8 pitfalls business owners looking to sell their company should avoid

An OnHand Counsel Guide

 

Along with your house and pension, owning a business can be your biggest asset. You can’t take it with you when you retire, so unless you want to keep it in the family, or just close it down when you retire, you will probably want to sell it one day and spend the money (or build another business!).

From a business owner’s point of view, selling your company could be extremely simple. All you need to do is find a great buyer, agree a great cash price, hand over a share transfer form, get cash on the nail, resign as a director, and walk away into the sunset with no ongoing risks or liabilities. What could possibly go wrong?

Sadly it doesn’t work like this in practice! It can be hard to find a buyer and to get a good price. Any buyer you do find will then want to protect itself in all sorts of ways. Selling a company can therefore be a complicated business, and can take a long time to arrange, negotiate and document. The average share purchase agreement (‘SPA’) produced by a buyer’s solicitors is over 70 pages long.

Most business owners don’t get to sell a company more than once in their lifetimes, and don’t know what to expect. It’s way outside their comfort zone. From preparing to get your company oven ready for a sale, to early negotiations with interested buyers, and dealing with all the challenges that buyers are going to put your way, you need an experienced specialist corporate lawyer on hand to guide and help you.

Here are 8 pitfalls you need to watch out for

1. Failing to plan for an exit

Over the years I have come across so many business owners who through lack of planning or focus have failed to get anything like the value they could have obtained for their business, or even worse, failed to sell it at all and had to wind it down (and up) on retirement.

Try not to fall into some of the traps I have often seen owner managers fall into, such as:

• Not planning for your retirement, and ending up having to retire without being able to find any buyer for your business. Instead, you may have to close it down, or at best pass the ownership on to employees for a knock-down price paid over time.
• Having to work on way past planned retirement age to try belatedly to build the business up for sale and find a buyer.
• Leaving the business so dependent on you that it has less value to a buyer. Any buyer might then insist that the price you get will depend on you working out a post-sale employment period with the buyer for years after you had hoped to retire. The buyer might also say that you might get paid more or less depending on the financial performance of the company in the years following the sale (an earn-out). Although to be fair, earn-out deals are often quite standard, particularly in the case of ‘people’ businesses.
• Not taking key steps to build up and protect your business value and make it attractive to potential buyers. Examples include not putting in place a motivated management team; not putting in place a solid business model (with good long-term contracts to underwrite the value of the business); and not protecting your IPR. And of course you should look to get rid of any skeletons in your cupboard which might put a buyer off (such as that long unresolved litigation, or that tax planning scheme which the Revenue have challenged…).
• Not managing your relationships with other shareholders in your company. This can create all sorts of problems when different shareholders have conflicting retirement or exit plans. For example I have seen many cases where founder owners of a company have given minority shareholdings away to employees or others without putting in place arrangements to protect their interests (such as drag-along provisions in the company’s Articles of Association, or in a shareholders agreement, requiring all shareholders to agree to sell on the same terms if the founder owner ever wants to sell).
• Not putting in place a planned and managed process to market your company for sale, and therefore failing to find the best possible buyer and the best possible price. And if your buyer suspects you have few other options you will end up in a weak negotiating position.

Click here for a more detailed Guide to marketing your company for sale

A good corporate commercial solicitor can help you anticipate and address all these issues and more, so that when you’re ready to start thinking seriously about selling  your business you have all your ducks in order and are in position to secure the best possible deal.

Click here for a more detailed Guide to planning for an exit

 

2. Getting off on the wrong foot

Once you’ve found potential buyers who have expressed an interest, you need to make sure you take control over protecting your interests. Failure to do so can cause a lot of grief and a lot of wasted time and cost. For example:

• NDAs

Be careful not to give away too much confidential information or access to key employees away without getting appropriate NDAs in place. I have seen cases where prospective buyers walked away from possible deals and instead used confidential information such as pricings for their own benefit, or went and stole the best customers or employees. Unusual but it can happen.

• Heads of Terms

Once you think you have agreed enough with an interested buyer to shake hands on a subject to contract deal, it makes a lot of sense to put in place an initial non-binding Heads of Terms (or Letter of Intent, or whatever you want to call it). A Heads of Terms should set out the key terms and principles of the deal. It’s not legally binding, but it makes it very hard for either party to back out later on anything they have agreed to in the Heads of Terms. Once agreed and signed, this sets the framework and tone for all the subsequent more detailed drafting and negotiation of the formal legally binding deal documents (share purchase agreement (SPA), disclosure letter, etc).

Failing to put a Heads of Terms in place can cause all sorts of problems later, plus lots of wasted extra time, energy and cost. It can lead to major negotiation fall-outs or even deals falling apart late in the day over issues which should have been thrashed out at the beginning. On occasion the process of negotiating heads of terms helps to identify issues which mean that the parties decide not to proceed with the deal. A shame, but far better for this to happen sooner rather than later.

For such an important document, it really is important to involve your corporate lawyer in the early stages of discussions with the buyer. All too often I have been approached for the first time by new clients who have already spent some time negotiating and documenting their Heads of Terms. It is awkward when I have to point out all sorts of things which are wrong with them, which means they have to go back to the drawing board. It is even worse when they present me with a Heads of Terms which has already been signed!

Click here for a more detailed Guide to Heads of terms

• Generally

you should try to manage the whole relationship with your buyer so that you retain an element of control and upper hand in contract negotiations. There are various ways to achieve this, from ensuring the buyer always knows you have other options and are in a position to walk away over key issues, to managing the due diligence and disclosure process (perhaps through use of an online data room controlled by you). The more control you retain (or can make the buyer think you retain…) the easier the whole process will be and the better the final deal you are likely to end up with.

 

3. Shares or assets? Not understanding what you are selling, and the implications.

The differences between a share sale and an asset (business as a going concern) sale are fundamental, yet often clients come to me having not thought about them. As a rule, it is better for sellers to sell shares. This is mainly because of the tax treatment. This is less the case for buyers.

In one way, share sales are much simpler – the seller just needs to hand over a share transfer form and get paid, and the buyer owns the whole company, warts and all. ‘Warts’ includes all the company’s assets (including any yachts (one example I have seen) or other assets bought through the company for the owners’ pleasure) and all possible liabilities to creditors, customers etc, and all tax liabilities, whether or not the buyer knows anything at all about them.

In a business sale, on the other hand, the company agrees to sell only whatever assets the buyer agrees to buy. For example, the company usually keeps its cash (and the buyer won’t want the yacht). And the buyer doesn’t take on any liabilities unless it specifically agrees to do so (the case of employees and the TUPE Regulations being the main exception).

So a business sale agreement can look a lot more complicated than a share sale agreement because a lot of effort goes into dealing with how different types of asset and liability are to be treated. This can get a bit tricky, but is largely logistical.

However, in a share sale agreement a buyer will want many more protections against the unknown (for example the financial position of the company, and any unknown risks and liabilities) as well as the known (for example possible liabilities the buyer knows about but doesn’t want to take on). As a result, a share sale agreement often has detailed provisions for adjustments to the price based on the company’s actual financial position at the date of completion, and more extensive warranties and indemnities than one would see in a business sale agreement. Much of the work involved in a share sale deal therefore revolves around the protections the buyer is asking for and how the seller responds to these.

So before you start thinking about selling (or buying), you need to get advice from a specialist corporate lawyer about the pros and cons of different ways of structuring any deal, and about the kinds of issues which are likely to come up depending on the type of deal. The more you understand and are ready to deal with these issues the more you will be able to steer the deal in the kinds of direction you want, and the less uncomfortable you will find the whole experience.

 

4. Not getting paid – meeting the buyer’s financial conditions

Your buyer is going to agree a price based on various financial assumptions it has made. It will want to be protected (ie pay less) if these assumptions are proved wrong. There are various different ways in which a buyer may want to protect itself in the SPA. As a seller, you have to be able to respond to whatever protections the buyer asks for.

These assumptions broadly revolve around two areas:

• The company’s financial position at completion.

There are various ways a buyer may look to protect itself here. One common way is to provide for a special set of company accounts to be produced on completion. The SPA will set out detailed provisions for how these accounts are to be prepared and finalised. The SPA will then set out assumptions as to how much these accounts should show in terms of net assets, cash, creditors or indebtedness, or in respect of a working capital balance. The SPA will then say that the buyer will make a part payment of the purchase price on completion, and that after the completion accounts have been finalised a balancing payment will be made depending on how the figures look as against the assumptions made.

These provisions need a considerable amount of input from both your corporate lawyer and your accountant.

• The earn-out. The buyer may well base a large amount of what it is prepared to pay for the company (the goodwill element) on what turnover or profit it hopes the company will make in the years after completion.

The buyer may therefore say that it will hold back on paying a significant part of the purchase price until it knows that the company has achieved various turnover- or profit-related targets in the years (usually two or three) following completion. So the SPA will contain detailed provisions setting out these targets and how any payments might be calculated and paid out after the end of different periods.

This can get quite messy when you have combinations of different earn-out targets or try to address questions such as whether a seller should be entitled to make up a shortfall in one year’s earn-out target in a subsequent earn-out period. Both parties have to be very careful that the resulting provisions might not have possible unintended and unfair consequences depending on different possible future scenarios.

The buyer might well also want to ensure that at least one of the owner manager sellers remains in the business in some capacity throughout the earn-out period, and there may be negotiations around the consequences if this doesn’t happen.

From a seller’s point of view, they will want the agreement to contain provisions protecting their ability to have some influence over the company’s ability to achieve the earn-out targets, and reducing the possibility of the buyer doing anything which might circumvent the earn-out targets being achieved. (Turnover-based rather than profit-based targets will be much safer for a seller if these can be negotiated.)

So there is often plenty for both parties and their advisors (corporate lawyers and accountants) to think about, negotiate and draft when it comes to earn-out provisions.

Needless to say, the more protections you can build in to any earn-out provisions the less you will have to worry over the earn-out period whether you are going to get the earn-out you were hoping for.

 

5. Not getting paid – the deferred payment

Sometimes a buyer will try to avoid having to pay the full purchase price up front. If a buyer simply says that it wants to defer some of the purchase price to a later date (or to pay by way of ‘loan notes’, which amounts to much the same thing), you have to ask yourself why. Why can’t the buyer afford to pay now? Why should you act as the buyer’s bank? Why should you take the risk of the buyer going bust or not paying for any other reason?

Whether you agree to such a deal may depend on what other options you do or don’t have. For example, for various reasons, but usually because they have left it to the last minute, owners end up agreeing to sell their company to their senior employees, and usually this deal involves the employees agreeing to pay out of funds generated by the company itself over a period of time. This might be called a ‘seller-funded management buyout’.

Sometimes the buyer says it wants an earn-out deal, where much of the ‘goodwill’ element of the price is held back for a few years until various turnover or profit targets have been achieved. This can be a good pretext for the buyer saying it has to hold back payments. But as a seller you should still try to get as much up-front as possible.

If for whatever reason you agree that the buyer does not need to pay the purchase price in full in cash (or bank transfer) on completion, then you have to think about the risks and how you can reduce them and protect yourself. The main risk of course is that the buyer will go bust before it has paid you, leaving you high and dry having sold your company and not having been paid in full for it.

An experienced corporate lawyer can help you to assess and negotiate the best ways to protect yourself. This can often involve insisting that the buyer provides some form of acceptable security.

Click here for a more detailed Guide to dealing with proposals for deferred payments

 

6. Not getting paid – getting shares in the buyer instead of cash

On occasion a buyer (particularly a larger PLC, perhaps a company on a spree of snapping up companies like yours), will offer some or all of the purchase price by way of issuing shares in the buyer (or a holding company) rather than in cash.

Taking shares in a buyer as part payment for your company may perhaps be a good idea where you are not thinking of retirement yet and see merit of merging into a larger group with future exit opportunities and where you have ongoing employment and various protections at shareholder level. Otherwise, it’s usually not a good idea. Worst case, the buyer company will go bust and your whole lifetime’s effort building an exit value for your business will have been wasted.

An experienced corporate lawyer can help you to assess any such proposals and negotiate the best ways to protect yourself.

Click here for a more detailed Guide to dealing with proposals for taking shares in a buyer

7. Getting sued and having to pay back – warranties and indemnities

Once you’ve completed on a deal you don’t really want to have to pay some of your money back in a year or two’s time if you could have avoided this risk during the deal process. But buyers quite reasonably want to know that once they have paid good money for a company they won’t subsequently find any unexpected problems which they hadn’t budgeted for. Much of the time spent negotiating and documenting the SPA is usually spent on the warranties and the disclosure letter (which effectively forms part of the SPA), and on any indemnities the buyer might want. Any breach of these can result in a claim by the buyer for you to repay some of your purchase price.

What’s the difference between warranty and indemnity claims?

• Warranty claims are basically where a statement made in the warranties proves to have been incorrect. If so, the buyer can ask for some of its money back (basically, the difference between what it paid against what it would have wanted to pay if it had known the truth) unless the buyer already knows about it, for example because the disclosure letter had fairly disclosed the incorrectness. An example would be a warranty that there are no claims against the company.
• Indemnity claims are where the buyer does know about a possible liability a company faces (because it was disclosed in the due diligence/disclosure process) but is not willing to take ownership of this liability. So it asks the seller to indemnify the company against any possible loss that might arise in relation to this liability.

As a seller, you want to try to manage the whole deal process in a way that minimises the risk of any warranty or indemnity claims. This includes:

• Preparing your company for sale by identifying and cleaning up all possible things that you don’t think a buyer would like to discover and take over.
• Managing the due diligence and disclosure process thoroughly and efficiently to ensure there is nothing the buyer can claim later that you hadn’t told them.
• Managing the negotiations of the warranties and the disclosures (which usually take over half the content of any SPA) so that you minimise the risk of a buyer being able to make a claim against you, and put limitations on when and how the buyer can make any claims.
• Carefully negotiating any indemnities to minimise your potential liability.

Dealing with the due diligence and warranty disclosure process usually takes up most of the time in any share deal. The legal issues which invariably come up can get quite difficult, and mainly involve the allocation of risk between the parties and the resulting extent of the seller’s potential exposure to liability to future claims by the buyer. The warranties, disclosure letter and any indemnities need to be carefully negotiated and drafted with the help of experienced corporate lawyers who know what they are doing (ideally on both sides of the negotiating table).

 

8. Not using the best advisors for your deal

Selling your business is usually the biggest deal you will ever do in your life, so it’s important to find the best advisors (lawyers, tax advisors, accountants) for your kind of deal. The deal process can involve months of stress which good advisors can help to reduce because they are experts in managing the deal process. They can help you to understand and deal with all the commercial, financial, tax and legal issues which invariably come up (and the tricks and traps that buyers usually come up with when producing their share purchase documentation); and good corporate lawyers are experts at drafting, advising on and negotiating the extensive legal documentation involved with share sales.

You need a lawyer for any deal, for peace of mind. But who is the right lawyer for you and your deal?

• Selling a company is not straightforward, so you need an experienced specialist corporate lawyer at your side. Not a ‘high street’ lawyer, or a property lawyer who dabbles!
• For smaller deal values of between £250k to around £10m it may well not be the best option to instruct large City or regional corporate law firms. Will they be able to provide you with a dedicated personal service throughout from an experienced partner-level corporate lawyer? Or will most of the work be delegated to junior lawyers or trainees who may not have the specialist knowledge and experience to enable them to pick up on and effectively deal with all the issues which might come up whilst taking a cost-effective and proportionate approach?

 

What next?

This Legal Brief outlines some of the issues and problems a business owner looking to sell their company might come up with. A good corporate lawyer can help you anticipate and address all these issues and problems and more, so that when you’re ready to start thinking seriously about selling your business you have all your ducks in order and are in position to secure the best possible deal.

 

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Contact me for a complimentary ‘Preparing to sell your Business’ consultation:

Whether you are already speaking to a potential buyer of your business or you are thinking about looking to sell it some time in the future, if you would like to discuss the possible sale of your business or any of the issues raised in this Guide or any other issues which you think might affect you in relation to a sale of your business please email andrew.james@onhandcounsel.co.uk to arrange a complimentary ‘Preparing to sell your Business’ consultation to help you to identify what might be involved and how Andrew can help. This will help you to avoid some of the pitfalls you might otherwise be exposed to, such as those described in this Guide, and give you the peace of mind of knowing that you have an approachable competent corporate lawyer ONHAND who can provide you with experienced, effective and cost-effective advice and assistance.

See here for more about the unique benefits of working with Andrew James of OnHand Counsel

If you are already at the stage where you are discussing possible Heads of Terms with a potential buyer DO NOT sign anything before you have obtained legal advice from a competent corporate lawyer. Have a look at this FAQs about Heads of Terms and email andrew.james@onhandcounsel.co.uk if you would like to have an initial complimentary ‘Preparing to sell your Business’ consultation.

 

About the author

Andrew James has been a specialist corporate lawyer for 35 years. He has the ‘City quality’ experience and expertise to deal with any deal. But he also offers a level of personal service and value of money that you would struggle to get from most corporate law firms.

His business model and approach are therefore particularly suitable for most deals of any range from £250k to £10m.

For any given job Andrew can generally provide better value for money (adding more value at less cost) than most corporate law firms. How can this be?

• A different business model and a lower cost base: Law firm partners can charge many £100s an hour. They need to feed their staff and have other expensive overheads. Andrew charges less per hour than he would as a partner in a regional or City law firm.
• No junior lawyers: Unlike a law firm partner Andrew does not have to try to push work down to less value-for-money junior lawyers. It might take Andrew one hour to do what might take a more junior lawyer three hours – and Andrew will get it right and won’t have to check himself and will add a higher level of value in the process.
• An experienced proportionate approach: Every job can vary, and the question is often how can a job best be done within a client’s budget. A £50m deal can raise the same issues as a £50k deal, but clients won’t want to pay the same legal fees. It needs different approaches to get the best deal done for the circumstances.
• Andrew has spent his whole career advising business owners who see a close link between writing their business cheques and what they earn! This has led to Andrew developing a very efficient, thoughtful, focussed and cost-effective approach, rather than the ‘checklist’ approach adopted by so many large law firms. Andrew is experienced in providing an appropriately proportionate service tailored for each deal within each client’s budget. Andrew’s broad experience means he can see the woods for the trees and quickly identify and focus on the issues which are important for his clients.

Here is what some satisfied clients have said:

‘I just wanted to add my thanks for steering us through some unchartered waters so skillfully and patiently’. Marion Jones, sale of Spotlite Entertainment Limited

‘Andrew is that rare beast amongst lawyers – trustworthy, unpretentious, speaks plain English and doesn’t overcomplicate matters. Andrew was a great help to me when I sold my business’. David Abbott

‘I was very grateful to Andrew James at OnHand Counsel for taking on the legal duties at short notice concerning the acquisition of my company. Andrew was understanding, dedicated and diligent from the outset and also right through to the completion day when he was literally ‘on hand’ to support, assist and advise. Andrew made the whole process as straightforward as possible and his recommendations and attention to detail certainly ensured that the sale and purchase was completed on time and to our full satisfaction. I wholeheartedly recommend Andrew’s services to any future client.’ Andrew Johnston, sale of Quiller Publishing

‘Andrew helped me with the sale of my business. I would highly recommend him as a lawyer who is easy to work with and always ready with problem solving advice. He dealt in layman’s language and took a pragmatic approach…. He worked quickly, and offered ideas on how to keep the costs down without compromising the integrity of the end result.’ Danielle Pinnington

‘To get this level of experience and acumen from a larger firm would cost at least 50% more. It’s good to know someone with experience at a high level is directly dealing with your legal matter.’ Peter Wastell, Verulam Advisory

‘Many thanks to Andrew for his help with the sale of our business – it has been a pleasure to deal with him.  A sane voice in the insanity!          Pam Farrant

‘Liked your personal service. Your experience produced something that was exactly suitable for us. Benefits of ‘London experience’ without London prices. Quick and efficient.’  Dale Emery, Clamcleat Limited

‘Over the last ten years Andrew has acted for a number of companies for whom I was acting as CEO/CFO. He has acted on a couple of management buy-outs as well as other M & A work and various other company and commercial work. Andrew is a pragmatic and personable lawyer. Do not be fooled by his nonchalant exterior. Andrew has integrity, loyalty and a willingness to go the extra mile.’  John Smithurst, Smithurst & Ryan Limited.

‘I have known Andrew for many years, and have worked with him on a range of things from corporate transactions to sorting out the constitutions of golf clubs! Andrew has a very strong skills set which he can apply to a broad range of corporate and commercial matters. He quickly spots where the real issues lie and suggests creative and effective ways to resolve them and to get deals done. He is reliable and responsive and I would be happy to recommend him to any business owner who wants a pragmatic business lawyer offering excellent value for money and with a refreshingly personal touch.’  Robert Twydle. Partner, Hillier Hopkins LLP.

‘I have instructed Andrew in the past on a variety of M&A deals. Andrew is an understated but effective operator. He has an enquiring, pragmatic and solutions-driven approach, unlike the ‘checklist’ approach so many lawyers take, which means that he can add value on a wide variety of deals and issues. Andrew is genuinely interested in his clients and the issues they face, and is a pleasure to deal with.’  Roy Simmons. Director, Roy Simmons Marketing Consultants Limited.