rhw will be running 5 blog updates on the basics of acquiring a business. This is part one.
There are 7 basic steps to any business acquisition. Skimp on any of them or get the order wrong and the dream deal may well go horribly wrong or not happen at all…
- Plan the deal.
- Strike the deal.
- Investigate (& if necessary renegotiate) the deal.
- Finance the deal.
- Document the deal.
- Complete the deal.
- Implement and enjoy the deal.
As we go through this series, you’ll find that each of these tips will fit into 1 of these categories. To help your enjoyment and interest, they are not labelled so you can do this for yourself. Go on then…
I have been trying to escape from legal jargon for 35 years and have now given up, having failed (not completely, I must add). You may need help from time to time throughout your legal dealings and these series of blog updates should help you out. It’s not intended to be a legal dictionary and if you insist on knowing all about promissory estoppel or Latin, then I’m afraid you’ll have to look elsewhere. It is meant to be a light-hearted series to help illuminate your tour through a business world and journey riddled with apparently bizarre jargon and obscure rituals, some based on an apparent black art ritual, others (sadly not all) based on common good sense. Above all, it is intended to be entertaining and useful and I hope that it is.
Heads of Terms/Letter of Intent
It is frightening how many transactions get to the lawyer stage without a summary of the main points of principle being prepared. This summary should be no more than one or possibly two pages long and really need be no more detailed that bullet points of the main areas agreed in principle between the parties.
More often than not Heads of Terms will say that they are “not intended to be of binding legal effect” but it is not unheard of for a deal to proceed based on binding Heads of Terms. The summary will contain points as diverse as price, parties and which jurisdiction will apply to the main contract.
What to include – as a general rule, deal with points of principle NOT detail
- Any part of the price subject to performance of business after completion? (for example, as a buyer, you may wish to make payment of part of the price conditional on performance of the business after you take it over. This could be judged by turnover or profit and usually payments would be made after completion based on the first year or 2 years’ profits)
- Seller staying on as employee or consultant for a period?
- Sale of assets or shares
- What’s included (and yes, please use lists)
- What’s excluded
- Staff arrangements
- Premises arrangements
- Timescale requirements
- NDA/confidentiality requirements
What not to include
Detail such as will be address in the main agreement e.g. limit for making warranty claims etc.
Binding or Non-Binding?
Very rarely, it may be appropriate to use Heads of Terms that are binding with immediate effect. The aim here is to create a legally binding framework very quickly but using the bare bones of a deal and without necessarily going into some of the more detailed administrative or boiler-plate type clauses that a full agreement can have. This is risky and will need detailed advice before proceeding – but it may help you out on one special occasion.
Confidentiality/Non-Disclosure Agreements (NDAs)
Never proceed in any venture based on an “understanding” or “gentlemen’s agreement”. Whilst there are many gentlemen in business, there are many more who are unscrupulous. Put it another way – why take a chance when you don’t have to? Rather than rely on an “understanding” that a document or information is confidential, make it absolutely clear by signing up such an agreement, If in doubt (and it’s yours), label it as confidential so that there is no misunderstanding. This leads nicely onto…
Never make assumptions
“Prevention is better than cure” – no sh*t! Well, go on then, prevent a problem from happening and then you won’t need to cure it! If we spent as much time thinking through the consequences of actions, then most mistakes would never happen. Unfortunately, people act spontaneously and, dare I say, sometimes rashly and just make a decision “in the heat of the moment” or “by instinct” (whatever that may mean). I have heard “well, you know me, I can tell if someone is taking me for a ride, I looked him/her in the eye, went for it and shook hands on the deal…”
Put it in writing
The rule about gentlemen’s agreements applies here (namely, don’t have one, have a “proper” agreement in writing. But, if you do put it in writing, make sure that you don’t score the classic unintentional own-goal…
Subject to Contract
This is rather more relevant in property transactions but it is scary how many people can fall into the trap. As long as a document has the necessary information, it is quite possible, legally, to create a binding contract without intending to. If in doubt, add “subject to contract” to the heading of any letter, e-mail or Heads of Terms – why take a chance (or make an assumption)?
Not strictly relevant to business sales, but often misunderstood anyway. The label “without prejudice” should be used in negotiations to try and settle a dispute. Briefly, adding this label will mean that neither party may show the document in question to a Court if proceedings are issued. It is a negotiating tool designed to help rather than hinder negotiation. The added bonus with this term is that, if it’s used incorrectly (normally out of context), it can make you look like a complete idiot and create much entertainment value! The best misuse of this was on a letter headed “with prejudice”.
What’s the difference between a contract and an agreement?
I’ve asked some highly qualified and successful men and women of business this very question. The amazing thing is that, whilst they are one and the same thing, very few people seem to know this. There’s a sort of mystique about legal jargon and processes and this can lead to puzzlement and confusion.
It’s for this reason that I urge you all to keep things as simple as possible and, if you don’t understand something, ASK!
Formation of Contracts
Offer followed by acceptance of offer and money changing hands can and usually will create a contract. So, is this what you want or need? Not necessarily, I suggest. So, make sure that you always offer on terms that suit you and not somebody else.
Unfortunately, we now live in a society where claims are issued before too much thought is given to merits of the claim and any discussion of the facts. This means that a simple “accident” will no longer be considered to be an accident (which is just an unfortunate event that “happens” and is not really anybody’s fault) but has now evolved into an “incident”. This blends nicely with the concept of a blame culture and is more likely to lead to somebody being sued. Hence “never knowingly volunteer anything” or you will probably wish you hadn’t.
Exchange of Contracts (or just “exchange”)
This is the point in the legal process when buyer and seller are committed to the transaction. Any label (subject to contract) will be meaningless after this point. It is normal on exchange to agree a precise date or timescale for completion, but the circumstances of the deal may mean that this is not possible (if completion is decided by other factors). Never (no, seriously, don’t do it) proceed to exchange on a sale unless you are happy to commit to the transaction and are aware of the trigger of potential Capital Gains Tax liability.
In more complicated or high value commercial transactions it is usual to have a completion meeting and this can last for several hours (I had one that lasted for 3 days!). If a transaction moves through particularly quickly, it is far from unusual to have a number of documents still being “thrashed out” on the completion day. Never assume (well, never assume anything! – see rule against assumptions) that a completion meeting will be straightforward and be prepared to debate a number of outstanding key points.
How many meetings you have during a transaction will be decided by a number of factors. However, a typical commercial transaction will involve at least two meetings, one between you and your lawyer and the other a pre-completion or completion meeting to iron out any outstanding points of principle. The lawyers may organise meetings between themselves (sometimes involving clients, sometimes not) to discuss drafting points and sometimes it is easier to arrange a meeting with telephone or e-mail contact.
The Role of the Lawyer
“My lawyer won’t let me do that…”
“My lawyer has advised me not to do that…”
Which of these are you more likely to say? The lawyer’s role is advisory and executive decisions in a commercial transaction are for the client. In an extreme (and we mean extreme) situation, the lawyer may decline to act if it is felt that the client is behaving in a stupid or commercially irresponsible way but otherwise the lawyer’s role is to advise and not further.
As with most things in life the acquisition or disposal of a business is probably going to cost more than you thought initially. You should be given a pre-estimate of fees for professional services and these estimates may be updated as the transaction progresses. However, for a sale, do bear in mind the impact of CGT and take proper advice. For an acquisition do bear in mind issues such as Stamp Duty (acquisition of company shares) Stamp Duty Land Tax (property) search fees, other professional services e.g. surveys, valuation fees, arrangement fees for funding and also bear in mind that some funders will require separate legal representation (i.e. a different firm of solicitors) who will charge you.
Valuation of the Business
You can ask 15 different professionals how much a business is worth and get 27 different answers. The simple fact is that there is no magic “one size fits all” rule that works in every case.
The starting point is to analyse how similar businesses in this sector have traditionally been valued. This may by way of a multiple of net profits or linked to Net Asset Value. It is very unusual (and dare I say fundamentally wrong) for any business to be valued based on turnover. If you see such a valuation, you should tread very carefully.
You can also usefully identify a trade or professional body that may be able to act as an expert to resolve any dispute over the valuation of shares.