What are some of the key preparations that a prudent business can make before entering into a share acquisition? Here, we outline the different transaction options available to you, a detailed look at the due diligence required, and how best a business might assess the value of purchasing a company to help it to achieve its goals. Read our guide for a complete guide to the share acquisition process and the steps you’ll need to take along the way.
- Is a share purchase the best structure for the transaction?
- How to prepare for the transaction
- What due diligence is required before the share acquisition?
- What are the tax implications of a share acquisition?
- Is there any additional finance that needs to be raised for the transaction?
- How does the share sale process work?
- What documents need to be exchanged for the share sale to take place?
- What agreements should be made ahead of the share transaction?
- What does the process of exchange and completion look like?
- Are there any other considerations once the share sale has taken place?
Is a share purchase the best structure for the transaction?
When a business is considering whether to enter into a transaction to purchase a company there will be many drivers that it will need to consider and prioritise. A lot will depend on the facts and circumstances of the sale and the nature of your business. It could be that the company being sold has great synergies with your existing business. It could be that the company is being sold at a lower price than you would expect and is a bargain, or it could be that the acquisition of the company makes sense strategically in some other way for your expanding business.
One consideration is whether a share sale (meaning that you would purchase (some or all) of the legal and beneficial interest in the outstanding issued shares of the company and therefore become the company’s shareholder) is the best type of acquisition for your business.
Becoming the (sole) shareholder of a company means that you can end up taking the company warts and all – complete with all its liabilities and obligations. This may not be ideal if for example you are only interested in the company for a particular aspect such as its real estate or its intellectual property and would rather not be saddled with its large workforce and their pension liabilities.
You may want to consider an asset sale in this instance (where you purchase certain assets only from the purchaser). This ‘cherry picking’ of assets however may mean that the price you pay for the acquisition is more expensive than it would have been with a share sale, not least because in a share sale the starting position is that you do not have the choice of picking which liabilities you are comfortable with keeping (this can however form part of the negotiations with the seller).
How to prepare for the transaction
Properly preparing for the share sale is important. You want to make sure that your business has a reliable deal team that it can work with and that will be diligent enough to engage with and understand the company and business that is being bought.
In addition to the management of your business and perhaps a deal lead, you will need corporate lawyers that have a strong reputation in managing share capital (acting for purchasers) as well as tax and finance advisors.
You then need to work out whether the company is worth buying and get a good idea of its value and any potential issues or liabilities that could prevent or hinder its operational success or that could end up costing you more than you would want (for example if there is any litigation or employment claims that have not been settled). Whether or not you proceed with the sale will then depend on how much value there is in purchasing the company.
This approach means that you will need a lot of information about the company from the seller and the chances are that most of this information will be confidential or contain commercially sensitive data. It is therefore usual to enter into a confidentiality agreement or non-disclosure agreement with the seller to allow you and your advisers access to this information for the purposes of assessing whether or not to buy the shares of the company.
What due diligence is required before the share acquisition?
For a share sale, it is sensible before being contractually committed to buying the company for you to ask your advisers to undertake legal, financial and tax due diligence into the status of the company so that you can better assess whether or not to make an offer to purchase the company.
The advisers will prepare due diligence questionnaires and information requests for the seller to answer and the seller may provide their answers either physically in a data room or more likely in an electronic online virtual data room. (An electronic data room is usually available 24/7 and is therefore often more convenient, particularly if there are a lot of documents being disclosed). The seller will usually ask the buyer and its advisers to consent to a set of rules as to how the data room may be used (such as the rule that no documents or information may be printed to protect the seller’s confidentiality). The advisers and your business can then review this information and form a picture of what the target company and its business look like.
If the company is being sold by way of an auction process (where there is more than one potential buyer as opposed to a bilateral process between one buyer and one seller) then the due diligence process is likely to be more process driven and formulated, with both buyer and seller having proscribed rules of conduct. The seller will have already conducted some internal due diligence and may provide an information memorandum, its own due diligence reports (there will usually be one for the legal, corporate, employment, real estate, and commercial aspects of the company, and then one for finance and tax aspects) and a data room full of disclosed documents to the potential buyers at an early stage in the process.
The buyers will then have a certain amount of time to review the information and ask the seller questions, usually through a form or portal provided by the seller. There may be more than one round of questions permitted or, in some cases, the buyers will have only one chance to ask any questions on the information disclosed and to request additional documentation because of their findings.
Due diligence checklist
The key considerations for any legal due diligence exercise conducted by a buyer will be to identify and consider:
- That the seller holds the legal and beneficial ownership of the shares in the company and the company is the legal owner of its assets.
- Risks and liabilities to the company and its business: including issues that are ‘live’ and need to be resolved as well as material risks that might affect the value of the business in the future.
- What the strengths and weaknesses of the business are.
- What the company is worth and its financial position.
- Whether the company is compliant with its legal and regulatory obligations and whether the company has all the consents and approvals it needs to carry on the business or to sell the business.
- What aspects of the business need more investigation or what buyer protection the buyer requires from the seller (for example, by asking the seller to give an indemnity against the issue or by the seller agreeing to fix the issue before the company is sold).
- Whether the sale will trigger any changes or terminations to material customer and supplier contracts.
- Whether any transitional services will be required because of the sale for the business to run effectively and whether there will need to be any arrangements made to separate the company or services provided to the company (or vice versa) from the seller or its group.
As well as looking at the corporate structure of the company and confirming that the seller holds the shares of the company, buyer due diligence will often cover the following aspects of the target company:
- Finance and loans
- Employment and pensions
- Real estate
- Leased property
- Government grants and aids
- Intellectual property
- Information technology systems
- Litigation and the company’s accounts (audited and management)
It is often usual for the seller to withhold or redact commercially sensitive information or personal data of its employees from the buyer until it believes that the sale of the company is certain. The parties will also need to be sensitive to any competition law or regulations about what commercially sensitive seller or target company data can be disclosed, particularly if they are competitors in a certain market. It may be in this instance that a ‘clean team’ needs to be established to limit the sharing of information and exclude those personnel that run the day to day commercial and operational aspects of the buyer’s business.
What are the tax implications of a share acquisition?
The purchase of a company could have a number of tax implications that a buyer and seller should make sure they are aware of prior to being contractually bound by the sale. The seller may need to consider reorganisation issues or the status of tax losses or refunds that may belong to the target company being sold. The share purchase agreement will need to provide for how the parties account for any benefits or losses that are sold with the company or are indeed owed to the company post sale.
There may be other tax implications relating to employment or pensions benefits and the purchase price may need to consider future tax treatments. The buyer will need to consider where the company is going to sit within its group after the sale and it might need tax structuring advice from advisers to make sure that the purchasing structure is the most efficient for tax purposes. The best way for both buyer and seller to get comfortable on tax related issues is to each engage specialist tax advisers to conduct due diligence, carry out tax planning and structuring and to negotiate any necessary tax warranties or indemnities in the share purchase agreement.
Is there any additional finance that needs to be raised for the transaction?
It may be that a buyer wants to finance the transaction by getting a loan either from its investors or externally through a third-party lender. This may be the case if for example, the buyer needs funding to pay anything in addition to the purchase price that it budgeted for or if it needs a top up of working capital to keep the business running from day one after it has bought the company.
Third party lenders (like commercial banks) can have their own due diligence and requirements for the transaction and will want to make sure that they are lending money to fund a reasonable economic decision. The riskier the company is, the less likely the funder will be to provide a good value deal to the buyer and there will likely be strict repayment and reporting terms that you will have to comply with. The buyer will need to engage with acquisition finance houses (and there may be more than one, called a consortium) early on in the process to ensure that it has the right funding package that it needs to make a legally binding offer.
How does the share sale process work?
As mentioned above, the most common ways that a voluntary share sale can take place is through a bilateral sale between a seller and a buyer or through an auction process where a seller puts a company up for sale and several buyers compete and bid to buy the company.
Typically, private equity houses prefer to sell companies using auction processes because although the costs of running the auction can be expensive for a seller, the company being sold is usually of high value and the seller can control the transaction timelines, which are usually very tight (i.e. the seller wants a quick sale) while at the same time the competitive process can increase the price paid for the target company. The table below sets out the processes between the two types of sale process:
|Bilateral process||Auction process|
|The buyer and seller enter into a confidentiality agreement or a non-disclosure agreement.||The buyers and seller enter into a confidentiality agreement or a non-disclosure agreement and the seller sends out a process letter to the buyers letting them know how the auction process will be run.|
|The buyer and seller enter into an exclusivity agreement or start to discuss heads of terms so that the main terms of the transaction are agreed before any of the transaction documents are drafted, giving both parties more certainty that the deal will go ahead.||The seller will carry out internal due diligence and will provide the buyers with an information memorandum and possibly access to a data room with preliminary high-level information in it about the company being sold.|
|The buyer will complete its due diligence on the target company. The buyer will send its information requests or diligence questionnaire to the seller and may go through several rounds of questions to get a picture of the value of the company.||Based on the due diligence, the buyers will send indicative offer letters to the seller in accordance with the auction timeline provided by the seller. The seller will shortlist buyers and invite those shortlisted to access the data room and the seller’s due diligence reports. Buyers will then have some access to the company’s management usually for Q&A sessions and management presentations and will be able to submit a limited number of additional due diligence questions. The buyers will also be provided with a share purchase agreement which they have to mark up and negotiate almost in a ‘one shot’ attempt.|
|The share purchase agreement between the buyer and the seller will be drafted. There may be other documents linked to the sale such as a transitional services agreement to ensure that there is a suitable transition of services from the seller’s group to the buyer after the transaction has closed to make sure that the company is able to carry on its business to the same extent that it did pre-closing. The seller may also prepare a disclosure letter setting out general and specific disclosures against the seller’s warranties in the share purchase agreement.||The buyers will submit their final offer and their mark-up of the share purchase agreement to the seller. The seller will negotiate the SPA with one or two preferred bidders and then decide on a firm bidder and negotiate and sign the SPA with them. There may be other documents linked to the sale such as a transitional services agreement to ensure that there is a suitable transition of services from the seller’s group to the buyer after the transaction has closed to make sure that the company is able to carry on its business to the same extent that it did pre-closing. The seller may also prepare a disclosure letter setting out general and specific disclosures against the seller’s warranties in the SPA.|
What documents need to be exchanged for the share sale to take place?
The signing of the share purchase agreement by the buyer and the seller is often referred to as ‘exchange’ as this is when the SPA contract is signed by each party and the signed contracts exchanged. This is different to closing which is when the transfer of shares and exchange of funds for the purchase of the company is held to take place.
In England, for the transfer of shares in a company to be valid, a legal transfer instrument called a stock transfer form will need to be fully executed by the transferor, in this case the seller. An example of a stock transfer form can be found in Schedule 1 of the Stock Transfer Act 1963 (as amended) but the Stock Transfer Act 1963 states that all that is needed for a form to be a proper instrument is that it sets out the details of the consideration (the value) that is being paid for the shares, the names of the transferor and the transferee and the details of the amount and type of shares to be transferred.
Usually, a proper instrument for transfer will trigger stamp duty. Unless an exception applies, the Finance Act 1999 states that the transfer of shares in a private company will attract stamp duty tax that is payable to HMRC. In practice, stamp duty is almost always paid by the purchaser of the shares (the transferee). Once stamp duty is paid, the stock transfer form will be stamped by HMRC and then it is ready to be presented to the company for registration before it is considered a complete and valid instrument of transfer.
It is a good idea, but not legally required, for the transfer of the legal and beneficial interests in shares to be documented in a share purchase agreement. The SPA will deal with several issues and usually include contractual protections for both the purchaser (such as seller given warranties) and the seller (such as limitation on its liability) as to the status of the company and the title in the shares themselves. Depending on the complexity of the company and the value of the shares, it is very usual to put a share purchase agreement in place to ensure that any pre- or post-completion matters, risks and liabilities are suitably apportioned between the purchaser and the seller. A share purchase agreement can often be heavily negotiated, and it is a good idea to seek legal advice when entering in to such a document to make sure that you are not left with unreasonable or onerous liabilities following the transfer of the shares of the company.
In addition to the stock transfer form and the SPA, the company’s board, and shareholder minutes authorising the sale of the company will be required to be given to the purchaser following completion of the transaction. The seller will also give the purchaser the register of members and the other company registers that will usually need to be held at the company’s registered office. The purchaser may be asked to give the seller the board minutes of the purchaser authorising the purchase of the company. If either party is using proxies or advisers to sign the documentation on its behalf, the powers of attorney granting those proxies authorisation to do so may be required to be shown to the other party. The purchaser may also require evidence of the resignations of the directors that are on the board of directors of the target company.
What agreements should be made ahead of the share transaction?
As noted elsewhere in this article, the seller will usually ask the buyer to enter into a confidentiality agreement ahead of progressing the transaction, on the basis that it will be sharing a lot of the company’s confidential and commercially sensitive information with the buyer and it is reasonable for the seller to ask the buyer not to disclose that information to third parties without the seller’s knowledge or consent. The seller may also ask the buyer not the disclose the fact that the transaction discussions are taking place in case they do not go ahead, and this harms the reputation of the target company or makes potential customers or investors nervous (if they become aware that the company may be sold shortly).
The parties may also decide to put an exclusivity agreement in place stating that they are exclusively negotiating the deal and that the seller is not also negotiating with other potential purchasers. This gives the buyer some comfort that it is not part of a competitive process and it then has more certainty that it is in a position to purchase the target company.
It is quite common in a bilateral sale for the buyer and seller to begin negotiations before the SPA discussions begin by putting in place heads of terms (sometime called a letter of intent) and this is a non-binding document that sets out the parties’ agreement on the key issues relevant to the proposed sale. Unless otherwise stated in the document, the heads of terms will only be enforceable once the SPA has been signed but they are designed to progress the negotiation process and make sure at an early stage that seller and buyer are aligned on what the sale should look like (including price).
What does the process of exchange and completion look like?
Once the buyer and seller have signed the SPA, this is considered to be the exchange of the contract and means that unless certain events happen, the buyer is legally bound to purchase the shares of the company. In some sales, the SPA can contain conditions that need to be completed before the sale can be closed (called ‘conditions precedent’), for example if competition clearance or a third-party funding approval is required. Completion of the sale cannot happen unless these conditions are satisfied, or if the parties agree, waived.
The SPA will also contain a list of documents and actions that need to be completed before closing can take place and the buyer can pay the seller and the seller can transfer the shares to the buyer. The SPA will usually set out the process for completion in detail and it may take place at a certain location physically or electronically or by phone.
Most SPA drafts give the parties flexibility to defer or delay completion by a period of time if the conditions precedent are not satisfied but the parties are often bound to complete the transaction by a mutually agreed cut off time called a ‘long-stop date’. If there are no conditions precedent then exchange and completion can occur at the same time, which is a more certain situation for the parties to be in as there is less risk that the transaction will be stopped during the gap between exchange and completion.
Are there any other considerations once the share sale has taken place?
There will be many considerations for the purchaser and the company once a sale has taken place, the target company’s register of members has been updated and the new directors appointed to the board of the company.
The company will most likely need to continue to be operational immediately despite a change of shareholder and management and it will be important that a clear leadership is established to give comfort to customers and the company’s workforce (if any).
If a transitional services agreement has been signed, then the seller and buyer will need to work together to ensure that the seller or its group are continuing to provide services (such as IT) to the company that it needs to meet its operational obligations. Depending on how the purchase price is being calculated, there may also be a post-closing ‘true up’ of the purchase price where the purchaser will put together a closing balance sheet or accounts in accordance with the agreed process set out in SPA. The purchaser will also have to make sure that the company has made all the filings that it is required to within the relevant statutory time limits or regulatory deadlines.
Going forward, the seller may have agreed in the SPA to be restricted in who it is able to employ or in the type and scope of business that it may engage in (so that it does not directly compete with the target company) for a limited period of time after closing. The purchaser may also have agreed to certain restrictions in the SPA as to who it can employ post-closing for a limited period of time, and it should be mindful to comply with these restrictions.