Miles Welch, Founder at Milestone Advisory, sat down with Haggis - who is also an adviser within SoDA, the global society of leading businesses in the digital and creative industries - to find out more:
Q: OK, we all know M&As need proper expertise, but are there some things the seller can do for themselves?
A: Absolutely. While the details need dealing with by experts (see below), there is important prep companies can do before they go to market. This includes making sure their company is, for want of a better phrase, ‘cleaned up’ – for example that is ensuring that you can evidence that the right people hold shares in the business and any previous shareholders or share purchases have been correctly dealt with, and having an up-to-date company register. Other things that can be looked at include whether commercial agreements have the right protections in place that any potential buyer would want, or just making sure that contracts are in place is a good start. During due diligence any skeletons that exist will be found out anyway [see below], so the earlier organisations can mitigate against any nasty surprises, the better.
Q: Where else do sellers need to think about?
A: Aside from not being prepared, when sellers appoint their typical legal partner – they tend to be people who often don’t do acquisitions regularly or haven’t worked in this sector day in, day out – having worked opposite lawyers like this on deals, they tend to get bogged down on points that aren’t commercial. This can frustrate both sides, elongate the process and sometimes cause the deal to fall over.
For sellers, understanding how their business will operate once they have sold it and if there are targets to be met that are tied to the purchase value is key, and especially where the buyer might not buy the entire share capital on day one.
Q: What’s the buyer thinking?
Most buyers want the fundamentals pinned down first. Most will want to know whether the founder will stay on or they may insist on this, and they will likely structure their price based on this and any other commercial targets they set are met. These, as well as earn-out levels, how to structure the transaction from a tax point of view, and how your business will be operated post completion if there are targets you need to meet, are the more relevant details that need to be settled earlier – almost from day one when lawyers are instructed. It’s better to stress test the deal at the heads of terms stage than after time and effort has been spent on disclosure and you begin the negotiations of the SPA – and especially as the buyer will want to hold the seller to what was signed off in the heads of terms!
Q: Where do elements like warranties and indemnities come in?
A: Warranties and indemnities form a huge part of sale and purchase agreements (SPAs). The buyer will buy the company subject to all its liabilities – past or present or future. As a result, the buyer will seek some protection against these liabilities by using warranties. Warranties are contractual assurances from a seller to a buyer – essentially statements of truth about the business, which have to be full and complete. If any warranty is subsequently found to be untrue, then, subject to agreed exclusions or limits of liability, the buyer can bring a claim against the seller for the resulting loss to the value of the company it is buying. As well as negotiating the warranties that are given, the Sellers therefore need to disclose against the warranties to highlight the actual position, and this is done though the disclosure letter. If the Seller has sufficiently disclosed against a warranty in the disclosure letter, it can’t come back to bite them. For a buyer, it’s about understanding what has been disclosed and making sure the disclosure is not so wide that a key warranty may not offer them protection. The warranty disclosures therefore encourage sellers to highlight any problems they know of, and the buyer can decide whether to proceed or vary the terms of the deal.
Indemnities require the sellers to underwrite any specific identified risks irrespective of whether the indemnified matters impacts the purchase value of the company. The skill is knowing which points will need pushing back on or not, and which are fair and reasonable.
There are practicalities that need ironing out too if exchange and completion of a SPA does not occur on the same day as what you warrant on exchange may not be true on completion, or the risk of an indemnified claim arising may increase.
Q: This all seems quite complicated. Is it?
A: Yes! The short answer is that no two deals are the same. In some, for example, the preference could be for simultaneous exchange and completion, while others want to wait to complete, which if parties don’t have the ability to further disclose, or the ability to walk away, this could impact the sale price and make the deal unattractive for them. It’s still often the case that deals fall through and don’t complete because essential ducks haven’t been lined up properly. It’s often overlooked by sellers that it’s not just the SPA they need to think about, but their personal tax implications for a deal, and any shareholder agreement that needs to be put in place with the buyer that can offer key protections, depending on the nature of the deal.
Q: What other tips would you give to people?
A: One area that’s often forgotten about is due diligence on buyers’ funds – i.e. where does this money come from? Do they need to get approval from their financial backer? Is it private equity-led? And, if the deal is part buying now, with the remainder in say, two-years’ time, what assurances are there that the buyer will still have the money then? Then there’s issues around what the seller can do if a buyer doesn’t proceed with the next tranche of the agreement. When deals are funded by other deals, this can also add a whole further layer of complication, so all these questions need considering. On the finer detail side of things, founders will have different share options to minority shareholders, but the package minority holders get after completion (pension, bonuses, salaries) are just as important. Buyers don’t want key people walking out. And lastly – tax. Always get personal tax advice to understand whether the deal structure is best for you or needs changes – and this is another reason to stress test the deal at heads of terms stage.
To discuss this topic in more detail, contact the Milestone Advisory team at firstname.lastname@example.org