Preparing your company for sale
Paul Raftery provides a checklist of things to consider for business owners who are preparing a business for sale.
Working towards an exit after many years of running your business can be a stressful process, one which can impact family and business life. Whilst you may not be thinking about an immediate sale, preparation is key when it comes to selling your business.
Very often, external factors may accelerate your exit timetable, but is your business sale-ready?
As the Spring Budget approached in early 2021, concerns that a change to the capital gains tax regime and rates may have been on the cards prompted a flurry of deal activity to get deals across the line ahead of the Budget. In fact, no changes were made to the capital gains regime in that Budget, but few commentators doubt that, as has been proposed in the USA, capital gains taxes will rise in the near future, quite possibly as soon as the November 2021 Budget.
The tax could easily be later this year or early next and that is not a long time if a seller is preparing their business for sale, marketing it, getting it through due diligence, getting through the legal process, dealing with any regulatory consents required and completing the deal. Plans have to be in motion now.
Experience shows that few business owners are ready for the sale process. Having your business exposed to the full glare of a buyer’s legal, accounting and tax due diligence can be a daunting process, one far better faced with advance preparation away from the timetable pressures of the deal itself, particularly important as throughout the process you have a business to continue to run.
Taking time to understand how deals and price negotiations are structured will enable sellers to make more informed choices when negotiating the deal. Learning as you go is no substitute for some prior preparation.
We need to see a lot more seller preparation for due diligence, especially if sellers want to bring deals to a speedy conclusion. Every deal we do, the sellers always say there are ‘no skeletons in our cupboard’; the business is completely clean. Just to be absolutely clear, that’s never in fact the case, there is always something. But what you can do is prepare for it, and make sure that you deal with those skeletons and you know what they are going to be doing.
As a full service law firm, we have a team of experienced transaction lawyers who can work with business owners to support you in good time before any deal is negotiated so that they understand the process and undertake a review of the business (known in the jargon of deals as a vendor due diligence exercise) and report on the legal health of their business. The aim of this process is to identify any potential issues in your business so that they can be addressed in good time, particularly if they could impact the value payable for the business. We offer a service designed to put you and your business in the best shape to negotiate and efficiently conclude a value-enhanced sale process.
How to prepare your business for sale
Planning and experience is key to a successful outcome
In a post-COVID-19 world, buyers will be more selective and opportunistic about which opportunities to target and spend time on. This more targeted approach will mean that sell-side corporate finance advisers will need to run different processes from those they ran pre COVID-19, spending more time identifying the right pool of potential buyers and working with them much more collaboratively so every party to the transaction can see the value in progressing it. Planning as far in advance as possible will therefore be essential as poor preparation can lead to an enormous waste of time, effort, energy and money. It’s much better to be on the front foot and take your business to the market on your terms rather than wait for an unsolicited or hostile approach when your business may not be in its best state to sell.
Experience is also key, more so than ever before, so take advice from specialist corporate lawyers and corporate finance accountants who know what they are doing, who can add value to the process and protect you from risk. Doing so will mean that you have a much better chance of making the process run as smoothly as possible, maximising the benefits of the sale for you, your business and your family.
Appoint the right team
The sale process is often the culmination of years of hard work so make sure you appoint the right team to give you, your business and your family the best possible outcome.
Make sure that your lawyers, accountants and other professional advisers have an in-depth understanding of your long term strategic and commercial goals and a good track record in the type of deal you’re embarking upon which will help avoid the pitfalls that can impact on its success.
Bad advice can be expensive whereas good advice can make all the difference and make all those sacrifices worthwhile. Whatever you do, don’t do it on the cheap. Take up references and ask to speak to clients who have also sold out in recent years so that you can gauge their experience of the sale process and the advice they received.
So how do you know when you’re ready to sell your business? Consider working with experienced financial planners to not only identify when you can realistically stop working and exit your business but to also identify how much money you’ll need from the sale of your business to achieve your personal financial goals. Personal cash flow planning can be a useful tool to forecast your future income, taking into account proceeds from your business sale as well as your other assets and expenditure. This will show you whether you are on track to achieve your lifestyle and retirement goals and how best to convert your business wealth into personal wealth.
Make use of the various tax reliefs
It’s also important to think about the tax-efficiency of your business and personal wealth both before and after the sale to ensure that your assets are structured tax efficiently to create the best possible outcome for you and your family. Whilst we still have entrepreneurs relief, its limit to £1m lifetime allowance means it’s ever more important to ensure that you get full use of it, and so ensuring that spouse or other family co-ownership is put in place in time and in accordance with the qualifying conditions to ensure the relief can be obtained.
Determine a realistic value for your company
Set a realistic asking price for your business. Too high and you’ll scare off potential buyers, too low and it could look like there is something wrong with your business. That’s why it pays to retain the services of a specialist corporate finance accountant who will assess the value of your business based on current and forecast market conditions, identify the value drivers and help you evaluate the offers you’ll receive.
There’s little point in building up value in your business only to see it undone by a valuation that doesn’t stand up to scrutiny or even worse fails to properly address the value drivers in your business.
One of the key challenges after any economic crisis is how to properly value a company, particularly when prior to the COVID-19 pandemic, its financial and trading position was good, but where it has been materially impacted by the pandemic. It is for this reason that we have seen changes in typical deal structures, with deferred consideration and earn-out mechanisms becoming increasingly prevalent so the future earnings and valuation risk becomes shared between buyer and seller.
However, the increased risk of deferred consideration may create concerns from the seller’s perspective. In a volatile market, where the liquidity of the buyer may be an issue, sellers may become increasingly concerned about a buyer having the funds to pay the seller when they are due to be paid. This will lead to some difficult and potentially unresolvable discussions around security for deferred consideration, whether charges, cash deposits in escrow accounts or some form of insurance solution. This issue may increase the deal risk profile for a seller and should potentially be factored into the headline price. Again, another reason to appoint the right advisors to fight your corner!
Lock in and incentivise your key staff
Not only will your senior management team and key employees be key to the success of your deal, they will have also played an important role in helping you build up value in your business. In our article on the employee shareholder, we explored the various HMRC approved share option schemes and other mechanisms you can put in place to not only attract but also lock in and retain key employees who are going to be essential to the future success of your business, ensuring that their long term interests are aligned with your long term goals. HMRC approved schemes such as the Enterprise Management Incentive scheme can be designed as ‘exit’ only and are a great way of incentivising management for the long term as well as allowing them to participate in the value realised from the sale process.
Once you’ve agreed to sell, not only will your key employees be needed to help with the sale process, they’ll also be needed to help you whilst you’re balancing the competing pressures of managing the deal and leading the business.
A strong management team will also demonstrate to a buyer that there is no overreliance on any one person, something which will be off-putting if you, your business and its relationships with key customers and suppliers can’t be separated.
First impressions count
Just like selling a house, first impressions count. Put yourself in your buyer’s shoes, does your business have ‘kerb appeal?’ It might sound obvious but keep your premises in good order, stock levels up and the business records up to date.
Work closely with your professional advisors to identify potential value issues in your business so that they can be addressed in good time so that they don’t become value destroyers and undo all those years of hard work and personal sacrifice. If issues can’t be fixed, then come up with solutions on how to deal with them rather than present problems to a buyer. Whatever you do, don’t go into the sale process if you have outstanding problems in the business. Your business should have tidied up any issues before you begin, and make sure they are tidied and not pending. A buyer doesn’t want to inherit someone else’s problems.
This is where ‘vendor due diligence’ really can make a big difference to the outcome of the sale process. This is a process where a specialist corporate finance accountant and lawyer produces an in-depth report on the financial and legal health of the business to prospective buyers which will provide an independent view of the business encompassing its performance and prospects. It aims to address the concerns that may be relevant to even the most demanding buyer and provides business owners with greater control over the sale process and the timing of the sale which can help secure a higher price for the business. It can also help the process run more smoothly as it can remove the requirement for a buyer to have substantial access to the business to do their own due diligence work as they will be able to rely on the vendor due diligence report.
Vendor due diligence can also help to identify value critical issues in a business, providing you with the opportunity to address any such issues before a sale process with prospective buyers has begun. For example, prospective buyers will also want to see strong and well-established systems, processes and procedures in place. Trying to sell a business without the accounts, premises and staffing structure properly organised creates the worst impression. Vendor due diligence can help a business owner focus on the quality of revenue/profitability by securing long term contracted revenues, negotiating preferred supplier status, maintaining a strong order book, developing long term customer relationships and aiming for a diverse mix of customers and markets. Your business’ history of profitability, competitive advantage, customer base, growth opportunities, brand loyalty and intellectual property rights are all valuable in the eyes of a potential buyer and any one of these items can have a negative impact on value if not dealt with properly.
You may think that selling your business in a post-COVID-19 world is going to be a lot harder. Indeed, this all may look rather gloomy for sellers. However, proper pre-sale planning in the business, such as managing working capital and profitability, as well as reviewing personal cash-flow requirements and pre-sale tax, estate and wealth planning, can mean the impact of a period of likely suppressed valuations can be minimised and the impact on the overall return to sellers reduced.
Understand the buyer’s approach
Having secured offers for your business, understand the buyer’s funding and internal process and be prepared to finance part of the deal yourself by deferring some of the sale price. As we touched on earlier, many buyers post COVID-19 will rely on the seller to help them buy their business. A failure to agree to this may reduce the number of interested parties, particularly if you’re looking to sell to the incumbent management team.
Negotiating the deal to a successful completion can at times become heated and protracted so it also makes sense to leave difficult or potentially acrimonious issues to be negotiated, wherever possible, adviser to adviser, as you and the buyer will more often than not need to maintain a close working relationship pre and post-sale.
Advantages of sale planning
Better understanding leads to better deal terms
Sellers who better understand the process and market practice of deal structures have a better basis from which, with their advisor, they can negotiate better deal terms (whether in terms of the price obtained, how the price determination is structured or otherwise). At the very least, they feel more in control of the process they are embarking on. Sellers still need quality advisors who understand the process and can guide them, but an earlier understanding of what’s likely to be involved will help you make better and more informed choices.
Avoid being hi-jacked mid deal
Dealing with problems identified by the buyer mid-process rather than in advance is inevitably creating the risk that less optimum solutions are adopted such as price chips or requirements that the sellers remain liable for a problem post-sale. If your advisors know about an issue in advance, they can attempt to rectify the issue or they can raise it at indicative offer/heads of terms stage so that it is factored into the price negotiation – far better for a seller than being on the back foot in price negotiation if the problem comes out in due diligence. The potential solutions which appear to be open during the timetable pressures of a deal are often narrower than when the same issue is addressed in an orderly way pre-sale. This can result in real value loss when not addressed upfront.
A business that is well-presented for sale is more likely to drive up interest and price competition as well as enabling a smoother transaction process once the deal gets underway. It may be that the potential sale value and interest in the target company is sufficiently high so as to justify presenting buyers with a formal seller prepared due diligence report and pre-populated disclosure data site if an auction for the business is a possibility. Transactions are all about trying to drive them as quickly as possible for sellers and make them as competitive as possible. Vendor due diligence reports ensure that at the bidding stage all bidders have the same information and can put in the best possible price for the business.
Driving up the price
A well-presented business is more likely to drive up competition and price and avoid price leakage caused by having to resolve problems unearthed only during buyer due diligence. But, in addition, by working early with your preferred professional team (lawyers and corporate finance accountants) you may have time to present an improved set of financials and income projections. This may come from e.g. having a fresh review of longstanding accounts provisions and reserves or from assessing costs and retendering services. Most deals are set at a price which is a function of earnings before interest and taxes (EBIT) or earnings before interest, taxes, depreciation and amortisation (EBITDA), so there is a multiplying effect to sustainable and repeatable cost savings that may be identified if these can be put in place in good time. From a seller perspective, financial and tax due diligence is incredibly thorough at the moment. Forecasting, a dark art if ever there was one, is crucial. Recurring revenue, replacing lost or deferred revenue, are all a focus for buyers. Normalised working capital and the ‘look forward’ element we now have will continue to prevent challenges to financial directors and accountants.
Prior planning may also enable more tax efficient ownership structures to be put in place and enable any longer term trust and will planning exercise to be undertaken prior to the sale (helping to maximise potential reliefs). Any valuable tax reliefs within the business (such as research and development (R&D) reliefs) can also be identified and factored into any price negotiations.
Identifying and resolving issues will result in costs needing to be incurred whenever the issues are dealt with but can be, in many cases, quite legitimately put through the target company if dealt with as part of pre-sale planning, potentially allowing for a corporation tax deduction and VAT recoverability.
First time sellers, in particular, are very commonly completely unprepared for the extent of buyer due diligence and the range of issues they are forced to consider and form a commercial judgement on as part of the sale process. This can make the process feel overwhelming at times. Well-seasoned advisors can take much of that stress away but early planning and prior seller due diligence will also help. This is particularly important as you will still have a business to run leading up to completion with a sale price impacted by final results and possibly by future earn out arrangements too. Keeping the business running whilst handling all that the sale process throws up can be challenging, so any prior work done to spread the load and anticipate issues can only help.
Examples of transaction problems we have seen ... and how prior planning could have helped
Gaps in contract coverage
It is not uncommon to see that businesses cannot find key contracts or have never reduced them to formal contact terms or even where there are contracts in place that their standard terms of trading are outdated.
Change of control clauses
Key contracts such as facility agreements, CBILs loan arrangements, long term supply arrangements or accreditation arrangements etc. often contain change of control provisions entitling the other party to terminate in the event of a sale. Identifying these early and having a strategy for obtaining consents to a timetable that makes sense of deal confidentiality and a completion deadline will be important.
Statutory licences and consents
Again, it’s not uncommon for licences to contain change of control provisions which will make it an offence to trade post-deal if consent to the change of control/ownership has not been obtained (for example businesses regulated by the FCA such as insurance brokers or any business with a consumer credit licence; or businesses regulated by CQC, NHSE or Ofsted). Identifying the issues early is key to getting these consents in a timely fashion. COVID restrictions have put a strain on the timetable for getting consents and so having these approval processes in hand is key, particularly as the “tax point” of any sale may not be effective until that consent has been obtained even if a prior exchange of contracts conditional on such consent is in place.
Missing property deeds or documents
We have seen lots of examples of sellers who just cannot lay their hands on key documents e.g. rights to use an adjacent strip of land or evidencing key rights of access or perhaps an agreed rent review concession. It’s usually easy enough to resolve these types of issues, but they can take a little time, as another party and its advisors will be involved (such as a third party commercial landlord) so, again, identifying the issue early helps.
Assets not in the target company name
Again fairly typical to see this, particularly with regard to intangible assets such as intellectual property rights, website and domain names etc., that are often held personally and need moving into the target group prior to sale. Any tax implications of this also need to be considered.
Assets that need moving out of the target group
What about those things which you know that the buyer may well not want (typically a freehold property where a buyer of the target company may only want to take a lease or part of the site?)? Having a plan to move these assets out pre-sale tax efficiently is going to be necessary. Again, timing can be a factor here. It’s often tax efficient to move property assets out from a target group through a process known as a ‘capital reduction demerger’, but that is only legally effective when the documentation is showing on the public records at Companies House and COVID delays have built up there, which again makes prior planning so important.
Ownership of intellectual property
If intellectual property (IP) value is an important part of the business value then sellers can expect heightened buyer due diligence around IP ownership rights to developed intellectual property whether that be a patent, software, website or other. We often see issues such as third party developers whose contact terms gave them full ownership rights or key employees who have worked on the IP but who have no written service agreement or one that lacks clear provisions about who owns the IP they have helped to develop. These can be tidied up if time permits, so the sooner the issues are identified and resolved the better.
Poorly drafted or non-existent employment contracts
Buyers will want the comfort of knowing that key members of staff are on acceptable terms as to the notice they have to give; that there are enforceable restrictive covenants against non-solicitation of customers and staff; and as to ownership of developed IP. If there are gaps the buyer may insist that fresh contacts are entered into on completion, but better to do this beforehand and without the risk that staff become alerted to the potential sale.
Share ownership structures
Are the shares held in a tax efficient manner so as to maximise available reliefs and legitimately minimise tax? We would also consider with you whether your personal estate planning is in order? The taxable characteristics of your assets as you move from shares to cash will change and this needs addressing. If time permits, can wider trust or other arrangements be put in place? Our corporate, tax and private client lawyers work together as one team to provide a service that brings our specialisms together to offer advice and solutions that fully address these issues.
What does Weightmans ‘preparing for sale’ service encompass?
Explain deal structures
One of our experienced corporate deal lead advisors will take you through the process from choice of advisors through non-disclosure agreements, heads of terms, the key transaction document such as the share sale agreement, the tax deed, the disclosure letter etc., and the completion process and the all-important distribution of sale proceeds.
We will also advise as to the key pricing structures commonly used and explain key concepts such as the use of completion accounts or a ‘locked box’ mechanism; price adjustments by reference to net assets; and price adjustments by reference to the so-called “debt free/cash free/normalised working capital” formula (and what those phrases mean).
We will ensure that you understand what warranties and indemnities are and how you are protected against claims; the importance of disclosure; the benefits, cost and availability of warranty and indemnity insurance; and what the market norm is for post-sale restrictive covenants.
Legal due diligence
Our team will agree with you a menu of areas to review and report to you on (and recommend steps to be taken), to carry out a health check on the company and its preparedness for sale with a view to being ready to satisfy buyer due diligence.
Legal due diligence report and data site
If considered appropriate, any report prepared for your benefit can be built out into a formal report and data site available for bidders to review.
Share ownership and will tax/will planning review
Our corporate, private client and tax advisors work with your existing financial advisor to review your present ownership structure and the tax implications of any likely deal and advise as to any steps or will or trust planning actions that may be advisable to take.
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