Contents
What to prepare for
The sale process is poorly understood by most business owners before and often during the transaction. Here are the headlines and what you should know in advance.
Due Diligence
The due diligence stage is the most difficult and stressful part of the process. This is when the buyer and their team get to look under the bonnet of your business. They are going to ask questions about everything in your business to enable them to understand your company and its operations, it’s strengths and weaknesses.
What they uncover exposes elements of risk that they may be unhappy with, and which can be used as an opportunity to reduce the offer price, request withholding amounts, or even withdraw their offer.
Your preparation and understanding of your business gives you a return on the investment of time and effort.
How long does it take?
Ask any business broker how long it’s going to take, and they invariably answer, “it depends.” Critical factors include your exit readiness, market conditions, industry sector, seller expectations and timing. The most common delays are caused by the sellers’ lack of preparation. This includes not having the right team in support and trying to do it all yourself.
No business owner has ever regretted starting the preparation early.
Typically, most advisors in the M&A field say 9 – 12 months between signing a broker and handing over the business. And that’s if the business is already prepared for going to market, which can take anything from 12 to 36 months depending on the state of the business.
The larger and more complex the business being sold, expect it to take longer than 12 months. It’s important to remember that getting an offer does not guarantee completion for the deal.
It’s a lot like buying a house – there are a lot of moving parts and multiple reasons for the deal to stall.
Doing a pre-sale due diligence process on your business, especially from an independent 3rd party, allows you to see your business from the buyer’s perspective and make adjustments that retain and increase the value of your business. Making it more likely you can complete the process.
Buyers often pay for the business using external finance, which takes time to put together. It’s important to check out how the buyer is funding the purchase as early as possible and see some evidence of their ability to complete the purchase before wasting your time and effort on DD. There is no point negotiating with someone who can’t pay!
Take your time when agreeing terms. Taking it slow at the beginning allows you to go faster at the end.
Understand that sSelling a business is difficult
Never underestimate how much energy and effort it takes to sell a business. It consumes you emotionally too. It is a test of patience and endurance.
Common Mistakes
There are some common mistakes people make in DD, even seasoned professionals. It’s such a detailed look at your business that sometimes it’s easy to lose sight of the big picture and get engrossed in the weeds. Magnifying risks is one of the outcomes of this kind of behaviour.
Assessing the culture and environment of the business often gets lost yet has significant financial impact when it comes to post-acquisition integration. Being aware of the internal dynamics and behaviours within a business can be as important as the numbers.
On-site experience of the business in action is a great way to see how it works in real life as opposed to how it presents on paper. Buyers want to see the business in motion. This poses a challenge if your team do not know what’s going on. In the absence of you telling them, they come to their own conclusions and make it up.
By focusing on risk mitigation, it can be easy to overlook potential and opportunities available. As a seller they may seem obvious to you but won’t necessarily be obvious to the buyer unless you point them out. If you’ve got opportunities, then sign post them – they add value!
Equally if the DD team focus on opportunities, they can lose sight of some of the risks. DD is a balancing act for both buyers and sellers.
Intellectual property (IP) is covered in other chapters. Paperwork for this is not a 5-minute job. Preparation means taking action which leads to value and more cash in your pocket. Be especially careful if your business has licences for other peoples’ IP that needs to be assigned or even renegotiated. Doing it in the DD phase is going to leave you on the back foot and possibly out of pocket. Get your trademark protection in place if applicable and make sure you own your website domain. Too many business owners find their domain is actually owned by their IT provider or web developer.
Getting contracts with suppliers and customers assigned generally only happens when the sale process is fairly well progressed. The first thing is identifying ALL the contractual relationships that need assigning. A good pre-due diligence process sweeps all this up, so you know what efforts are required to get the deal across the line and what legal fees are involved (and who is going to pay them). Assignments are also captured in the indemnity clauses of the SPA.
Taxes cannot be escaped. VAT, if you are VAT registered, particularly comes into play if you are selling assets as opposed to the entire business, which must remain a going concern. If in doubt, get tax advice and include VAT.
What does it cost?
Lawyers are one of your biggest bills. There is no legal requirement to have a lawyer act for you. You can do the whole thing without a lawyer, but it is not a route I would advise. Lawyers protect your interests now and in the future.
Costs vary enormously from £1000 per hour for big city firms to smaller boutique practices charging a lot less. Some solicitors work on a 1% of the transaction value as well as some fees, which can be negotiated on a fixed basis. The more prepared you are, the less your legal fees will be.
Of course, if DD shows some missing pieces there’ll be the fees associated with putting them in place. Doing this last minute always costs more money. Don’t forget you have to pay tax liabilities. And for tax advice. If money is held back in an escrow account, you’ll need to think about the escrow costs too.
Preparation is key and it’s never too early to start planning all aspects of this transaction.
Negotiating factors
The SPA has elements that confuse sellers as much as buyers. Here are some of the key parts of an SPA that may be new to you.
It’s often when the first draft of the SPA is drawn up that a business owner comes across the terms such as wWarranties, iIndemnities, cConditions and eEscrow. Whilst this isn’t an exhaustive list, here’s some brief insights into these terms. As always if you are going through the sale process you are advised to get a good lawyer with M&A experience on board. This book is not a replacement for legal advice.
Warranties
Warranties provide protection to the buyer by a seller. Despite any amount of due diligence that the buyer does, they have ultimately relied upon information provided by or on behalf of the seller. Assumptions are made as a result.
Warranties provide one of a number of mechanisms to compensate the buyer if any information or assumptions is proven to be incorrect.
A warranty is an assurance of the condition of the business and can be either specific or implied (by law, for example). Warranties protect a buyer by providing a mechanism for adjusting the price or reclaiming funds from the final price paid. The seller becomes liable to pay compensation where a warranty is proven to be false and results in the buyer experiencing a loss. The onus is on the buyer to show evidence of such loss. The buyer also has the responsibility to mitigate losses incurred due to breach of warranty. The clear purpose of warranties is to ensure full and honest disclosure.
Indemnities
A subtle difference from a warranty, an indemnity is a promise to the buyer to reimburse any loss which they suffer because of a particular event or set of circumstances. The seller undertakes to indemnify (make good) a loss. The liability of the seller is dictated by how widely the parameters of the indemnities are drawn.
An indemnity provides guaranteed compensation to a buyer in circumstances in which a breach of warranty would not necessarily result in a claim for damages.
A claim under an indemnity is likely to be easier to establish than a claim for breach of warranty and there is no obligation for a buyer to mitigate its loss under an indemnity unless the contract expressly applies or excludes the rules on mitigation, remoteness, and causation.
Conditions
Conditions are the terms of a contract that are significant and if not performed or if breached mean the contract can be terminated. They are most used when regulatory approval is required. It should be noted that much like warranties, conditions can be implied by the law. A condition can protect both a buyer and a seller by ensuring that the parties are not obligated nor liable until the conditions have been fulfilled. Equally an innocent party can waive their right to treat the contract as terminated which is likely to affect any claim for damages.
A warning about delays
Warranties are statements of disclosure that are only true at the moment they are given. Understanding this is important if there is any delay between when the warranties are given and the completion of the contract. This is of special interest to the buyer, who may get last-minute disclosures if there are any changes in circumstances. As the seller you are advised to make complete, even last-minute disclosure of all relevant matters. Some sellers make late disclosures of material issues which, if on a tight completion timetable, a buyer is unable to properly consider. If you are tempted to do this (as a seller) don’t be surprised if this results in further delays in the process by the buyer
Withholdings and guarantees
To ensure the seller is able to pay out indemnities or for breach of warranty, the buyer may require funds to be held in escrow for a period of time or for guarantees to be provided. Retention of part of the purchase price for a fixed period or a deferred payment of the sale price are also common.
The purpose of withholding or escrow funds is to make it easier for the buyer to receive claims that are successfully bought against a seller. Having a mechanism to claim is only worthwhile if the funds are available. Otherwise, a buyer may end up in protracted and potentially fruitless recovery processes and incurring more legal fees.
My experience of one exit was a sizable withholding fund resulting from the possibilities of pension liabilities AND the seller being an offshore resident. Two risks that meant that £6m was held in escrow for 6 years. No claim was made, and the funds were released to the shareholders in the appropriate time frame.
“Risk comes from not knowing what you are doing.”.
Warren Buffet
Are you ready to leave. your business (no matter when it happens)? Click here to contact Christine by email alternatively you can book a call with the Business Mentor of the Year 2020, author and speaker. Who helps business founders get their businesses exit ready so they can enjoy a happier, richer future. She saves them THOUSANDS and increases the value of their businesses by MILLIONS.
