The successful sale of any business depends on the early identification, timely disclosure and appropriate allocation of legal risks and liabilities. The nature of these risks and liabilities will vary greatly depending on the sector and type of business involved. Nevertheless, almost all sale processes will require the following matters to be addressed:
- Collation of a data room: The early collation of a virtual data room of information relating to the business is critical to the success of any sale transaction. The adequacy of a data room will be a function of both the completeness of the information provided and the way in which the information is organised. A comprehensive tailored legal due diligence questionnaire is a key tool in identifying and organising the relevant information. Early discussions between the sellers (or management) and legal advisers can also help flush out further relevant information. The technical integrity, accessibility and functionality of the data room require close attention as well. Shortcomings in these areas can hamper the sellers’ ability to control which parties have access to which documentation at what stage; the buyers’ due diligence process; and further disclosure later in the process. There are many different ways of managing the demands on management time and external costs of setting up a data room. Your legal advisers can help you identify the most cost-effective solution for your transaction, including helping you to identify an appropriate data room platform.
- Review of material contracts: The sellers’ legal advisers will need to review any material contracts uploaded to the data room for restrictions which may prevent the benefit of the contract passing to the buyers or which adversely affect the value which the buyers are willing to attribute to the business. These contracts may include intellectual property licences and real estate leases as well as more generic customer and supplier contracts. Two key types of contractual restrictions on which your legal advisers will focus are termination rights where there is a change of control of the legal entity (where shares are being sold) or requirements for an entity to obtain consent to the assignment of a contract (where the entity is selling its assets).
- Consideration of regulatory issues: Regulatory requirements may influence whether sellers dispose of shares in the legal entity or the underlying business and assets, and the timetable for the transaction. Depending on how the business is regulated, whether the sale involves a disposal of an entity or assets and (in some cases) the size of the transaction and who the likely buyers are, one or both parties may need to notify the regulator, make a regulatory filing and/or seek regulatory approval for the transaction. The sellers will also need advice on the risk of regulatory intervention (particularly by the competition authorities such as the Competition and Markets Authority).
- Consideration of separation issues: If the sale involves part only of a group or business, the sellers will need to anticipate whether the buyers may require ongoing IT and other support for a transitional period from the part of the business which the sellers retain. The level of support which is likely to be required may need further iteration during the sale process, and may depend on the identity of the buyers (for example, a private equity buyer may require a different level of support from a strategic buyer).
- Advice on pre-sale structuring: As well as contractual restrictions and regulatory issues, tax and commercial considerations will also have an impact on what is ultimately sold. For example, the sellers may need to consider whether certain businesses and assets are hived up or down into new vehicles, for the purpose of the disposal or to exclude them from the sale
- Planning around HR issues: Where a sale is to involve the transfer of a business rather than a sale of shares in a legal entity, the sellers and their advisers will need to address how to provide the information and comply with the consultation obligations required by the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). In the case of any corporate transaction involving a business with employees with defined benefit pensions, sellers will also need to satisfy themselves that they run little or no risk of being targeted by the Pensions Regulator's powers to ensure defined benefit pension schemes are properly supported.
- Preparation of a vendor due diligence report: Sellers’ legal advisers may sometimes be asked to prepare a legal diligence report to be shared with potential buyers, alongside financial vendor due diligence reports. Formal legal vendor due diligence tends to feature more often in larger, more competitive processes. The work involved in preparing such a report can be considerable, but it should reduce the amount of due diligence which potential buyers may need to carry out themselves. On transactions involving multiple properties or complex real estate issues, the sellers’ lawyers may also usefully prepare City of London Law Society Certificates of Title.
- Preparation of key transaction documentation: In the context of an auction or other competitive sale process, the sellers’ legal advisers will typically prepare initial drafts of the sale and purchase agreement (SPA), the disclosure letter and (in the case of a share sale) the tax covenant which will indemnify the buyers in respect of various pre-completion tax liabilities. The disclosure letter will include specific matters which are inconsistent with the warranty statements in the SPA and a list of matters of which the buyers will be deemed to have notice (for example matters disclosed in certain public registers). These drafts will inevitably be seller friendly, but drafts that anticipate the reasonable concerns of the buyers will facilitate the successful and efficient conclusion of the transaction. As well as the principal transaction documentation, the sellers’ lawyers will also generally need to prepare non-disclosure agreements to be signed with any potential buyers who want access to the data room and an exclusivity agreement to be signed with any preferred buyers.
- Consideration of warranty & indemnity (W&I) insurance: Sellers should consider whether to require the buyers to seek insurance for any breaches of the sellers’ warranties or any claims under the tax covenant and to agree they will not have recourse in this respect against the sellers. This may require some negotiation as to how the cost of the policy will be met and whether the buyers may still have recourse against the sellers for liabilities which insurers typically exclude from cover (see the previous article in Ashfords’ M&A series, “Warranty and indemnity insurance: bridging the gap between the expectations of buyers and sellers”). W&I may not be suitable for smaller transactions for which the cost of the insurance premium and underwriters’ requirements for detailed due diligence reports may seem disproportionate, but may be crucial if investment funds are involved in the sale.
- Management of the sale process: How sellers will conduct the sale process will primarily depend on whether they have appointed financial advisers to help them manage this process and identify potential buyers. In any event, there should be clarity as to the different roles of the advisers involved and regular communication between them and the sellers on how the process will be conducted, what timetable should be followed and how this should be communicated to potential buyers.
Perhaps more important than any of these specific issues is the need to appoint advisers who will support the sellers through a demanding process with good humour and a detailed understanding of their business and objectives, and who will work smoothly and proactively with other advisers.
Further articles in this M&A series will address different aspects of the transaction process, including legal, tax and regulatory workstreams.