process can constitute a second full-time job for you and your management team and taking some simple steps to prepare your business for sale will alleviate some of the strain.
Due diligence
An integral part of any sale purchase is due diligence. A buyer will carry out due diligence on a target company to understand what they will be purchasing and to confirm the purchase price they are prepared to pay. If the target company’s liabilities are greater than expected or the company is found not to own or have the right to use certain assets, a buyer may seek to revise their offer. The buyer’s due diligence is important as the outcome of the buyer’s review of the target company can have a direct impact on the value of the sale.
Legal health check
Whilst each sale is different, there are certain aspects that all buyers will focus on during their due diligence exercise. A simple legal health check will help you to identify and manage potential legal issues before a formal sale process commences and remove some of the pressure on management resources.
Common pitfalls
Below are five common issues we have seen raised by buyers in a sale process as a result of their legal due diligence review.
The target company’s statutory registers and Companies House filings are not up to date
A company’s statutory registers (also commonly referred to as company books, which include the register of members, register of directors, register of transfers, register of Persons with Significant Control (PSC) and register of charges) and Companies House filings are often viewed as low priority housekeeping items for management but, from a legal perspective, they are important and need to be maintained by law.
The company’s register of members is the prima facie evidence of who the shareholders of a company are and their shareholdings in the company. A buyer will need to check the register of members to confirm who is able to sell the company and that the public record at Companies House reflects the same. It is not uncommon for a company’s statutory registers to be out of date or for there to be discrepancies between the statutory registers and the company’s record at Companies House. In the event that the statutory registers have been lost or mislaid, the company will need to reconstitute its company books and formally adopt the same.
Carrying out a review of the statutory registers and Companies House filings ahead of time will speed up the sale process and allow a seller to present all the corporate information in relation to their business in a clear and coherent way.
The target company does not own all of its intellectual property
Any buyer will want to ensure that the company owns or has the right to use all intellectual property that it needs to operate its business.
Sellers should review the company’s contractual arrangements with consultants and other third parties that have been engaged to create or provide products and services for the company or on the company’s behalf. Unlike employees, where the default position is that intellectual property created in the course of employment belongs to the company, intellectual property that has been created or developed by a consultant must be expressly assigned to the company. In the event there has been no express assignment of intellectual property, the company can seek to negotiate and agree a confirmatory assignment of the intellectual property without the risk of an imminent sale being used as leverage against the company.
Sellers should also review how the target company uses the intellectual property owned by third parties and ensure that the correct licences are in place. A health check will identify what new arrangements need to be put in place or whether any existing arrangements need to be varied.
Employment contracts are no longer fit for purpose
If the role of a key employee has changed over time as they have risen up the ranks, has their contract of employment also developed to reflect their new position? A senior executive with a minimal notice period and limited restrictive covenants could be a cause for concern for a buyer.
The employment contracts should comply with all latest employment (and other) law and be accurate in respect of, as an example, all employee benefits.
Invalid share option schemes
EMI share option plans and other share incentive plans are a common way of incentivising key members of personnel and management. However, incorrect or unsigned option documentation, invalid returns or missed filings could invalidate the grant of options or result in EMI options losing their tax efficient status for employees. A review of the company’s option plans can identify issues at an early stage and provide the company with the opportunity to rectify any oversights (and if necessary grant replacement options) ahead of a sale. Catching any issues before a sale will prevent the undermining of goodwill that the issue of options was designed to maintain.
Key commercial arrangements have lapsed or are subject to change of control provisions
Sellers should ensure that the target company has suitable contracts in place with all key customers and suppliers. A buyer will want to ensure that the target company’s material contracts have sufficient longevity and legal and commercial certainty. A buyer will also want to confirm whether any material contracts of the business can be terminated by third parties on completion of the sale under a change of control provision.
A review of the company’s material contracts will enable the target company to identify any key arrangements that need to be renewed or renegotiated ahead of any sale in order to put the company on the best possible contractual footing to support the company’s valuation.
Business incentives: tax efficiency
From a personal taxation perspective, a selling business owner would be concerned to ensure that available reliefs are being maximised. In particular, the availability of Business Assets Disposal Relief (“BADR“) could mean that the applicable rate of capital gains tax (“CGT“) on up to £1 million of gains is reduced to 10% for qualifying shareholders. Making sure that the strict technical requirements for the relief to apply are met throughout the two-year qualifying period for all relevant family members and trusts is critical. With speculation rife about potential CGT rate increases to be announced in the forthcoming Autumn Budget, the value of BADR to entrepreneurs should not be underestimated.
Less often at the forefront of younger entrepreneurs’ thinking, Business Relief from inheritance tax (“IHT“) and the ability to contribute relievable assets into a trust with no upfront IHT cost can also be highly beneficial. In the right circumstances, this would allow appreciation in the value of the business and ultimately the proceeds of selling the trustees’ interest in the business to accrue outside the estates of relevant individuals.
In each case, taking advice early could mean the difference between qualifying or failing to qualify for valuable reliefs at the time of sale.
How we can help
Whether a business exit comes following a carefully planned and delivered strategy, or in response to an unexpected bid, as with all liquidity events, it creates a tabula rasa in investment terms and space for reflection regarding the purpose of wealth, how it should be invested (and with what impact), enjoyed and passed down the generations. As such, it may provide impetus for the creation of a formalised family office and governance framework where one did not exist previously; it would certainly be an occasion for revisiting the entrepreneurs’ aspirations for the future and wider succession planning.
Please do get in touch if you would like to discuss any of the issues touched on above. Our Corporate specialists can help you prepare your business for sale by carrying out a legal health check, discussing discrete items or advising more generally on any sale process. Our Private Client team would be pleased to support you with your personal tax, Will and succession planning; as well as the implementation of a bespoke family office and governance framework that evolves with your circumstances.