Andrew Woolf and Sarah Carlton outline key points for sellers to consider when selling a business.
The travel sector is facing some of the greatest challenges it has faced for a century due to the rippling effects of COVID-19. An end to the furlough scheme, uncertain government policies and a slump in bookings have put incredible pressures on the industry. Unsurprisingly, M&A activity both in the sector and more generally has fallen since the beginning of the pandemic, however despite the continuing uncertainty, deals volumes are looking likely to increase with opportunities arising for both potential buyers and sellers.
Buyers with a stable balance sheet will be looking to acquire businesses with strong brands or customer base. On the other hand, sellers may be looking for a sale in order to exit before possible changes to capital gains tax comes into effect or to gain financial support once government support schemes fall away. For a seller, in addition to agreeing a favourable purchase price, five key points to consider are highlighted below.
- Know your buyer
- Be prepared
- Due diligence – the devil is in the detail
- Travel business regulatory considerations
- Tax implications
1. Know your buyer
Although not fixed, buyers are often categorised as trade (strategic) buyers and institutional (financial) buyers. Trade buyers will look for a company to synergise with its existing operations and look to pursue more strategic acquisitions, whilst institutional buyers consider acquisitions solely from a risk and return perspective as they will be selling the acquired business at a later date. For a trade buyer, one of its first decisions will be whether to embark on a share purchase or an asset purchase of a target business. On a share sale, you will be selling the company’s shares which in turn encompasses all the company assets and liabilities; effectively “the entire business”. An asset sale enables a buyer to “cherry-pick” the specific assets it wants to purchase. An asset sale may be a convenient option when you want to sell a part of the business and reposition other parts of the business operations, however, it may also mean you are left to deal with the business’ liabilities. Generally, a share sale would be preferable for a seller trying to achieve a clean break and favourable tax treatment, but this would be specific on the facts of a particular transaction.
The financial covenant of the buyer is also key, especially if part of the purchase price is to be deferred. Thought should also be given to the way a buyer is looking to finance the purchase. A buyer may be looking to fund the transaction entirely out of its own resources, but it will usually need to involve other parties such as banks, investment partners or institutional investors. Involving third parties often creates a need for further negotiations and legal documentation and can affect timetables when transactions are reliant on buyer funding.
Before heading into negotiations, know what you want and where you will compromise and what you will not accept. Getting legal advisers involved at the term sheet stage can help with negotiations of the term sheet and can often make the entire M&A process more efficient once the term sheet has been agreed.
2. Be prepared
From a seller’s perspective it pays to prepare in advance for a sale. More often than not a buyer will be given a period of exclusivity to finalise their due diligence and negotiate the final terms of the purchase. At this stage the balance of negotiating power moves away from the seller. It is difficult to go back to potential bidders that you have turned away if negotiations with your preferred buyer turn sour. We would therefore recommend before granting exclusivity:
- negotiating detailed heads of terms as it may be harder to negotiate points at a later stage of the transaction; and
- undertaking a legal and financial due diligence review so that any material issues can be thrashed out with the buyer in advance (see further below).
3. Due diligence – the devil is in the detail
In M&A, a buyer will be looking to undertake varying degrees of due diligence of a seller’s business. A buyer will look to obtain a full picture of the company’s past performance, especially if the transaction is structured as a share sale where it is taking on all of the company’s liabilities. Preparations for the due diligence process from a seller’s perspective should begin as soon as a decision to sell is made.
Legal due diligence can uncover issues regarding employment matters, debt and security, intellectual property rights, data protection matters and compliance (or lack of) with relevant legislation. A well-advised buyer in the travel sector may also be looking for any potential regulatory issues in terms of compliance with travel regulation, insurance distribution regulation and consumer credit laws.
A buyer will also undertake financial due diligence which will usually focus on the quality of historical earnings and profits, future prospects of the business and balance sheet issues and will progress with its own commercial due diligence on the target business.
For regulated travel businesses, a key part of the legal due diligence will be whether there are change of control consents required from the relevant travel regulators or associations upon a successful sale, whether that be from the Civil Aviation Authority, the International Air Transport Association (IATA), the Travel Association (ABTA) and any other international regulators that regulate the target business (see further below).
Advisers (both financial and legal) can assist sellers in the organisation side of things and may undertake some form of seller due diligence (prior to the buyer reviewing any documents) to help mitigate any material issues, such as contracts which have not been properly executed, missing financial records or incomplete corporate information. Being ready to allow a buyer to review documentation and information regarding the business and thinking ahead about any potential issues that the buyer may want further details on will help save time in the long run. It can send a positive message to a buyer that the business is well organised and the management know what decisions have been made and for what reasons.
The results of due diligence may give a buyer opportunity to seek to re-negotiate the purchase price and along with usual sale warranties (factual statements about particular aspects of the target business) require specific indemnities in the sale documentation to protect it in respect of the risks and liabilities being purchased. Responding to such warranties, a seller will undergo a process to disclose information against the warranties being given, usually in a disclosure letter prepared by your legal advisers. A properly advised seller will be able to limit its liability in the future, with the prepared disclosures qualifying the warranties and hence avoiding a claim for damages for breach of contract. Negotiated limitations on liability including financial and time limitations will also be included in the sale documentation.
4. Travel business regulatory considerations
One of the more significant aspects of an M&A process involving a travel business is the ongoing regulatory compliance and assessment of the impact of a change of ownership or control of a regulated corporate entity. For a buyer of a regulated entity, ensuring that business critical licences and authorisations continue post-closing is vital.
A sale of a business is a change of control which is likely to trigger obligations to notify certain regulators and travel associations. The key regulatory considerations in the UK are the UK financial protection scheme – the Air Travel Organisers Licence (ATOL), ABTA and IATA, amongst other membership bodies in both the UK and overseas, depending on the international scope of the target business.
The different regulators and associations each have differing notification processes and timelines to comply with and may require certain financial information to be provided as part of a change of ownership consent. This can be a particularly detailed process in relation to ATOL. It is recommended that sellers seek advice and address these points early on in a transaction to avoid delays due to waiting for third party consents. We have an expert team at Fox Williams who specialise in this regulatory landscape on M&A transactions.
5. Tax implications
Tax implications will impact the return made by the seller on the sale of the business. The structure of a transaction is often heavily driven by tax and we recommend that detailed advice on the transaction structure is taken at the outset. If structured incorrectly the sale proceeds can be taxed as income. This is particularly a potential risk where there are deferred purchase price payments that are conditional upon the seller remaining in the business after completion.
Early tax planning to provide a reward to staff at the time of a sale is important. We often see rewards being taxed as bonuses when proper tax planning could result in staff only being subject to CGT and the target company also benefiting from tax savings upon the exercise of options.
Please contact Sarah Carlton or Andrew Woolf if you would like to know more about any of the matters mentioned in this article or simply to discuss our particular approach to your legal needs.