Preparing your company for sale
Whether or not you are considering the sale of a standalone company, a subsidiary within a wider group, or the division of a business, there are preparatory steps that can be taken in advance to ensure that when the sale process commences, it can run as smoothly as possible. We set out here some initial steps to consider in anticipation of a sale, whenever that may be and whether actively sought or following an unexpected approach.
One of the key drivers of the structure of a sale is the impact of taxation on the sale proceeds. However, even prior to discussions on transaction structure take place, there are tax considerations that business owners and management should think about:
- Business Asset Disposal Relief (‘BADR’) – formerly known as Entrepreneurs’ Relief, BADR enables individual selling shareholders (who are also employees or office holders) of a trading company to decrease the rate of capital gains tax (‘CGT’) due upon up to £1m of any chargeable gain, following the sale of shares, to 10% (rather than the current CGT rate of 20%). This is subject to the individuals ensuring they meet certain qualifying conditions and then make a claim for the relief at the relevant time. The qualifying conditions include the requirements that, in the two years prior to a sale, the relevant shareholder held at least 5% of the company’s shares (including voting and economic rights), and that they were an employee or office holder throughout this period. Some conditions differ for shares acquired under certain types of employee share options. Where your company is an owner-managed business or with employees with significant shareholdings (or share options), eligibility for this relief should be considered as early as possible, given the ‘two year’ requirement mentioned above;
- Capital Gains Tax – although rumoured changes to the CGT regime did not occur earlier in 2021 as some predicted, individual business owners should be alive to the risk that CGT rates may rise in the near future and, if a company sale is being actively considered, this is something to bear in mind when considering the timing of a potential sale. Specific CGT advice (and potential tax clearances from HMRC) should be sought in advance where selling shareholders expect to obtain deferred consideration, earn-out consideration, or a form of “rollover” consideration by the buyer;
- Incentive Scheme – are key employees, who will likely be essential to a smooth sale process (and also the post-sale success of the company), properly incentivised? Often schemes which are approved by HMRC and which incentivise key employees and management are put in place well ahead of any sale process, and can provide a motivation for management and employees to drive up the company’s value ahead of the sale process, as well during the challenging periods of the process itself. It will also be important to review and consider the impact of a potential sale on existing incentive schemes, such as whether the sale will trigger an exercise of share options, and the extent any vesting or performance conditions may have been met;
- Estate Planning – primarily a consideration for business owners rather than management, personal estate and wealth planning can impact on the structure of any transaction, and personal shareholder estate planning should be given real thought (and proper advice sought) alongside the other preparatory tax steps highlighted.
We would normally suggest that specialist, tailored tax structuring advice is sought well ahead of the commencement of any sale process.
Alongside tax matters, ahead of any sale, it is important to check whether corporate record keeping, filings and general corporate compliance are up to date, and records available for when purchaser due diligence commences. In particular, the company’s statutory registers (e.g. the register of members) will be carefully reviewed by a purchaser’s due diligence advisors, and any material discrepancies or issues are likely to need rectification as part of the sale process (if not already addressed) and could lead to sale proceeds being held back by the purchaser and/or the vendor(s) having to indemnify the purchaser in respect of any related liabilities.
One particular issue that can cause problems during a sale process is when a company has completed a buyback of its own shares which, if not carried out properly, can be difficult to unwind or rectify. It is advisable that prior transactions involving the company’s share capital are properly documented and any issues identified and rectified as part of this ‘corporate housekeeping’ review. Similarly, where share transfers have not been properly recorded in the statutory registers, a purchaser will most likely insist this is rectified prior to completion of a share sale.
Vendor Due Diligence
Although in almost all sale processes a prospective purchaser will undertake their own due diligence – typically instructing lawyers, accountants, tax advisors and/or (depending on the business) specialist property advisors to assist them – an appropriate level of vendor’s own due diligence prior to marketing the business can greatly help identify possible future problem areas. The benefits of identifying possible problem areas at this stage include:
- rectifying them before the purchaser’s own due diligence process starts, so that process can be completed more quickly;
- avoiding distractions during the sale process;
- ensuring that sell-side team are not on the back foot due to unknown risks arising in the sale process;
- avoiding the need for more costly and time consuming solutions during the sale process (which can often be the subject of negotiation with a purchaser); and
- in the most extreme circumstances, avoiding the risk of a transaction aborting, the purchaser losing confidence in the deal or seeking to renegotiate the price.
At the same time, the vendor due diligence process need not be disproportionate, and is often focussed on some of the following areas:
- Commercial contracts – considering whether arrangements with important customers, suppliers or other partners are adequate, properly documented and whether potentially disruptive provisions (such as termination or change of control provisions) could be triggered by a sale event. Management may also wish to consider whether there are any significant gaps in the company’s contract coverage which might alarm a prospective purchaser, or whether the company’s standard terms are in need of a refresh;
- Other company records – in addition to corporate records mentioned above, are employee contracts, policies and handbooks in order and compliant with current employment law requirements? Are the company’s pension records properly maintained? Are all title deeds and leases relating to company’s real estate easily available? This last item can particularly cause issues in relation to businesses with a significant real estate asset base or where there are otherwise complex property arrangements;
- Disputes – in the event that there are any ongoing disputes or litigation, or even known events that are likely to lead to the commencement of formal dispute resolution procedures, where possible it can be advantageous to try to settle in advance, so that the prospect of that litigation does not loom over any sale process;
- Regulation & Compliance – where purchasers are undertaking due diligence on businesses in a regulated sector, there can be a specific focus on ensuring the company has complied with their regulatory obligations (usually also the subject of specific warranty protection in the sale documentation). It is therefore important to be able to evidence compliance by maintaining up to date records. This can include hot topic areas such as data protection or holiday pay and minimum wage compliance, as well as other potential risk areas such as health & safety, environmental and anti-bribery compliance;
- Intellectual Property – where there is key IP within the business, it is important to ensure that such IP sits within the correct entity, is properly registered and any renewals or new applications are submitted and up to date. It is also important to consider whether there are any specific gaps in the company’s IP coverage and whether those can be easily explained to a potential purchaser. One issue that can arise in a purchaser due diligence exercise is where important IP has been developed by a third party contractor and it is unclear whether the company owns that IP – tackling this as part of the vendor due diligence exercise can prove particularly time-saving, given the possibility of needing to engage third parties in order to rectify (who may not be particularly motivated to assist);
- IT, payroll & other systems – as a practical consideration when selling either a business division, or a subsidiary within a group, are there any systems or services that the subsidiary or division relies upon that will need to be addressed as part of the sale process? If it is not possible to separate these systems or services out prior to a sale process, prospective purchasers can gain comfort where management teams have considered how a selling group can provide any necessary transitional services following completion of a sale.
Of course, it is difficult to cater for every eventuality that may occur during a sale process, and there are often ‘unknown unknowns’ that can crop up even in the most well-prepared sale processes. This is even more so now, in a less predictable world, in which recent examples such as Brexit and COVID-19 reflect unexpected challenges that even robust businesses can face. Whist not possible to identify all possible risks when considering selling a business, we have sought to highlight some of the key actions shareholders and management can consider taking in order to prepare for a sale event in the future.
If you are considering a sale process, or feel that your business could benefit from advice on some of the matters highlighted in this article, please do not hesitate to contact Hamish Perry, Michael Barrington or your usual Charles Russell Speechlys contact.
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