The insiders’ guide to the day of completion
The last few hours of selling your business may be the most painful, so expect the unexpected.
Selling your business: An introduction
It’s your biggest financial decision. Whether retirement, time for a change, an offer that’s too good to resist, or your investors are demanding it, selling up is a fundamental part of owning a business. Horror stories are legion and the people we spoke to didn’t disappoint. But for all the pain, ultimately it will be your gain. We get an insiders’ view of ‘closing’ the deal and take a closer look at carve-outs (selling a section of your business).
The closing stages of a business sale is the stuff of nightmares. You’re in the offices of a corporate law firm – almost certainly the buyer’s. You’ve already been there 16 hours surrounded by 15 sweaty, fractious lawyers, picking holes in your business and blinding you with technicalities. And you’re only half way there. “The longest I attended was 36 hours,” says John McBride of accountancy firm Vantis.
It’s said corporate lawyers get a perverse kick from such sessions, but it’s more likely simply the case that no one leaves until the job gets done.
Who needs to be present?
You and your counterparts are the most important guests at this last supper. With your advisers, you’ll come to the meeting with a contract ‘Heads of Agreement’, (drawn up by the purchaser following the deal). This will have been the subject of masses of amendments, setting out the terms of the deal, the warranties and indemnities, and if that were not bad enough, there is also an associated document referred to as a ‘Disclosure letter’, which makes the purchaser aware of any areas within the contract that need supplementing. You’ll also bring your finance director, or the person who keeps accounts. And you’ll probably have a corporate finance representative or an interim executive hired to see the deal to the door.
Then there will be the lawyers. “In a typical mid-market deal,” says partner at Eversheds, Mark Spinner, “you’ll have 12-15 lawyers and up to 20 if a private equity firm is involved.” This will consist of two or three from your side, three or four representing the bank’s interests, the same again for any investor, and a raft of lawyers for the buyer. The bank will also have representatives, as will the investment house, the buyer and your team. This could add up to 20-30, although you can shave off a few if the deal is under £10m.
How can you prepare?
It’s fairly formal, and with larger deals there will be 40 or 50 documents requiring a signature, warns Roy Ashton, director at Titcheners Chartered Accountants. Be ultra prepared, as documents and supporting information will be heavily nit-picked and your financial director will be bombarded with questions. “If the target can’t provide detailed audited accounts and subsequent regular management accounts the deal is unlikely to proceed,” warns Robert Coe of Wilder Coe Chartered Accountants.
Assuming you’ve been through the due diligence stage, though, everything should be in order and it may simply be the purchaser looking for ways to knock down the asking price.
What needs to be resolved?
Transactions are often leveraged, meaning senior debt is being provided by a bank, which will be looking to satisfy the ‘Conditions Precedent’ document through articles of association, share certificates, board meeting minutes and key man insurance. These are rarely signed prior to closing, but getting them out of the way early helps. Bankers usually take their own office and won’t enter the fray until all else is agreed.
You’ll probably kick proceedings off by resolving outstanding issues, with the principals (you and your counterpart) thrashing out terms, while another team focuses on more ancillary documents. Warranties or indemnities to cover perceived risks will be high on the agenda and can prove tricky – potential bad debt or what is deemed ‘adequate insurance’, for instance. If it’s insurance policies, present them to the purchaser and let them decide whether they are ‘adequate’ – it’ll prevent a claim after the event, says McBride.
Valuations of net assets, he adds, can also prove a sticking point. “The vendor tends to have a view, but the purchaser will argue the information is dated.” He cites an entrepreneur who had 250 tyres in stock and expected full price. He was told that as he was so sure of the value, he could remove them from the deal. He died two years later with a garage full of tyres. A sobering thought. On the buyer’s side, the purchaser will have to sign the Financial Assistance Statutory Declaration of Solvency, part of the Companies Act, whereby testifying the company is solvent and will remain so for a period of 12 months.
The final stages
If you’re remaining with the business, meetings tend to be less tense. “Both sides realise they don’t want anything to affect the relationship post-completion,” says Debbie King, partner at Farley’s solicitors. McBride adds, though, that most deals are being done on variable terms now, meaning a six-month ‘consultancy’, with the option for the purchaser to remove overhead (namely you). “Earn-outs were very popular a few years ago – the ideal scenario for getting full value out of the business,” he says. “But vendors fear purchasers will affect the profits by adjusting overhead to the detriment of the business or diverting income elsewhere.”
By the time you’re resolving such issues, the office will be full of breakout groups in various meeting rooms. The barometer of cost will by now be at over 90% and the dawn chorus will probably be in full swing, so the likelihood is the spirit and intention of all parties will be very willing. But that doesn’t stop last minute bids to change agreed terms, says Ashton. “You need to have an ace up your sleeve – lots of deals are on rocky ground at the end as one party tries to ‘pull a fast one’,” he warns. “They think that having come this far the seller will cave in.” Be ready for anything.
The eBay-induced desire to dispose of non-essential items appears to have permeated into business. With increasing frequency, companies like yours are carving-out and selling-off sections of their businesses.
Why do you carve out?
A carve-out is likely to happen for one of three reasons: your business will be worth more overall by separating it; you only want to dispose of part of it; or there’s been an acrimonious split between partners.
In the first instance, it’s all about maximising interest and price. Clive Sanford, a partner for corporate finance firm Magus Partners, says: “Entrepreneurs are prone to vertical strategies not acceptable to buyers. For example, there might be few buyers for a retail company with a distribution arm but separately those businesses could garner a lot of interest.”
Growth can also leave sections of a business no longer critical. It can make sense to carve-out these redundant divisions to redistribute revenues to core business, or to isolate the risks of under-performance.
Alternatively, it can make sense to sell the core of a business and keep a minor part. Rose Edmunds, a partner for Deloitte, represented a computer equipment company that spun-out an embryonic training arm before selling the main business. “It didn’t affect the price,” she says, “but went on to become very successful in its own right and led to further spin-outs.” In the unfortunate occurrence of partner acrimony, splitting the business is often the best solution.
How does a carve out work?
It won’t work unless you separate all operations: accounts, management, staff and supply networks. To achieve maximum price you’ll need to present a fully independent proposition.
“You must provide robust independent analysis and it’s something you can’t fudge,” says Sanford. “Wade through the record books and work out where the margins are in each section of the business.”
When carving-out, or de-merging a business, there are complex tax issues to consider and you’ll need advice from an accounts and financial advisor with de-merger experience. In brief, they are:
– Statutory de-merger
A statutory de-merger is the straightforward splitting of a company, with shares redistributed accordingly. It’s not a process commonly deployed, as shareholders must pay corporation tax on the ‘disposal’ and again on the sale of shares. The process needs to pass through the Inland Revenue’s clearing mechanism and there are restrictions on future sales to adhere to.
– Non-statutory de-merger
This is more common and doesn’t require clearance or sufficient reserves. The existing company is wound-up and reformed as two separate new companies, which can then be sold. John McBride, of accountancy and tax advisors Vantis, says it’s a case of establishing which type of transaction will benefit shareholders most. “It’s really just a way of reshuffling the cards to make sure cash goes into pockets.”
You’ll need legal advice. When transferring employees to a new company you’ll incur TUPE and pensions regulations. Adrian Cutler, partner for law fi rm Cobbetts, warns: “Every man and his dog now knows TUPE is an opportunity to win cash off an employer, so make sure you follow consultation protocol and keep records accurate.”
You’ll also need to establish how shared contractual issues will be separated. Licenses, IP, IT, and contractual issues such as buy-on clauses and retrospective sale agreements need to be documented and a timescale placed on how long the buyer can return to you for information (12 to 24 months is standard).
But get ready for a slog. “The transitional services agreement can be three times the thickness of the T+A,” warns Cutler.
Case study: Downsizing to grow
Company: Hesley Group
Owner: Stephen Lloyd
Stephen Lloyd separated and sold-off 55% of his residential care business, Hesley Group, in a deal worth in excess of ?100m last year. Geographically the business had two core bases, in Hampshire and south Yorkshire. Lloyd opted to separate the businesses into Hesley South and Hesley North, carving out the south section for sale.
?It helped that there was a natural split as the bases had their own IT and training facilities, but the accounts had to be totally separated,? says Lloyd.
For Lloyd, the key was not to rush the process. ?Over time we?d put the management in place so aspects of the company could exist without me. You have to go through a process of pre-management with staff too; gradually wean yourself away and assure them that, as much as possible, nothing will change. That?s where you have a responsibility in selecting purchasers too.
?You need to treat the process as you would a succession by planning well in advance.?