Legal matters
HERE’S ONE I MADE EARLIER!
There’s a real advantage to buying an existing business; you don’t have to spend time, effort and money building up goodwill. However, there are, as company law expert Catriona Wheeler points out, a few matters that you need to bear in mind.
Until you and the seller have come to a binding agreement, you’ll want your discussions kept private. The seller will want to be reassured that you’re not simply extracting information and setting up on your own account, so may expect you to sign a confidentiality agreement.
At the same time, it may well be in your interests to ask the seller to enter into an agreement, or ‘lockout’, to prevent them talking to other interested parties. Bear in mind that, depending on your relative bargaining position, you may in return be asked to pay a non-refundable deposit for the privilege of being the sole person they speak to.
Many problems arise because parties make assumptions about what has been agreed, be it price, assets, referrals, earn out etc. Heads of Terms can be drawn up between parties to summarise the main points. These will be signed but should make it clear they are not a binding contract so don’t get too bogged down in the Heads of Agreement themselves, the detail will come in the contract. Your solicitor and accountant should be involved at this stage so that neither you nor the seller start down a route that the professionals may advise against later.
If the seller is a limited company, then a vital question to consider at this stage is are you buying shares from the owner of the limited company or the business from the limited company? From a buyer’s point of view, it is usually preferable to buy the business, as buyers can pick and choose what’s bought and what’s left behind. There may also be some advantages to buying the limited company such as ongoing contracts which would otherwise have to be assigned, or saving stamp duty costs when acquiring the business premises (stamp duty on shares is ½%). However, many sellers will find it more tax effective to sell their shares.
Once Heads of Terms and Confidentiality Agreement have been signed you’ll want to know more about the business itself. Instruct your solicitors and accountants to carry out due diligence. They’ll ask questions about the business, its contracts, its employees, liabilities and, from the answers and any specific matter you’ve asked them to investigate, can build a better picture and highlight any matters of concern that may arise.
While due diligence is being conducted or when a more informed picture has been acquired of the company, the contract for sale is drafted. This sets out what’s being sold, details of any restrictive covenants that the seller is giving, how the monies should be paid and, if there is a split between exchange and completion, how the business should be run in the meantime. There may be conditions on certain matters like obtaining consent from a landlord for the assignment of a lease or obtaining a new licence for licensed premises.
The contract will contain warranties given by the seller. Depending on the value of the business sold, these warranties may be relatively short like simply confirming that the seller owns the business, that there is no known litigation, and that details given of employees and other assets are correct. Some warranties, however, may run to several pages setting out more detailed representations about the business.
There will be circumstances where a warranty is generally true but has some exception e.g. the seller may warrant that there is no litigation but will disclose formally that there is a debt collection matter. These disclosures are quite useful as part of the information gathering exercise. If there is any doubt that the seller will be able to pay in a warranty claim, you can negotiate that you will keep a retention from the purchase price. This is usually held by the solicitors and paid out at the end of the warranty period. Warranties are generally given for between one and two years although if given in relation to tax, the period is between six and seven years.
Where you buy shares in a limited company, as mentioned before, everything belonging to the company transfers across and there is simply a change in the shareholder. Employees remain employed by the company and the Transfer of Undertakings Regulations (TUPE) are not relevant. However, where you buy a business, the employees generally transfer with all their rights against their current employer becoming your liability. Due diligence should provide enough information to identify who those employees are, how long they have been employed, their salaries and other terms of employment. If you are considering making employees redundant or changing their terms of employment, you must discuss this with your solicitor as dismissal in connection with the transfer is automatically unfair, except in limited circumstances.
As regards restrictive covenants you need confidence that having bought a business and its goodwill, the seller is not going to get bored with having sold out and set up in competition six months later! So it is standard to have a covenant from the seller that they will not compete; although enforcing them is notoriously difficult. They must be reasonable at the time they are enforced, regarding both the area and time. For example, if you’re buying a town centre shop, it’s not reasonable to prevent the seller from setting up in business in another town 35 miles away. However, it would be reasonable to prevent them from setting up a shop of the same type of business around the corner, two months later.
Throughout the whole transaction, keep your professional advisers completely up to date with negotiations with the seller and any conversations you may have. This is particularly relevant concerning warranties as it is standard for any sale agreement to state that it contains all the terms of the sale. So, If your professional advisers are not aware of some side arrangement that you made, or a statement that you’re relying on, it will be difficult for you to enforce it later.
