Consider these 10 points before you begin the M&A process for a private limited company.
1. What do you hope to achieve from the potential sale?
The goal in an M&A process is typically to achieve a clean exit from your business and you need to decide if that is what you want.
You may be interested in staying on with the business and working with others to achieve growth of the business after you have sold it, but are no longer interested in being its owner. Alternatively, you may wish to stay on with the business and achieve a sale, but look to become a part-owner of a bigger business that acquires yours (e.g. a private equity firm).
In focussing on your motivations and goals at the outset of the sale process and communicating these to the potential buyer upfront, you are more likely to achieve your desired outcome. There will be nuances and details to be worked out for each driver for a sale, so you should also make your goals known to your advisory team at the outset.
2. Are you selling shares or assets?
Most sales that we are involved with take the form of a share sale, as opposed to an asset sale. A share sale is the sale of the ownership interests in the company, whereas an asset sale is the sale of all (or part of) the assets and business of the company, which will be transferred across to the acquiror.
There are pros and cons to each structure, but one of the key reasons why a share sale is generally preferable to an asset sale is tax-related. A share sale should give rise to capital gains tax on the profits made. An asset sale will result in corporation tax on the proceeds of the sale made by the company. Once the company has paid the corporation tax, the proceeds of the sale can then be distributed, but if the owners are individuals, they will be charged income tax on the proceeds. In effect, there can be double taxation on an asset sale, so often, a share sale is preferred.
Below we set out further points to consider which assume that the seller has elected to proceed with a share sale.
3. How much will I be paid?
One of your primary concerns will be how much a buyer might be willing to pay for your business. For private limited companies, as there is no open market for the shares, it can be difficult to determine a valuation without external advisers. We recommend obtaining a valuation from a reputable corporate finance adviser early in the process, to understand what you seek to gain from a sale.
You should also consider whether the deal will be priced on a ‘locked box’ or ‘completion accounts’ basis. With a locked box, the price is ‘locked’ on a particular date (e.g. the most recent audited accounts date) and any leakage out of the company to you, any other seller and your connected persons from such date is owed by the relevant sellers to the buyer. With completion accounts, the price is subject to adjustment once accounts have been prepared and finalised following the completion date, to reflect the true position at the date that the buyer acquired the company. A locked box is generally preferable for sellers as it provides certainty as to the price to be received on completion.
4. What are the most important terms?
Other than the price, there will be other key terms that you will want certainty on before you instruct lawyers to draft the official documentation. These will link with your goals (see point 1 above) for the process.
These key terms should be documented by way of a letter of intent or heads of terms and it is good practice to engage a lawyer to do this for you. While such a document generally won’t be legally binding (save for certain specified provisions e.g. confidentiality), it will record that the parties agreed to proceed with the deal on the basis of the terms. This therefore makes it much harder for the buyer or its lawyers to argue otherwise when the official sale documentation is drafted and negotiated.
5. How do you expect to be paid?
If your intention is to depart the business entirely, it is likely that you will be looking for the buyer to simply make a single cash payment upon completion of the transaction.
However, if you intend to or are required by the buyer to remain with the business following completion, the buyer may suggest a different consideration structure such as an earn-out. This is a provision that links a target (e.g. profit level or revenue level) to the price that is payable to you at a future date.
There are myriad other potential consideration structures that may be proposed, depending on the motivations and finances of the buyer. For example, in private equity transactions where the buyer expects certain sellers to stay on with the business, the buyer may require the sellers to reinvest a portion of their proceeds into shares or loan notes within the buyer’s group.
6. Are there any obstacles to overcome to get to completion?
You may already be aware that there are certain issues (whether they are from a commercial, legal, tax, regulatory or timing perspective) that a buyer will need or want to be resolved ahead of completion. For example, if your business is FCA regulated, the buyer will most likely need to obtain FCA approval (or deemed approval) of the change in control of the entity. This can take several months to obtain. You may have material customers whose contracts contain change of control provisions, whose consent the buyer will need or want to obtain prior to completion. There might be other issues that you know will be significant to a buyer of the business and will be uncovered by or revealed to them via the diligence and/or disclosure processes.
In all cases, you should communicate these potential issues to your advisers at the outset of the process, so you can consider together at what stage to make these known to the buyer and how best to handle them at that time.
7. How long might the process take?
Ultimately, this is not a question we (or anyone else) can answer, as there are a vast number of factors that can influence the timing of a transaction.
On any deal, the buyer will want to conduct a due diligence exercise. The timing of this exercise will depend on the buyer’s level of urgency, the amount of information to review and the materiality thresholds the buyer might have set for such review. You should be considering the logistics of this as well – management time and effort will be required to provide the information and documentation required for the buyer to conduct its due diligence.
Further, you will almost certainly be required to give warranties in the sale documentation relating to the company and its business operations, against which you can disclose any untrue or misleading information to limit your liability. This disclosure process can also take some time to complete.
In addition, there can be other deal-specific complicating factors such as regulatory approval, which can take several months to obtain.
We have exchanged and completed complicated deals in relatively short timeframes and can work with you and any other advisers to ensure the deal is concluded as soon as reasonably practicable.
As part of the sale process, the potential buyer and its advisers will conduct a due diligence process to investigate the company and its affairs. This will naturally involve the disclosure by the company of a large amount of information and documents. You may also be concerned about the public or customers or suppliers learning of the deal itself before it completes. There is likely to be a particular concern if the potential buyer is a competitor and/or within the same industry.
We recommend entering into a confidentiality or non-disclosure agreement at the outset of discussions to provide some comfort that potential buyers will keep the information they learn during the deal process, and the existence of the potential deal itself, confidential. There are other ways you can protect sensitive information that will need to be disclosed as part of the transaction, for example only uploading it once it has been established that the buyer is sufficiently serious about the deal and applying certain permissions to documents (if hosted on a virtual data room platform) so that they cannot be printed or downloaded.
9. What will the tax implications be for you personally?
Your proceeds from a share sale should be taxed as capital gains. The rate of capital gains tax will depend on whether you are a basic rate, higher or additional rate taxpayer and whether you have made any other capital gains within the same tax year.
You may also be entitled to business asset disposal relief (BADR) (formerly known as entrepreneurs’ relief) on the sale of the shares. This entitles you to a 10% tax rate rather than the otherwise applicable capital gains tax rate. Broadly speaking, this relief is available on asset sales and share sales to those who have owned and run businesses for at least two years prior to the date on which they sell their shares. We can assist with advising as to the applicability of this relief.
We recommend that you speak with a tax adviser to discuss the potential tax implications of a sale for you personally and how best to structure it. We can introduce you to recommended tax advisers if you wish.
10. When should lawyers and other advisers become involved?
Once you are seriously considering a sale of your business, we recommend instructing lawyers and any other advisers as early as possible. If you are in the early stages of the transaction and have not instructed other advisers, we can recommend corporate finance advisers, accountants and other advisers to you. Early involvement of advisers, as mentioned above, maximises the chances that you achieve your desired outcome.
If the sale of your business is high on your agenda, do get in touch. We are experienced in advising on all the areas outlined above. We will explore your preferred outcome with you and are able to recommend other advisers. Please contact Paul Taylor or Stephanie Tsang if you require any further assistance.
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