Formation of Contracts – Take 2
Making an offer (they can’t refuse)…
Or how to avoid making an offer you can’t (but want to) refuse
This is the second article in a series of 5. See the original Acquiring a Business – The Basic Steps
Most of us know that to form a contract there are three essential ingredients:
- Consideration (money changing hands)
Who is making the offer? Who is accepting (and thus forming the Contract)?
The golden rule here is to take control of the process. Are you making someone an offer that you can’t then refuse? (thus scoring an own goal)?
The golden rule here is to take control of the process (you can see where this is going!)
Whose terms win? The battle of the forms. This is a bit like the good old game of snap where cards are placed one on top of the other. Whoever’s Terms of Business are “on top” when the Contract is formed will “win” the battle of the forms.
Therefore, as the golden rule is to take control of this process, never ever, ever, ever, ever, ever, ever make an offer – you should always get your customer to make an offer to you.
You should insist on using your own order form and you should send this out in response to an order or an enquiry. The order form should include your Terms of Business and you could usefully have these printed on the back.
REMEMBER – Take control of the process!
Buying or selling – who does what?
When the purchase gets underway, there are a few variables that need to be clarified as follows:-
Due diligence i.e. the extent of any pre-contract investigation to be raised with the existing business owner and advisers. This would be in connection with the business itself the contract commitments, staffing situation and property issues, possibly involving a lease.
The seller and his legal team should prepare and issue the draft contract where there is small business sale of assets. However, in bigger deals or where the buyer is acquiring shares in a company, the buyer and his legal team will deal with this. It is important that there is control over this process.
If there is a sale agreement with warranties, there will normally be the need for the seller to give disclosures against those warranties. This is done through a Disclosure letter.
Know Your Business and disclose accordingly (sellers)
This applies whether you are buying or selling the business. If you are buying, the idea is to find out as much as possible beforehand (see due diligence). If you are selling, then the best tip is to put yourself in the position of the buyer and identify the information that the buyer will need. Plan to have that information available at an early stage and know how to go about getting it (whether contacting accountant, bank manager, lawyer or otherwise).
Is something unlawful or illegal? What’s the difference?
Illegal is a something which is criminal. Unlawful is less dramatic but may still land you in hot water. Basically, illegal means that you may end up dealing with the police, unlawful means that you may end up getting sued.
Plan your Exit (sellers)
Very much a tip for contact with your accountant and tax advisor, this will have an effect on when you dispose of your business and the tax implications of that. Depending on how the business disposal is structured, you should bear in mind that the sale price is frequently broken down into component parts and “split” between individual assets e.g. property/lease, equipment, plant etc. and goodwill. Your accountant should advise both on the figures relevant to your acquisition of the business and, subsequently, the disposal.
Tax Planning Concerning Retiring (sellers)
Plan probably further ahead than you would otherwise consider necessary. It will take time either to assemble a package of papers relating to a business disposal or to plan the strategy and timing, better to start too early than too late.
Capital Gains Tax – Basic Principles (sellers & buyers)
Always bear in mind the basic principles of CGT when buying a business as well as selling. If you understand the principles when the business is developed or bought then there is less likelihood of getting it wrong or misunderstanding the position later.
CGT Relief – Taper, Entrepreneurs’… Whatever (sellers & buyers)
Sadly, taper relief is no longer available but still used as the yardstick for entrepreneurs looking to maximise sale price and tax efficiency. This is a relief which reduces the value of the gain that will be charged to Capital Gains Tax and the effective rate of tax is reduced accordingly sometimes as low as 10%. Replaced by Entrepreneur’s Relief for the first £2m of gains made, reducing effective rates of CGT to 10% (HMRC terms and conditions apply!). The figures here were “tweaked” shortly before the May 2010 election and CGT is likely soon to be on level-pegging with income tax at 40% or thereabouts.
CGT – Important Safety Tip – gain will be realised on Exchange NOT Completion (sellers)
Capital Gains Tax will be triggered on exchange of Contracts rather than completion. This is frequently misunderstood and you need to liaise closely both with your accountant and your lawyer to make sure that there are no misunderstandings there. This will catch out the unwary or poorly advised and include in a charge to CGT:
- Deferred consideration
- Unquantified (there I go again – unknown yet, because the basis of the calculation is not yet clear – e.g. a payment based on profits where the figures are not yet available) consideration that may change and be payable later
- Sums held on retention and in escrow (I can hear you sighing again and so…).
Escrow (sellers & buyers)
It is a close relative of a rent deposit agreement for a commercial property. A sum of money held on escrow is held normally in an interest earning deposit account. There are many variables here and the terms of the escrow deposit will be determined by the deal itself. However, the money is intended to offset risk and so there will normally be some “problem” with the deal where the buyer is worried and so has agreed that a sum of money should be “parked up” in escrow until this particular snag has been ironed out. It could be a problem with a property (poor survey) or a claim against the business or the company. The terms on which the sum is to be held and subsequently released (whether to satisfy the “problem” anticipated or to refund the payer if the problem never actually happens or is less costly than feared) will be regulated by the Escrow Agreement which will be negotiated as the deal unfolds.
Stamp Duty – equally important safety tip (buyers)
If you buy a company and defer some of the price by way of escrow deposit or retention, then you will probably (there will always be exceptions!) be liable for stamp duty on the full price payable for the shares even though part of the money has not yet been paid and may never, in fact, be payable.
Due Diligence (sellers & buyers)
This is the process of investigation carried out by a buyer who is planning on buying a business. The process should pick up key information on a number of points; some of these may be more relevant where a company (rather than just assets) is being acquired and they include:
- Commercial contracts of the business
- Bank arrangements
- Accounts and finance
- Regulatory arrangements including Data Protection
- Intellectual Property Rights (IPR)
- Why the seller is selling
- Likely threats to the business
- Tax and accounts
- Corporate Social Responsibility (CSR)
- Claims and insurance
- Existence of any private agreements between multiple sellers
The due diligence process is intended to give a buyer enough information to make an informed decision about proceeding “sensibly” with a planned business acquisition and investing in the professional services needed to implement e.g. legal, surveys, accountants. There are 3 possible “results”:
Result 1 – no change, full steam ahead. Nothing untoward is picked up and the deal proceeds as originally planned
Result 2 – no way, Jose. Something “terminal” is picked up and the buyer decides to withdraw. There may be provisions in the Heads of Terms that bite e.g. each party is liable for his or her own fees and obligations of confidentiality and ownership of Intellectual Property Rights can still apply. Otherwise, the “subject to contract” principle will apply and each side will walk away.
Result 3 – the deal still proceeds but there is an adjustment to the deal price. E.g. a tax demand is uncovered during due diligence. The amount in question is not great and does not trigger any further concerns for the buyer who wishes to proceed subject to an adjustment to the price or through the Completion Accounts
Think Like the Other Side (Poacher turned Gamekeeper) (sellers & buyers)
If you are selling, imagine that you are buying the business and work out what information you will need. If you are buying, imagine that you are selling the business and work through the sort of problems that you may have as a seller and the sort of issues that you may be trying to hide.
Part Three to follow next week! In the meantime, if you have any queries about Commercial Legal matters, please email firstname.lastname@example.org or call 01483 302000 and ask to speak to Nick Richardson or Alice Ryder.