2020-03-11
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What can go wrong when buying or selling a business and how to fix it?

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Posted by Susan Hopcraft on 03 March 2015

Susan Hopcraft - Professional Negligence Lawyer
Susan Hopcraft Partner

You have worked hard to build up your business and finally ‘cash in your chips’ by selling.  Or possibly you are still on the ‘escalator’ and buy another business to add to your burgeoning empire. Or, and say this quietly, getting rid of a part of the business that just doesn’t work for you…… 

These can be exciting times, but whether you sell/buy shares or assets, things can go wrong.  Often deals are hammered out late into the night with last minute changes to sale and purchase agreements; hardly the ideal environment in which to negotiate the fine detail of the sale of your life’s work or an acquisition of the key to your future!

Avoiding pitfalls is best, but there are ways to put things right if the ball is dropped. This article highlights some of the things that must be dealt with carefully when buying and selling businesses and explains how to address problems if they result.

How to sell or buy businesses

You can either trade the whole company by selling the shares, or acquire or sell a particular part of the business by an asset sale. They are different, notably in relation to the liabilities that pass with the shares but which are excluded from an asset sale, but the issues that need to be dealt with are broadly similar.

Typical problems

  • Due diligence: Sale and purchase agreements usually result from lengthy investigations into the target business.  This ‘due diligence’ should lead to the discovery of most of the warts, and these are usually dealt with in warranties and indemnities set out in the sale and purchase agreement (SPA). 

    If a particular hole in the accounts or liability is missed, or a contract is overvalued, then this may lead to the buyer over paying for the business.  The due diligence must therefore be done carefully and often solicitors or accountants carry this out.  Failing to identify an issue in due diligence may cause a purchaser to fall at the first hurdle and that is why, with larger businesses in particular, it is often the professionals that carry out the due diligence (especially the legal and financial due diligence).
  • Drafting warranties: Once the due diligence has been completed, solicitors then draft the SPA.  A contention section for SPA is the warranty schedule, which consists of numerous positive statements being given by the seller to the buyer.  If it turns out one of the warranties is incorrect and the seller had not notified this inaccuracy to the buyer prior to completion (which is known as ‘disclosing’), the buyer may sue the seller for breach of contract.  This obligation on the seller to ‘disclose’ details of where/how a warranty is inaccurate, provides the buyer will valuable information about the business.  Importantly, this information can be used by the buyer to reduce the purchase price or to decide to walk away.  If the warranty/disclosure process is not carried out properly by both the buyer and the seller, there are potential risks to both sides.
  • Drafting indemnities: During the warranty/disclosure process, if a problem is discovered, the buyer may request an indemnity to cover any loss arising from that issue. The careful drafting of the indemnity on both sides is very important; to make sure it covers the issue in question (to protect the buyer) but making sure it is not too broadly drafted (to protect the seller).   
  • Employees/pensions/competition: Some of the other key issues which a buyer must consider are an effective transfer of employees under the Transfer of Undertakings regulations (generally only relevant with an asset sale), or of any pension liabilities, and to advise on any competition implications.  Here any failure to consider the issues could leave one party or another with a higher cost than intended, and may mean that key personnel who it had been thought would transfer to the new owner do not do so.  Customer relationships with those personnel should also be considered – are they critical to business with those customers?

  • Change of ownership clauses: Sometimes a change of ownership of a business can put it in breach of some of its key contracts (including banking facilities).  ‘Change of control’ clauses must be identified and if some are found in key contracts then that must be addressed in advance of completion to minimise the risk that the sale causes termination of the relationship with a vital supplier or customer.  Key contracts should be considered and evaluated as part of the due diligence exercise referred to above.

  • Insurance: various policies can be affected.  If the liabilities within your existing business are affected do you need additional insurance cover immediately on the completion of the deal, or will your current insurers be prepared to offer cover; either way, what level of premium will be payable and has this been factored into your budget?

  • Tax/earn outs: Does the company or any director need advice on any tax provisions such as entrepreneurs relief?  Are there any ‘earn out’ provisions from a previous deal that might trigger an accelerated payment clause?  These need to be identified and dealt with before the agreement is signed otherwise unexpected liabilities might arise.

What if an unintended liability comes back to bite?

All professionals acting on the sale and purchase of businesses owe duties of care to their client to carry out their due diligence, advice and drafting with reasonable skill and care. If they do not then they are negligent, and if that causes loss then a claim for damages can be brought.

The loss might be the unexpected sum that needs to be paid, or it might be the difference in price that you would have paid/accepted at the time with proper advice.  But you cannot assess that with hindsight.  Your assessment of loss must be a true reflection of what you would have done then, without hindsight!

Both accountants and solicitors carry insurance to pay claims as a result of negligence so a legal claim is often a good method to make good the damage.

Any of the examples above could be the result of an accountant or solicitor failing in the investigation of the business, the contracts review, or a failure to appreciate and advise on the implications for employees and tax liabilities.  Solicitors bear a heavy burden when drafting the agreement and the warranties and indemnities but, without proper drafting, the contract will not reflect the deal that was intended and loss can arise.

The first step if a loss has occurred is to complain to the professional, but if that fails then legal advice should be sought.  Time limits apply to negligence actions, usually six years from the breach of duty, although this can be longer depending on when loss accrued, or three years from when the right to claim was known about. These are inflexible limits and if in doubt about whether you have a claim you need to take advice soonest to make sure you do not miss a time limit to obtain redress.

Summary

So, whether you are cashing in, or upsizing (or even just getting rid of a part of the business you just don’t like any more…..) it is vital that you choose your professional team carefully.  The risk of a liability coming back to bite is best avoided, but if things do not go to plan there is still a route available.

About the author

Susan is a disputes and professional negligence lawyer, mainly in the financial services sector.

Susan Hopcraft

Susan is a disputes and professional negligence lawyer, mainly in the financial services sector.

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