What do corporate lawyers do when selling a company?
In this issue of Strictly Boardroom we look at a company sale where the corporate lawyers are acting for the selling shareholders. A related article looks at how lawyers approach things when acting for the buyer.
Let’s assume that you have received an indicative offer from a reputable company that wants to buy the entire issued share capital of your private limited company. You have taken some accountancy advice on the offer price and been advised that it is at or above market value. You and your co-shareholders consider this is the right time to sell and are keen to proceed.
Let’s also assume that you have been recommended to a law firm that specialises in company transactions. They have given you a fee budget for the transaction and, quite reasonably, you want them to explain exactly what they will be doing for their fee and what benefit you will get from instructing them.
You’ll know if you’re in good hands if the lawyer leading their team puts the kettle on and makes some tea. This is not perhaps the most technical thing corporate lawyers do but there are few better ways to start a relationship. The explanation of what is involved should go something like this.
Understanding the deal drivers – Corporate lawyers are often criticised for not spending enough time listening to their clients to properly understand why the transaction is taking place and what the key objectives are. The process of selling a company ‘belongs’ to the sellers and not their advisers and so the tactics and timetable should be worked up collaboratively.
Engagement letters – The engagement letters of all professional advisers (including lawyers, accountants, corporate finance advisers and other due diligence providers) are legal contracts and should, ideally, be considered with the benefit of legal advice. Typically, this advice will cover the scope of the professional’s work, the fees they propose to charge, how and when the fees are to be paid and the wording of any proposed limits on liability. As it is the shareholders of the company, rather than the company itself, that will be the contracting party, other issues include the recoverability of VAT and what fees, if any, are due if the transaction does not complete.
Confidentiality agreements – Before entering into any meaningful discussions with a potential buyer it is essential that a properly drafted confidentiality agreement (a non-disclosure agreement or NDA) is put in place to protect the company’s confidential business data including information about finances, customers, employees and know-how. Corporate lawyers will advise on issues such as who the contracting parties should be, how to define the nature of the transaction, how long the agreement should last and, importantly, the contractual remedies available in the event that the proposed buyer breaches the terms of the agreement.
Heads of terms – Converting an indicative offer into formal heads of terms is a key step in any transaction as it establishes the ground rules between the parties, gets some agreement on key deal points and flushes out any potential stumbling blocks at an early stage. The process aims to minimise the risk of everyone wasting further time and money. Heads of terms can be drafted by the sellers themselves with input from their financial and legal advisers or drafted by the advisers for the sellers to approve. Important legal issues are around the overall legal structure of the deal, which matters the deal is conditional upon, who the contracting parties should be, which elements of the heads of terms are binding and non-binding, confidentiality and exclusivity. Buyers tend to push for some form of exclusivity period to reduce the risk of them investing money in instructing advisers and conducting due diligence only to have the deal pulled from under them. Not all sellers agree to this and those that do should take great care not to lock themselves into one specific buyer on onerous terms.
Enquiry memorandum – Prior to preparing the first draft of the sale and purchase agreement based on the agreed heads of terms, the buyer’s lawyers will very likely send through to the sellers or their lawyers a long list of questions about the business. The aim of this ‘enquiry memorandum’ is to help the buyer better understand the detail of the business and to formulate a due diligence plan. Many of the questions create traps for the unwary as the buyer will no doubt seek to rely on the answers given during or after the transaction. The job of the sellers’ lawyers is to ensure that answers are given in the correct way. There is an element of protocol to this based on established commercial practice and, correctly done, the answers should offer the selling shareholders a high level of protection from future claims for breach of warranty, non-disclosure or misrepresentation.
Dealroom – To avoid exchanging large volumes of documentation and data by email or in paper format, it is now common to set up an online dealroom where everything is stored in a secure password-protected environment accessible only by the professional advisers. The dealroom provides a single repository for all information that a seller wishes to provide to a buyer. The sellers’ lawyers usually set up the dealroom, advise on how information should be presented and then manage the access to it.
Due diligence – Due diligence is the process by which the buyer attempts to verify that the asset being bought is worth what the buyer has offered. As well as reviewing the sellers’ responses to the enquiry memorandum and the contents of the dealroom, the buyer and the buyer’s professional advisers may want to conduct other investigations into the company. These investigations might include interviewing selected staff and customers (once it is clear the deal will happen), auditing IT systems and financial data and reviewing legal contracts and intellectual property rights. The role of the sellers’ lawyers is to advise on issues of confidentiality and assist the sellers in responding to any issues arising from the buyer’s due diligence process in the right way.
Sale and purchase agreement – This is commonly drafted by the buyer’s lawyers and it is the job of the sellers’ lawyers to go through it carefully and amend it in a way that protects the selling shareholders. The agreement should reflect the agreed heads of terms and include details of the company being sold, the price being paid, the payment structure, the security being given in relation to any deferred consideration, any restrictive covenants being given by the selling shareholders with regard to their future business activities and the terms of any involvement the sellers may have with the company. The agreement will also reflect any warranties (contractual promises) that the buyer’s will ask the selling shareholders to give about the company. Negotiating the terms of the agreement is where the skills and experience of the sellers’ lawyers are perhaps most in evidence as this tends to be where the ‘deal’ is won or lost. How hard a bargain each party can drive depends to a large degree on their relative bargaining positions but it is not unfair to say that a good lawyer can play a poor hand more effectively that a poor lawyer can play a good hand. Securing the right deal is about knowing which cards to play and when to play them. For sellers, a good outcome is achieved when, at completion, the headline price offered at the outset has not been reduced without good reason and that, following completion, there are unlikely to be any warranty claims that could claw back the sale proceeds paid to the sellers. Much of the negotiation tends to be around the nature and form of the warranties being given and the limitations as to when and how the buyer can make a claim under the warranties.
Disclosure letter – Selling shareholders can be protected from a claim for breach of a warranty in the sale and purchase agreement in three main ways. The first way is for the warranties to be worded correctly. So, for example, a warranty that says ‘there is no outstanding litigation against the company’ can be qualified to say ‘the warrantors have not received written notice of any litigation against the company’. This may appear to be semantics, but it can make all the difference if it turns out that a claim had been brought against the company but this had not yet come to the notice of the shareholders. The second way is to limit the buyer’s ability to bring a warranty claim by limiting the time within which a claim can be brought and by excluding minor breaches below certain value limits (called ‘de minimis’ claims). The third way is via a document called a disclosure letter. This letter is issued by the sellers with the assistance of their lawyers shortly before completion and discloses anything that the sellers want to make the buyer aware of that could cause the sellers to be in breach of a warranty. So, taking the same warranty above as an example, the disclosure letter might say ‘with regard to warranty X, the sellers disclose that a claim has been brought against the company from XYZ Limited, details of which are attached to this disclosure letter in Appendix 1’. If the buyer accepts this disclosure (without the protection of an indemnity, a retention or a price adjustment) and proceeds to complete the transaction, the buyer will not be able to sue the selling shareholders for breach of that warranty arising from the disclosed matter. Had the warranty not been disclosed against in this way, the chances are the buyer could bring such a claim.
Pre-completion consents and consultations – Completion of the sale of a company may be dependent on the sellers securing various consents from banks, regulators, competition authorities and others. It may also be dependent on carrying out certain consultations, for example with the company’s employees. Managing these issues can be tricky and time-consuming and needs the sellers and their professional advisers to work closely together to make this run smoothly.
Completion – At last, the day comes when the due diligence process has been finalised, the documentation is agreed, the necessary consents have been obtained and consultations concluded and the parties are ready to complete. The parties will commonly meet together with their advisers present, sign all the documentation and complete the transaction. Whilst this should really be an administrative process, it is surprising how many issues can be raised at the last minute and the sellers’ lawyers may need to act robustly to bring matters to a satisfactory conclusion. The last job for the sellers’ lawyers is to receive payment for the shares, settle any agreed liabilities, distribute the net proceeds to the selling shareholders and attend to any post-completion formalities.
Oh, and to open a bottle of chilled champagne to enable the parties to toast a successful outcome!