A detailed look at M&A activity

Buying or selling a business can be complex and here at Gullands, our Business Hub team will guide you through the whole process.

Shares of a company are bought and sold between existing shareholders or by new shareholders under a share sale agreement.
The key features of a share sale agreement should include:

  • Agreement to sell and purchase
  • Conditions precedent
  • Consideration (and any adjustments)
  • Warranties and indemnities
  • Restrictive covenants
  • Completion and
  • Tax

There are of course advantages and disadvantages of a share acquisition and sale. For the seller, selling shares has a number of advantages including:

  • Where the entire issued share capital of the company is being sold, the seller will benefit from a clean break. For the buyer, this means that the company is being acquired with everything in it, including its assets, liabilities and trading history. As a consequence, the buyer will usually require comprehensive protection from the seller in the sale agreement in the form of warranties and indemnities.
  • The seller will pay capital gains tax (assuming it is over the current tax-free threshold) on the disposal of shares and they may be able to claim entrepreneurs’ relief if certain conditions are met.

Advantages for the buyer often include:

  • Buying the shares in the target company maintains the continuity of the business, as there is no need to legally transfer the assets, property or employees of the business.
  • The target company continues as before which can simplify the tax position for both the buyer and seller.
  • The buyer can take advantage of any loss reliefs contained within the target company.

There are of course also disadvantages on the sale of shares:

  • The buyer will need to carry out a detailed due diligence process as a share purchase does mean they will be carrying forwards all the current and past contractual and financial liabilities and debts. Of the business.
  • The warranties and or indemnities required by the buyer in the sale agreement, will typically be more widespread.
  • The overall costs of the transaction for both the buyer and seller are likely to be higher.

When there is an agreement in principle reached between the seller and buyer, it is advisable
for the parties’ next step to enter into a heads
of agreement.

The heads of agreement typically contains the essential terms of the transaction which forms the basis for drafting the legal documents. The heads of agreement are generally not legally binding, with the exception of exclusivity (for the buyer) and confidentiality provisions (for the seller).

If not dealt with in the heads of agreement, it is advisable for the seller to have a confidentiality agreement in place prior to the buyer commencing their investigations or due diligence in relation to the company.

The sale and purchase agreement is different for every deal, but often covers:

  • The price of the shares can take a variety of forms, for example, cash, shares or debt. The main factors dictating this will be the tax strategy of the seller and the ability of the buyer to finance the purchase.
  • Agreements often include an earn-out arrangement. Typically, all or part of the purchase price is calculated based on the future performance of the business. The seller will therefore need put suitable protection in place to ensure that the operation of the business is maintained.
  • There will also be covered all of the administrative details that need to take place at completion including payment of the purchase price, the transfer of the shares, appointment/resignation of directors, the release of bank security and the release of the seller from any personal guarantees given to support the obligations of the company to third parties.
  • The transaction may also complete on the basis that the buyer will pay a provisional sum in respect of the purchase price at completion and that this sum will be adjusted following the preparation of completion accounts. The purchase price is sometimes increased or decreased if the net assets are greater or less than expected. Other adjustments to the price paid may also be made.
  • The seller will be required to give warranties to the buyer in relation to various aspects of the affairs of the company. These provide the buyer with a remedy for breach of contract if a warranty is breached.
  • A disclosure letter from the seller will set out details which are inconsistent with the statements made in the warranties. Generally anything fairly disclosed in the disclosure letter will prevent the buyer from making a claim for breach of the warranties. It usually won’t prevent the buyer from reducing the price to be paid pre-completion if there is anything which would reduce the value of the shares set out in the disclosure letter or alternatively all parties may agree on an indemnity.
  • The ability of the buyer to make a claim for breach of the warranties against the seller is limited typically to a maximum amount. Claims must be of a certain minimum value and made within a certain period of time following completion.
  • Specific issues of concern from the buyer will be covered with an indemnity, whereby the seller agrees to be responsible for loss suffered by the buyer.
  • The seller will be expected to give a tax covenant in relation the company’s tax affairs. 
  • Restrictive covenants protect the buyer from the seller setting up a competing business and or approaching customers/suppliers and employees of their former company.
  • Where the deal is funded by a third party, or through a loan, the lender will usually take security over the company and/or its business. A seller may also wish to take security if the purchase price is to be paid in instalments over a period of time post completion. Security is typically in the form of a debenture, mortgage or personal guarantee.
  • The rights of any minority shareholders will be covered by a shareholders’ agreement. 

Management Buy Outs, Management Buy Ins and Buy In Management Buy Outs:

Typically, external finance is needed for whichever form of buy-out structure is chosen, as it is unlikely that the managers will have sufficient funds to complete the deal themselves.

These types of transaction normally involve a management team setting up a new company which then acquires the business or shares of the existing business. Funding for the new company is typically from:

  • External funding from a bank or other lender.
  • Investment from a third party by loan and share capital.
  • “Funding” by the “exiting” majority shareholder, where the consideration for the business or shares of the target is made on a deferred basis.

There is clearly much to consider with M&A activity, and our Business Hub team will be delighted to help:

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