In order to grow, streamline or diversify your business, you may contemplate acquiring another company or alternatively you may be approached as a potential buyer for a company that is being put up for sale.
What does it mean to buy a company by share acquisition and what process is involved? This article provides a guide on what you can expect from a share acquisition, the pros and cons versus an asset purchase, where to take special care and the additional considerations that apply in times of economic difficulty.
- What is a Share Acquisition?
- What is the difference between a Share Acquisition and an Asset Acquisition?
- A brief overview of a Share Acquisition process
- Confidentiality and exclusivity – what do they mean?
- What special considerations are there in an auction process?
- What is due diligence and what typical due diligence is required for a share acquisition?
- Purchasing a company in a recession: what additional due diligence is required?
- What happens if you are raising finance to fund your share acquisition?
- What documentation is required for the acquisition to take place?
- What additional protections can you insert in the SPA in a recession?
- What happens once the SPA has been signed?
- What happens if you find a nasty surprise once you own the company?
What is a Share Acquisition?
A share acquisition involves a buyer acquiring the shares of the target company from the company’s shareholders. Normally the buyer will acquire the entire issued share capital of the target company and have complete control of that company.
What is the difference between a Share Acquisition and an Asset Acquisition?
There are distinct differences between an asset and a share acquisition. Therefore, the very first step that you must take, when contemplating any form of corporate acquisition, is to satisfy yourself that a share acquisition is the right route to take in all the circumstances. Critical to this will be the key commercial drivers for the acquisition, your valuation of the business and the tax treatment, which will vary depending on whether you proceed via a share or asset purchase.
How a Share Acquisition Works
A share purchase involves purchasing the shares of the target company from the shareholders. As the target company is a limited company with a ‘legal personality’ distinct from its shareholders, it is able to own assets and acquire rights, obligations and liabilities on its own account. A buyer purchasing the shares of a target company acquires everything owned by that company and takes on all the rights, obligations and liabilities of that company. This is called buying a company ‘warts and all’, meaning that you acquire the obligations and liabilities of that company, whenever they occurred and even if they are unappealing.
- In many respects, it is simpler to buy all the shares in a company, than attempt to split out specific assets.
- It is more certain in terms of acquiring title to certain assets with potentially fewer assignment rights being triggered.
- There are often fewer third party consents required.
- It can provide certainty in terms of employees and customers.
- It might be cheaper as you take on all the liabilities, which in turn might allow you to lower the price.
- You take the company ‘warts and all’ which can be onerous particularly for a company with a long legacy. This puts additional onus on your due diligence process and negotiation of contractual protections.
- You require all the shareholders to consent. One minority shareholder may prevent the transaction going ahead.
How an Asset Acquisition Works
In an asset acquisition, you purchase a collection of specified assets and rights and can choose to take responsibility for certain liabilities. The types of assets, which you might acquire through an asset acquisition, include property, business contracts, intellectual property rights, plant and machinery, goodwill and stock.
The buyer and seller will negotiate precisely which assets the buyer will acquire. The assets and/or liabilities, which the buyer decides not to purchase, will remain with the seller.
- You can ‘cherry pick’ the assets that you wish to purchase, leaving behind any liabilities and avoiding the risk of legacy liabilities turning up.
- It is unusual to require shareholder consent for asset purchases.
- It can apply where the seller is unincorporated, not a separate legal entity and in some insolvency situations.
- It is more complex to split out specific assets from an existing business.
- It can trigger assignment rights and third party consents in key contracts.
- There is greater uncertainty in terms of employees. There could be an obligation to notify and consult with employees.
- It might prove to be more expensive as you decide to exclude liabilities.
- It is potentially more time consuming in the long run to integrate specific assets within your existing business.
If you are contemplating buying a business and would like to discuss whether a share purchase or asset acquisition is the better route in your circumstances, then please contact our corporate team who can assist in making this decision.
A brief overview of a Share Acquisition process
A share acquisition can proceed by a bilateral or auction process. In both scenarios, the main elements of the process are the same, namely confidentiality, due diligence and the negotiation of the contracts.
A brief overview of the sale process is as follows:
|Bilateral Process||Auction Process|
|Initial contact is made||Initial contact is made|
|Confidentiality and exclusivity||Confidentiality|
|Deal team assemble: lawyers, accountants, tax specialists, business managers||Deal team assemble: lawyers, accountants, tax specialists, business managers|
|Access to initial confidential data||Access to initial confidential data|
|Heads of terms||Indicative bids|
|Due diligence process; access to data||Due diligence process: Access to data room and to draft documentation|
|Draft documentation provided by sellers||Submit final bid and marked up documentation|
|Negotiation of sale documentation||Negotiation of sale documentation|
|Signing of sale documentation||Signing of sale documentation|
|Interim period||Interim period|
|Post completion warranty claims||Post completion warranty claims|
Confidentiality and exclusivity – what do they mean?
Once you have a target company in mind, then you must work out whether it is worth buying. It is critical for you and all your deal team to understand the key commercial drivers for the acquisition, as this will inform the approach to the acquisition and the timetable.
The first step after initial contact has been made is to find out more information about the target company. This requires a confidentiality agreement or non- disclosure agreement (NDA). These documents require undertakings from you that will apply to your whole deal team in terms of keeping confidential any information disclosed to you. It is important that you make yourself aware of the extent of the confidentiality undertakings and the time during which it applies, especially in an auction process where you might be unsuccessful.
Sales can be bilateral or can be through an auction process. An exclusivity agreement can apply in both scenarios, giving you a window of time to negotiate in good faith for the purchase of the target company. This gives you comfort that you are not in a competitive process and therefore not incurring potentially needless costs.
If you are considering acquiring a business and would like to put in place a confidentiality agreement or have received a confidentiality agreement, please contact our corporate team for advice.
What special considerations are there in an auction process?
A bilateral negotiation occurs between a buyer and a seller, where one might approach the other or the deal is mooted by a third party intermediary, for example an investment house.
Alternatively, a seller might approach a number of potential buyers via an auction process. In this scenario, there will often be an initial screening of bidders via indicative bids and then a reduced number will go forward into the data room and due diligence procedure. The price submitted post data room will involve not only a monetary figure but also, typically, a mark up of the draft documentation provided.
As a buyer, one of the main implications of an auction process is your risk of incurring professional fees and becoming the final successful bidder.
What is due diligence and what typical due diligence is required for a share acquisition?
Due diligence is the information gathering process that you will carry out in order to investigate the commercial, financial, trading and legal positions of your target company. It is through due diligence that you will satisfy yourself on the critical factors that influence the target company’s success and where the key risks to that success lie. This will influence whether you actually wish to proceed with the acquisition, the price that you are willing to pay, whether you require any issues to be resolved in order to go ahead and the extent of any protections that you seek through the sale documentation.
The due diligence process is more detailed in a share acquisition as you will take on all the liabilities of the target company, no matter when they were incurred.
In order to facilitate the due diligence process, the seller typically provides access to a data room, often virtual, which comprises documentation that seeks to substantiate the trading, financial and legal position of the target company.
As a buyer, your legal team will prepare due diligence questionnaires and as you review the material in the data room, you may ask other questions in order to investigate an area or issue to your satisfaction.
Typical areas of due diligence include:
- That the seller holds the legal and beneficial ownership of the shares in the company and the company is the legal owner of all 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.
- The trading, financial and tax position of the company.
- 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 and/or to sell the business.
- What legal and regulatory approvals are required in order for the target company to be sold/acquired.
- 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.
It is typical for the contents of the data room and responses to any due diligence questionnaires to be ‘disclosed’ against the warranties in the sale and purchase agreement, which means that you cannot make a warranty claim if you were deemed to have knowledge of the issue by virtue of the data room information. It is critical that you review the data room material thoroughly and understand its implications to any contractual protections that you may seek.
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If you’d like to know more about Mergers or Acquisitions or would like further information about buying or selling a company contact our team of expert M&A lawyers.
Purchasing a company in a recession: what additional due diligence is required?
If you are considering purchasing a company during a recession, then you will need to carry out all the detailed due diligence set out above but with an additional focus on the potential financial, trading and contractual pressures that a recession brings. This may include:
The financial position of the target company may be very different at the time that you are looking to acquire it than at the date of its last accounts or financial statements. Therefore, you will need to see up to date finances and financial statements.
You will need to review not only the terms of the contracts but also whether there are any existing late payments from customers or late delivery from suppliers and what this means for the price you wish to pay and what your remedies would be if this situation was to continue.
Where the target company relies heavily on some key suppliers or customers, then you will need to carry out additional due diligence on these customers and their own ability to withstand a recession.
If you are taking on existing loans of the target company as part of your acquisition, then a review of the vulnerability of the company to interest rate rises will have to be undertaken and also your ability to vary the terms of the loan agreements.
If you are considering purchasing a business and are concerned about economic uncertainty, then please contact our corporate team to discuss what steps you can take to satisfy and protect yourself in the circumstances.
What happens if you are raising finance to fund your share acquisition?
If you are looking to finance your acquisition through raising finance or taking out a loan then your investors and/or lender may also want to complete their own due diligence prior to making those finances or loans available to you. This due diligence may influence the amount they are willing to invest or loan and also the investors and lender may require certain contractual protections within the share purchase documentation. You need to take care that any funding complies with the financial assistance provisions of the Financial Services and Markets Act 2000.
What documentation is required for the acquisition to take place?
The main contractual document that you will negotiate is your share purchase agreement (SPA). Once this document is signed by all relevant parties then you are said to have ‘exchanged’ contracts and you are legally required to go ahead with the purchase of the target company, subject only to the satisfaction of certain conditions, called ‘conditions precedent.’ Conditions precedent are conditions that are outside the control of either party, namely government consent, tax clearance, the consent of other national or international authorities or third party consent required by contracts. Some buyers make the purchase conditional upon acquiring relevant financing.
Much of the SPA negotiation is focused on:
- The price and any withholding of the price or staggering of payment of the price, upon certain trading conditions being met.
- Any conditions precedent and what happens if these are withheld, especially if this relates to a major customer or supplier.
- Warranties and indemnities, which seek to give contractual protections to the buyer around certain critical aspects of the company or where an issue has come to light through the due diligence process. These are subject to financial caps, time limits and to the seller’s ‘disclosure letter’.
- Interim/transitional service agreement, which seeks to balance the needs of both buyer and seller in the period between exchange of the SPA and the completion of the transaction.
- That all the necessary internal consents and approvals, namely of all shareholders, have been acquired and are evidenced.
- Tax covenant from seller to buyer.
- Completion accounts which seek to adjust the price to take account of interim period trading.
In a bilateral negotiation, the SPA may be preceded by a non-binding heads of terms and in an auction process by indicative offers, which both seek to assess whether there is the potential for agreement between buyer and seller.
To complete the transaction, formal stock (i.e. share) transfer forms need to be lodged with the Registrar of Companies.
What additional protections can you insert in the SPA in a recession?
If you are buying a company in a recession and you have identified key areas of risk that make your price vulnerable, then it is worth considering ways of structuring payment of the price to provide you with some protection. This may be a mechanism where you stagger payment based on certain financial metrics being met (called an ‘earn out’).
What happens once the SPA has been signed?
Once the SPA has been signed, then the buyer or the buyer and seller jointly will apply for the consents and approvals required to satisfy the conditions precedent. Once these conditions are satisfied, then the parties will complete the transaction by lodging the stock transfer form and paying the price. The buyer will pay any stamp duty and file any documentation at Companies House.
What happens if you find a nasty surprise once you own the company?
If you find a nasty surprise in your new company, then you may be able to claim damages under your contractual warranties or indemnities.
It is very important therefore to summarise these contractual provisions for your operations team as otherwise, these potential claims can be missed. If you would like to discuss any of the topics or issues discussed in this article or require assistance with a share acquisition process, then please contact our corporate team who can support you.