Considerations for a buyer when purchasing a business

Introduction

The decision to buy a business is exciting but naturally carries with it an air of trepidation. There are many factors of a legal, commercial, and financial nature that the buyer will want to think about before and during the acquisition process. Likewise, the seller of a business will also encounter an array of matters to explore and address.

In this article, Will Mudd, Corporate Finance Director, of Westcotts Chartered Accountants and Business Advisers and Matthew Libby, Senior Associate of Trowers & Hamlins LLP outline the key considerations for a buyer and how, as trusted and experienced accounting and legal advisors, we can work together with you to ensure that your acquisition is as smooth as possible.

Objectives

Before taking a decision to embark upon an acquisition, it is important to establish a clear rationale and purpose for the acquisition. The strategic goals of each buyer will be particular to them, but this should always be driven by a desire to benefit from characteristics of an existing business. For example, a buyer may identify that it could benefit from greater resources, deeper talent pool, reputation, products, technology, markets, connections and more varied revenue streams.

By acquiring these features from another business, a buyer may be able to readily fulfil its own business’ specific aims, such as increasing market share, cost efficiencies or brand awareness, with greater ease and expediency. Determining exactly what you would like to achieve will inform what features are required and therefore what businesses to target for acquisition.

In contemplating an acquisition, it is often a good time for the potential acquirer to consider reviewing their own business plan and forecast. They might refresh their own corporate finance goals and re-consider their funding needs.

Acquisition Structure

Once a target has been identified the buyer can begin to consider exactly what they would like to purchase. Generally speaking, there are two ways of structuring an acquisition: as a share purchase or an asset purchase. As the name indicates, in a share purchase the shares of a target company are sold and acquired and therefore, the buyer takes on every asset and liability of the target company without exception.

Conversely, in an asset purchase the buyer will purchase selected tangible and/or intangible assets relating to the business from the company that is operating that business. This means that the buyer can ‘cherry pick’ the assets to purchase and leave behind anything undesirable with the seller. It follows that an asset sale is generally better for a buyer. The most preferable structure will depend on the specific circumstances and so professional advice should always be sought at the outset of the acquisition process.

Trowers & Hamlins has extensive experience advising buyers on the most appropriate acquisition structure for a particular business acquisition – we can provide you with the necessary bespoke advice to ensure that you make the correct decision on this fundamental point.

Westcotts have specialist teams to help advise on transaction structuring around accounting and tax efficiency. It is worth investing time and effort upfront to get this right.

Finance

Discussions surrounding the acquisition will also feed into the negotiations on price. For instance, with an asset sale a seller may command a higher price since they will not get the clean break a share sale can offer. However, whatever sale price is ultimately agreed it is important for the buyer to think how their prospective purchase will be financed in advance.

There are many ways to fund an acquisition but broadly the two main methods are: paying in cash on completion and debt financing (e.g., obtaining loans or acquiring debt securities). The funding method will also influence the negotiations on the sale price as a seller may agree to a lower sale price for a buyer paying cash on completion.

Will Mudd’s view is that “Bank debt for M&A deals is still reasonably expensive and leverage not as high as a few years ago, although it is improving especially as the banking landscape continues to change with new SME focussed players emerging.

Therefore, a key component in getting a deal done from a buyer’s perspective is to try and negotiate with vendors to bridge a deal value gap using components such as vendor loans/deferred consideration/contingent consideration and/or a mixture of all three.”

Westcotts corporate finance team works on many mandates including buyside and sell-side and we can see things from the other sides viewpoint. This helps inform us as to what is important to both the buyer and seller and greatly helps with negotiations and getting a transaction over the line.

Preliminary Documents

Once the key terms of the acquisition have been agreed the terms should be recorded in a document which is generally referred to as the Heads of Terms – this document clearly sets out the parties’ intentions to enter a contract for the acquisition in due course.

At this stage it is sensible to put in place certain legally binding agreements covering exclusivity and confidentiality between parties. The buyer will want to ensure that the seller agrees to not entertain offers from other potential buyers for a specified period. This reduces the risk of the buyer wasting time and money on assessing the suitability of the target only to find it will not be sold to them.

In a proposed business sale, the seller will provide information about the target, through due diligence as explained below, that it would not want to be publicly available for legal and/or commercial reasons. For example, the seller will not want their trade secrets to be leaked. To this end, the seller should also insist that a confidentiality agreement, or non-disclosure agreement is entered into by the buyer.

The Corporate team at Trowers & Hamlins regularly advises buyers on all of the preliminary documents that should be in place at the outset of the acquisition. Having suitable preliminary documents in place is an important step for ensuring a smooth acquisition process and will help manage the expectations of the parties from the outset – getting this right will help ultimately help ensure that the transaction is managed in as time and cost-efficient manner as possible.

Due Diligence

It is vital to appreciate that a buyer does not have any statutory protection with regards to the business that is being acquired (“caveat emptor” – let the buyer beware!). It follows that a prudent buyer will not proceed with the purchase of a business without first carrying out some level of due diligence. This generally involves conducting careful research into multiple areas of the company or the business and assets of the target company. Generally, this includes looking into finances, tax and operations, but more subjective aspects may also be examined such as employee motivation or culture.

A buyer should consider their appetite for risk when determining the level of due diligence to undertake. Whilst undertaking due diligence has a cost, it can be more financially savvy to investigate a target thoroughly in the long run. This is because it is only when risks are identified that concrete steps can be taken to eradicate or mitigate them. For more information on due diligence, see this separate article here.

Warranties and Indemnities

Requiring the seller to provide warranties and/or indemnities is an important way of protecting the buyer against risks. Both are forms of contractual protections which will be set out in the transaction documents governing the sale and acquisition of the business.  Warranties are statements or assurances regarding the business that is being acquired. If after completion a warranty is found to be untrue, then the buyer may be able to bring a claim of damages for breach of contract.

Typically, in a share purchase where all assets and liabilities are taken on by the buyer, the warranties are extensive. The buyer will want the warranties to cover all aspects of the business and usually, among others, this would include tax, accounts, employees, disputes and intellectual property. The seller will need to undertake a careful review of the warranties to ensure they are true and accurate. If this is not the case, in order to obtain protection from a claim for breach of warranty, the seller should seek to qualify the relevant warranty (for example, by qualifying the warranty with the awareness of the seller) and to formally disclose to the buyer the existing circumstances, in a disclosure letter, that makes the warranty untrue or inaccurate.

In the context of a business sale, an indemnity is a promise made by the seller to the buyer to pay a sum if an event causing loss to the buyer occurs. If during the due diligence process, it becomes apparent to the buyer that there is a potential liability, for example, if the purchase involves a property and an environmental issue with the land that the property sits on, is identified, the buyer should seek an indemnity from the seller. If the environmental issue arises following the sale and the buyer is forced to pay out of their own pocket to cover the cost of dealing with it, the buyer can enforce the indemnity and recover the loss from the seller on a pound for pound basis.

The warranties and indemnities should be bespoke to the transaction in question and the drafting should be informed through the due diligence investigations carried out by the buyer. With lawyers in a wide range of teams who are able to advise across all different sectors, Trowers & Hamlins has the specialist knowledge in order to provide the buyer with the comfort that will be afforded by having appropriately drafted warranties and indemnities set out in the transaction documents.

Westcotts work alongside the legal advisers to ensure the terms of the deal are reflected in the legal documentation. As a ‘one-stop-shop’ we can bring in tax, VAT, accounting experts as well as our dedicated, experienced M&A team to give the right advice to client undertaking deals.

Post-Completion Success

The share and asset purchase agreements will also likely include provisions designed to maximise the businesses’ chances of success after the sale. Such provisions may include clauses known as restrictive covenants which broadly operate to prevent one party to the agreement from doing something post-completion. A common example is a restrictive covenant that works to stop the seller from setting up a competing business. In agreeing restrictive covenants, a seller will usually require temporal, geographical or other caveats, such as ‘for a period of two years’ and ‘within a ten-mile radius’.

Another method of helping to achieve continued success is the inclusion of an earn-out clause. Such a clause requires the buyer to pay a certain amount for the business on the sale, but then further monies later to settle the total purchase price. The deferred amount is determined by the performance of the business so if it continues to be successful then the buyer will pay a higher figure than if it falters. An earn-out helps to incentivise and motivate those involved within the target business but also arguably achieves a fairer and more accurate price for it too.

Conclusion

Both Trowers & Hamlins LLP and Westcotts have extensive experience acting for the buyers businesses in a range of contexts and in doing so advising on the considerations outlined above. If you are looking to buy a business, please get in touch and we would be very happy to discuss your acquisition strategy and how we can help further. The earlier you speak to a professional advisor on your business purchase journey, the better your chance of success in the long-run!