The process of buying a business is often long and complex, but it can be straightforward if you cover all of your bases.19
Type of purchase, assets or shares
If the business is run by a sole trader or a partnership then there will be no shares to buy. The assets including contracts and goodwill of the business will be sold by the seller – an “asset sale”.
If the business is owned by a company there is a choice of buying the assets from the company or buying the whole company itself by acquiring its shares from its shareholders.
Much of what follows concentrates on share sales and purchases, but most of the principles are very similar in an asset sale. We have highlighted the main differences where appropriate.
The general rule of thumb for a company sale is that a buyer will normally prefer to buy the assets of a business and the seller will prefer to sell the shares; the next section explains why.
The important point to remember is that in an asset sale, the company itself will be selling the assets, whereas, in a share sale, the individual shareholders of the company will be the sellers.
From the Seller’s Perspective
Share Sale
If a shareholder sells his shares in a company then he achieves a complete break in the relationship between him and the company. However, the buyer will probably insist on some contractual promises (warranties) and indemnities about the company, which will continue to bind the shareholder after the sale.
No Liability for Debts
Assuming that the seller of shares is released from all third party guarantees (eg: as a director, any personal guarantees given to the bank) at completion, he will have no liability for the debts of the business which remain the responsibility of the company in the hands of the new owners, because in law a company has a separate legal personality from its directors and shareholders.
Asset Sale
If there is an asset sale, then, with a few exceptions (eg: employees), the seller will keep all the current liabilities of the business – unless he can negotiate with the buyer to take them over with the business.
Purchase Price
By selling his shares, the selling shareholder will usually receive the purchase price directly himself. If there is an asset sale then the money is received by the selling company. The owners (shareholders) of the company have the problem of extracting that money either by dividends (often tax inefficient) or liquidation (expensive).
Tax Clearance
In some circumstances the seller’s accountant will need to apply to HMRC to obtain “clearance” for the structure of the deal to avoid unexpected tax liabilities after completion.
From the Buyer’s Perspective
The buyer will generally prefer to buy the assets and goodwill of a company, as this will enable him to pick exactly which assets he is buying and identify precisely those liabilities he wishes to take over. All other liabilities will be left with the seller.
“Warts and All”
As mentioned above, when buying shares, a buyer takes the company “warts and all” – which is why thorough due diligence is so important. Although the buyer can take warranties from the seller and receive indemnities, they are generally only as good as the wealth of the person giving them. Also, the buyer may be forced into expensive litigation to recover monies under the warranties/indemnities.
Retention
Sometimes the buyer may be advised to keep back part of the purchase price (“a retention”) as security against unwelcome undisclosed liabilities after completion.
Due Diligence
In-depth business, legal and accounting investigations into the target company (called “due diligence”) will inevitably be more extensive in a share sale than would be the case in an asset purchase. This does cost time and money but we strongly recommend that you take the opportunity to make these enquiries to assess the true position of the business before you are committed to the deal. For more detailed discussion on due diligence please see section 10.
When would a buyer choose to buy shares rather than assets?
There are several instances where this might be the case:
- There may be important contracts that are non-transferable, or certain licences and consents might be unique to the seller. Sometimes a buyer will want simply to preserve as many of the customer relations as possible.
- There may be tax losses that can be set against future profits to minimise tax liabilities.
- The company may occupy leasehold premises and there may be a problem or significant delay in obtaining the landlord’s consent to an assignment (i.e. a transfer) of the lease. Alternatively, the buyer may not be in a position to take an assignment without personal guarantees being given in support of the buying company by its directors, which may not be acceptable.
- The buyer may not want to alert the company’s customers to a change of ownership.
Stamp Duty
If shares are purchased, the duty will be payable at the rate of 1⁄2% of the total consideration paid for the shares. Only once the duty has been paid, and the stock transfer forms have been received back from the Stamp Office, can the transfer be registered in the target company’s books.
The Price
The decision to buy or sell shares or assets is one that has to be made early on in the transaction following negotiation between the buyer and seller. This should be one of the first points you agree. To change when the legal process is underway can add unnecessary substantial fees. Whichever route is followed, it will have an effect on the format and structure of the deal and crucially on the price paid by the buyer.
Steps to review when acquiring a business
- Identify the industry you want to be in: Step one of business acquisition is defining the type of enterprise you’re looking for.
This will begin with a general decision of which industry to move into. You’ll need to research the mid-to-long-term prospects of the sector before moving forward.
Pay specific attention to legal concerns, changes in regulations, and look at local competition within the industry.
Trade magazines and newsletters are a good start – they provide expert opinion on the prospects of your chosen business. - Target the business for acquisition: With broad marketplace knowledge now at your disposal, the next logical move is to target a suitable, specific business.
Have in mind an ideal budget, size, location and annual turnover and, most importantly – whether you feel you can make a success of it. Now to find one which matches these expectations.
Think about businesses that are not actively seeking a buyer, as well as those advertised for sale. Every enterprise has its price, and tabling an unsolicited offer may convince the owners that the time is right to sell.
You will also beat competitive bidders to the negotiating room this way.
Don’t promise a deal that you cannot deliver, simply to open negotiations. A professional broker can be instructed to begin talks discreetly on your behalf and help draw up mutually agreeable terms. - Research: Before you bring in the experts you can undertake a little investigating of your own.
Pose as a customer to experience the service first-hand, whilst also working with the company to look through its finances.
This position of trust and privilege cannot be abused, and you will most likely need to sign a confidentiality agreement before you can get access to sensitive company data. - Open negotiations: At this point in the acquisition, you will have a more detailed picture of both the target business and the industry within which it operates.
With your clearer understanding of its business activities, you can begin to talk directly to the current owners and work together to build a deal that will satisfy all parties.
One of the first points of negotiation will be price, after a preliminary valuation. At this point, you do not have to worry whether your initial offers are legally binding – they are not.
Spend time formulating a plan to work towards so that everyone is pulling in the same direction. - Evaluate the enterprise: The valuation stage of buying a business is perhaps the most vital to ensuring a successful purchase.
The approach you use will differ depending on the type of concern that you are buying. Assets will often make up the bulk of any valuation: value from property and real estate to machinery and equipment.
However, whilst these can be relatively easy to appraise, you shouldn’t overlook the importance of turnover, profitability, and ongoing contracts as a way of informing your offer.
A specialist accountant may be brought in, and they will often provide expertise within a certain field or industry that can help inform your offer. - The Heads of Agreement: The Heads of Agreement, though not a legally binding document, is nevertheless an important and useful stage in the negotiations process. It essentially condenses the key elements of a sale into a single document.
Payment, responsibilities, periods of confidentiality will all be set down in the heads of agreement at a point in the negotiations when each party is still free to walk away from the proceedings.
Most importantly, the Heads of Agreement will act as a timetable towards completion: explaining to each party the time-scale and deadlines for every step of the deal, from financing to the release of payments. - Due diligence: By this point in the buying process, you will be intimately familiar with all aspects of the sale and you should have a detailed understanding of how the rest of the process should unfold.
Having already undertaken your own, informal due diligence in the early stages of the purchase, you can now look to bring in the professionals, who will offer a more thorough analysis of the target business’ accounts, practices and day-to-day operations.
Although you don’t want to take risks by cutting costs at this important stage, remember to stay in budget and keep your outgoings to a sensible ratio of the overall purchase: you do not want to be spending tens of thousands on accountants and lawyers for a firm worth only a hundred thousand. - The Sale and Purchase Agreement: The completion of your sale and purchase agreement will mark the closing stage of the acquisition process.
Whereas the Heads of Agreement sets out in broad, non-legally binding terms an overview of the purchase, your Sale and Purchase agreement will give both parties their legal obligations for the sale. - Pay: You will have a different set of options for paying for your new acquisition, depending on the size and scale of your purchase.
A larger merger of multinational interests may involve complex financing from multiple sources. For a smaller scale buy-out, the most common method is a straightforward payment on completion agreement.
Financing can come from private means, angel investors, banks, loans companies, or peer-to-peer lending platforms.
Sometimes, the current owners may relinquish full control of their business at sale, but take only a percentage of the full value on completion, in return for ongoing shares in company profits. - Completion: With the final documents completed, contracts signed and payment agreement in place, you have completed your newest business acquisition.
Although this ten step process may at times seem slow and the workload insurmountable, everything will fall into place with time. Even the hardest negotiations can find a positive resolution.
Working capital impact on enlarged business
The amount of cash tied up in a business as working capital is broadly determined by the relative speed of being paid by customers compared to the speed at which suppliers are paid.
All private equity investors will look very closely at the working capital of the business. Many will have an explicit plan to reduce the amount of working capital by reducing stocks, or paying suppliers later, or speeding up customer collections, or a combination of all of these. From the perspective of the company, this is unequivocally a positive thing to do; it represents a step change in the efficiency of the business.
From the perspective of the overall economy, if all that happens is that the reduction
in working capital in a company creates an equal and opposite increase in the working capital of its suppliers and customers, then there is unlikely to be a gain in efficiency in the supply chain. However, if the pressure to reduce working capital flows up and down the supply chain, it is a net gain in economic efficiency: the product or service is being produced using less valuable capital.
Irrespective of the overall effect on the economy, it is one significant way in which leverage creates the imperative to maximise cash flow.