Guide:

Legal Aspects of a Business Sale

Contents
The legal aspects of a business sale can be complex. This guide is designed to give you a good insight into the process and tasks that will need to be undertaken: Main Differences Sale of Business/Sale of Company Legal Process o Heads of Agreement o Finance for the Purchase o Request for Information (Due Diligence) o Response to Request for Information o Draft Share Purchase Agreement/Business Purchase Agreement o Negotiate Warranties o Disclosure Letter o Exchange of Contracts o Completion o Completion Meeting o Guide to TUPE (transfer of Protection of Employment) o Sample - Legal aspects of the deal timetable o Sample - Heads of Terms Main differences Sale of Business/Sale of Company People often get confused between the sale of a business and the sale of a company. When selling a company it is the shares that are sold. As far as the outside world is concerned there is no change as they still deal with the same company. Behind the scenes, however, the owners of the company have changed. In contrast a business can be owned either by a sole trader, a partnership or a company. Any aspect of the business its assets or division can be purchased or sold often this is without liabilities. There are tax implications and differences between the sale of a business and the sale of a company and tax advice is essential before proceeding. Heads of Agreement/Terms Once you have agreed in principle to buy or sell a business or company, a document which sets out the basic terms agreed, called The Heads of Agreement/Terms is signed. This will include the amount to be paid, how it is likely to be financed, and any other specific terms. Usually the Heads of Agreement/Terms comprise the main points only, and only in outline The Heads of Agreement/Terms are normally not binding except in respect of confidentiality clauses and exclusivity if included. Finance for the Purchase It is normally at this point, if not before, that the purchaser needs to decide how the business purchase is going to be funded. This may be done by a variety of methods including bank loans, cash, paying over a period of time (earn out or deferred consideration), or a combination of these factors depending on the amount the bank is prepared to lend. Once it is clear that the finance has been approved in principle, we can proceed onto the next stage.
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Guide: Legal Aspects of a Business Sale

Request for Information (Due Diligence) The due diligence process serves to confirm all material facts in regard to the business or company. It refers to the care and research a reasonable person should take before entering into an agreement or transaction. Most purchase offers will be contingent upon the results of a due diligence report. During these process financial records, commercial contracts, legal agreements and anything else deemed material to the sale will be reviewed. Vendors may also carry out due diligence on the purchaser, to investigate their ability to purchase and or anything that may affect the purchased entity or the vendor after the sale. The process is often begun by the purchaser issuing a questionnaire, asking for particular documents and points they may want clarified. The answers to these questions will then likely form the basis of the warranties in the sale and purchase agreement. The seller must respond honestly and openly and in detail to this request so that the purchaser can be satisfied that the company is free of any liabilities other than those identified. A data room is often used during the due diligence process, which will contain all financial, commercial, and legal information on the business, including detailed accounts, particulars of all properties, and employees and copies of all contracts. They are often provided to the purchaser in an on-line format, hosted by a third party with a password and protected internet access. Alternatively it may take the form of an actual room at the legal advisors offices, or simply in electronic or hard copy format. The following are some issues, which should be considered during the due diligence process. There might be forgotten guarantees, which could be subsequently activated. Can it be certain that all taxes have been declared and paid up to the point of sale? Might the tax authorities subsequently question the basis upon which returns have been made? Have all claims against the company been fully disclosed? Could any mistakes have been made in stocktaking? Intellectual property matters. Product liability matters. Pension liability. Environmental issues.

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Guide: Legal Aspects of a Business Sale

Response to Request for Information Once the sellers solicitor has received the Request for Information, they will together with their client compile a package of information (with documentation attached if necessary) setting out answers to all the queries raised. The Buyers solicitor will discuss the information disclosed with their client and in particular review any areas of concern e.g. liabilities of the company which they might be accepting. They will then decide whether they want any warranties (guarantees or statements of fact) or indemnities from the seller. For example, a seller might be asked to warrant/guarantee that a particular state of affairs exists (that the books and records are true and correct), or to indemnify the purchaser if a particular event happens. Draft Share Purchase Agreement/Business Purchase Agreement This is traditionally drafted by the purchasers solicitor. It generally includes a long section of warranties (guarantees) and indemnities protecting the purchaser in the event that the business is found not to be as has been represented. The agreement also covers all terms that have been agreed. Negotiate Warranties Once the first draft of the agreement has been sent to the sellers solicitor, they will review the terms and in particular the warranties and indemnities with their client. The seller must check carefully that they are able to give the warranties either as requested or by qualifying them (diluting them). If the purchaser needs to be made aware of any other issues in the business this is the time to disclose it. If information which is relevant is withheld by the seller, a purchaser could later sue the seller particularly if the seller has guaranteed a certain state of affairs and they transpire not to exist or be wrong. Depending on the warranties and indemnities being requested, both sets of solicitors will try and negotiate a compromise which adequately protects both parties. These negotiations can take a long time with a lot of horse trading before final agreement is reached. Sometimes a sale can collapse because the parties cannot agree. Warranted statements provided by the vending shareholders of a company to the purchaser or the financial advisor sponsoring the sale of shares to the public are used by the purchaser to paint a picture of the company which is being bought. Indemnities are to secure potential future losses. Warranties guarantee that a particular set of facts are as they are stated to be. They are a result of the due diligence exercise to serve to contractually bind the vending shareholders to their statements in order to avoid the common law defence of caveat emptor Let the buyer beware. The basic premise is that the purchaser buys at their own risk, and should therefore examine and test themselves the facts given to them about the business for obvious defeats and imperfection upon reasonable inspection so by making these warranties and indemnities it is making the purchaser aware of any defect, thus they cannot claim they were unaware and thus have any cause to claim against them. The warranties will provide comfort over those matters which are most important to the purchaser. If the purchasers subsequently discover after the sale that any of these warranties were incorrect or misleading, and that the company is worth less than they expected it to be, they can then make a claim against the vendors for breach of warranty. It is usually possible to claim under the warranties for up to seven years in relation to tax and up to two years for non-tax claims. Generally, the amount, which the purchaser can claim back under the share sale agreement, is the amount paid for the company. This leaves the vendors at risk for possibly the entire sale price for up to seven years. This is a risk many would prefer to transfer, in the form of an insurance policy. Disclosure Letter Generally, there will be an agreement between the two parties as to the standard of disclosure before the acquisition is completed. The warranty as to this standard of disclosure will be contained in the Sale and
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Guide: Legal Aspects of a Business Sale

Purchase Agreement. A disclosure letter is then commonly used to evidence the disclosure by the seller to the purchaser of key information about the target business with the bundle of documents disclosed attached to the letter in paper or electronic form. The purchaser will then be able to make an informed decision as to whether it wished to complete the purchase, or whether to ask for an indemnity from the purchaser in relation to any of the risks set out in the disclosure letter, or withdraw from the sale all together. Guide to TUPE The Transfer of Undertakings (Protection of Employment) Regulations 2006, commonly known as TUPE. Protects employees terms and conditions of employment. TUPE applies to relevant transfers - almost all transfers of businesses from one employer to another e.g.: where a business (or part of it) is sold and where services are changed / outsourced. TUPE is not applicable for Share Transfer sales as there is no change of employer. Does TUPE apply; is it a relevant transfer? 1) Business transfers - The key question is whether or not there is a transfer of an economic entity that retains its identity. Factors to consider include: Is the type of business being conducted by the transferee (incoming business) the same as the transferor's (outgoing business)? Has there been a transfer of tangible assets such as building and moveable property (although this is not essential)? What is the value of the intangible assets at the time of the transfer? Have the majority of employees been taken over by the new employer? Have the customers been transferred? Is there a high degree of similarity between the activities carried on before and after the transfer? If the answer to all (or several of) the above questions is 'YES', there has been a transfer of a stable economic entity. 2) Service provision changes - A service provision change occurs when a client who engages a contractor to do work on its behalf is either: reassigning the contract (whether by contracting out, outsourcing or re-tendering), or Bringing the work in-house (where a contract ends with the service being performed in-house by the client themselves). It will NOT be a service provision changes if: the contract is wholly or mainly for the supply of goods, or The activities are carried out in connection with a single specific event or a task of short-term duration. The effects of TUPE Upon the transfer of the business employees employed just before the sale, automatically become employees of the purchaser, on the same terms and conditions of employment. It is as if their contracts of employment had originally been made with the purchaser. The purchaser inherits liability for any employees dismissed by the vendor for reasons connected with the transfer. Any dismissal connected to the transfer is automatically unfair. The purchaser cannot select which staff to take on. The consultation rules Where employees are represented by a trade union the employer must inform and consult with the union about the proposed business transfer. Otherwise the employer must inform and consult employee representatives about the proposals. There are legal requirements that apply to the election process and rights of employee representatives. What must the vendor tell the employees who are due to transfer?
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Guide: Legal Aspects of a Business Sale

that the transfer is going to take place, when approximately it will take place, and the reasons for it; the implications of the transfer for the affected employees; Whether the new employer is planning to make any changes, such as reorganisation as a result of the transfer, and if so, what arrangements are being planned and how those will affect the staff. Consultation should be undertaken with a view to seeking agreement on the proposed changes. Both vendors and purchasers are obliged to inform staff about the proposed changes. ETO reasons Neither the purchaser or vendor can fairly dismiss an employee because of the transfer or a reason connected with it, unless the reason for the dismissal is an economic, technical or organisational reason entailing changes in the workforce (known as an ETO), such as a redundancy situation. Dismissal because of a relevant transfer will be unfair unless an employment tribunal decides that an ETO was the main cause of the dismissal, and that the employer acted reasonably in the circumstances in treating that reason as sufficient to justify dismissal. To avoid claims of automatically unfair dismissal being pursued by affected employees, purchasers / vendors contemplating the need for redundancies should seek specialist advice as this is a very technical area of law. Transfer related dismissals and Tribunal claims Dismissed employees can complain to the Employment Tribunals. An employee claiming to have been dismissed because of a transfer may claim their dismissal is automatically unfair. Employment tribunals may order reinstatement or re-engagement and/or make an award of compensation. Transferred employees whose terms and conditions of employment have changed for the worse as a result of the transfer have the right to terminate their contract and claim constructive unfair dismissal, on the grounds that actions of the employer have forced them to resign. Employee representatives have the right to protection from detrimental treatment and paid time off to discharge their duties as employee representative. Where the employer fails to properly consult with the employees under TUPE, complaints can be issued in the Tribunal and the employer who is at fault may be ordered to pay compensation to each affected employee. Compensation can be up to 13 weeks pay. Pensions The Transfer of Employment (Pension Protection) Regulations 2005 came into force on 6 April 2005. Where the vendor provides a money purchase scheme or stakeholder pension, the purchaser is under an obligation to match the vendors employer contributions to the scheme up to a maximum of 6% of basic pay. Practical TUPE tips for the vendor: Seek Advice regarding TUPE at an early stage, in order to determine the tactics / assess the risks involved with the proposals. Ensure all staff have up to date employment contracts, accurately reflecting their current terms and conditions. Do not change the work force terms in the lead up to a sale. Do not make people redundant if the purchaser asks you to. Make sure you comply with the consultation rules. Timetable enough time to consult with the staff. Practical TUPE tips for the purchaser: Seek Advice regarding TUPE at an early stage. Raise enquiries regarding the staffs existing terms and conditions, length of service, roles and functions etc in order to find out what employment liabilities you are taking on; Carry out a risk assessment regarding the employees; Make sure you comply with the consultation rules; Timetable enough time to consult with the staff;
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Guide: Legal Aspects of a Business Sale

Ensure that the vendor has complied with its legal requirements under TUPE regarding consultation etc; Sample legal aspects of the deal timetable Avondale will manage the timetable, and fully liaise with all parties throughout. Monitoring the progress and ensuring momentum is not lost. 18 July 23 July 25 July 1 August 5 /6 August 13 August 22 August 29 August 1 September 8 September
th th th st th nd th th th st th rd th

Purchaser and vendor to have formally requested solicitors to proceed. Purchaser solicitor to send vendors solicitor initial due diligence enquires. Purchaser to provide Avondale financial letter of comfort from bank or accountant. Vendor and vendor solicitor to reply to all initial due diligence enquiries. Purchaser/purchaser accountant to visit vendors premises to carry out any further due diligence required. Purchaser solicitor to send draft sale purchase agreement to Vendor solicitor. Vendor solicitor to review & respond to draft sale contract. Purchaser bank or purchaser accountant to confirm finance in place. Purchaser solicitor to send back revised draft sale contract Sale purchase contract to be agreed (or round table meeting for all parties to overcome issues and get it agreed).

10 September Vendors solicitor to provide disclosure letter and bundle. 12 September Transaction completes Note: The above is a guide only with example dates, and will vary considerable for each sale. Sample Heads of Terms The heads of terms is a summary, non-legally binding in most respects of what the parties have agreed. Most parties will offer using a form of draft heads of terms. This saves time and creates clarity early on, by highlighting the requirements of both the vendor and purchaser. Sample Date: Ref: This document outlines the head terms agreed between the parties, prior to negotiation of a final sale and purchase agreement. Save in the respect of confidentiality and exclusivity; the terms are not legally binding, and are subject to due diligence and contract. The parties are (the Parties) The Vendor The Purchaser XYZ Vendor/s, or key shareholder/s, name/s Full name/s of individuals C/o Co. name or home address if share sale Or Company name c/o of individual/s Or Company name & no. of private Address of purchaser town Address In private town County Postcode Postcode
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Guide: Legal Aspects of a Business Sale

1. The sale basis Mr. / Mrs. Shareholders/XYZ Company (the Vendor) will sell to Mr. / Mrs. Purchaser/ABC Company (the Purchaser), the business known as (XYZ name, of 00, XY Street, any town) (or company XYZ reg.no.123456678) and any associated names (the Business). The sale will be on a fixed asset and goodwill basis/share transfer basis. 2. Timescale The parties will conduct their best endeavours to secure completion by (date XYZ). 3. Purchase Price/Terms To delete or insert rows click on table command. The purchaser will pay the vendor as follows: Item Amount Payable Note Initial payment On 1.Share deal Share deal completion For the purchase of the entire share capital of the Business to include the net assets at completion to be at least 45,000. The Vendor may take a pre-sale dividend to reduce the net assets to this level if appropriate. OR to exclude the net assets see below. Other Add details here Net assets On Share deal (if not included above) (estimated) completion A payment will be made for the net assets of the company on Share deal completion. The net asset value per accounts to 31-4-2001 is 45,000. It is estimated this will be materially similar at completion. Target TOTAL 4. Protections for deferred or performance related/earn out To protect the payments, the purchaser will provide the following protections to the vendor for the duration of the payments: A personal guarantee A charge over the freehold property A debenture on the assets of the Company Not if preference shares are being used Key-man insurance or life assurance to protect outstanding payments in the eventuality of illness, incapacity, critical illness or death. Access to all the records, including legal, accountancy, ledger, and banking paperwork and documentation. The issuing of statements regarding the payments, and produce accounts. Undertakings that the business will be run materially the same as at the present time and for the duration of the earn-out period and that the accounts will be run according to UK accounting standards... Undertakings that the purchaser shall not in any way compete with the business during the earn-out period. 5. Protections for part sale/mergers, vendors retaining minority shareholders The shares in the Newco/oldco will be enhanced by a quality shareholders agreement with caveats that: The shares will be valued pro-rata Offer first refusal to buy each other out either on a voluntary transfer or a deemed transfer (for example on death and bankruptcy or ceasing to be an employee) Cross options if the vendor dies ensuring the estate benefits from cash not a minority shareholding. To ensure that the company or the other shareholder has the cash to acquire a deceaseds shareholding it may be appropriate for a life policy to be put in place. A seat on the Board to reflect the shareholding
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Guide: Legal Aspects of a Business Sale

Agreed minority shareholding protection to ensure that the minority shareholder has rights of veto over certain fundamental matters. In the event of the Vendors death or mental incapacity during the period of the earn-out, then the shares should pass to the ownership of the Vendors estate.

6. Premises and/or as follows, or similar! The current premises are XYZ address, anywhere The Vendor will sell to the Purchaser the freehold premises at (premises address). The Business owns the freehold and it will be transferred by way of the share transfer New or existing lease terms or licence terms Period: Terms: Rent: Deposit: Payment Costs: Reviews Break clause: 7. Landlords consent Granting or assigning a lease or Directors guarantee is subject to the Purchasers status and the landlords consent (not to be unreasonably withheld). 8. Consultancy or handover The Vendor agrees to provide the Purchaser a 2-week initial handover free of charge during office hours. Thereafter, they agree to be available by telephone or fax within reason for a further period of (six months. As an Employee or Consultant, consider the following as applicable dependent on circumstances, age and expertise of Vendor. XYZE names and WXY names, shall on completion be employed by or provide consultancy services to the Purchaser. Final terms to be agreed between the Parties but to include: Title: Expenses: Salary: Hours: Benefits: Benefits: Commission: Duties: Car: Holidays:

Private Medical Insurance to include in-patient medical care with a maximum contribution by the employee of 15%. The Policy should be uunderwritten by a branded provider and be operative from day 1 of his/her duties as General Manager. A Company Pension Scheme will be made available to the General Manager and will be operative from day 1 of his/her start date. The Scheme should allow for Additional Voluntary Contributions and should provide for a final pension of not less than XYZ. 5% of all turnover introduced up to a maximum of 20,000 commission p.a. Recruitment of new Consultants, Business Development to existing and new client.

9. Resignations share deals The following shall resign as Directors on completion - XYZ and ABC exiting (Directors name/s). 10. Employees The Vendor agrees to provide the Purchaser with a list of all staff to include: their names, ages, length of service, salaries, benefits and duties. The Parties also agree that: Any redundancies will be the Purchasers legal and financial obligation.

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Guide: Legal Aspects of a Business Sale

During negotiations of the final sale & purchase agreement that no employees will be taken on or dismissed without the Purchaser's reasonable consent (except where the employee may be summarily dismissed).

For fixed asset and goodwill sales only Any obligations under the TUPE regulations to consult with the staff about the transaction will be met. Staff salaries and holiday pay will be apportioned between the Parties. Key staff retention idea To assist the Purchaser in continuation of goodwill the Vendor agrees to pay the staff listed below a loyalty bonus after (six) months of successful service with the Purchaser of (2,000 each) in recognition of their endeavours and contributions to the business. 11. Tax The Parties agree to give fair consideration to each others tax position in the negotiation of a final sale and purchase agreement. The following is for asset deals only The Parties will agree an apportionment of the sale price between (goodwill, fixed assets and leasehold interest/freehold) for tax purposes. 12. Non compete and protection of goodwill To protect the goodwill the Vendor will provide covenants that they will not for a reasonable period and within reasonable proximity enter into a competitive business or carry out an action that might materially affect the goodwill of the Business. The Vendor will also conduct the Business in its normal and ordinary course until completion. 13. Confidentiality, due diligence and disclosure The Parties agree that the terms, negotiations and sale are confidential save in taking counsel from their professional advisors, or as required by the rules and regulations of the London Stock Exchange, or any TUPE obligation to consult with employees. The Parties agree to disclose any facts material to the transaction. The Vendor will grant the Purchaser or their advisors and employees access to the Business, its operations and books in order to perform due diligence. Access will be provided consistent with the Vendors requirement to protect confidentiality. 14. Representations and warranties The Vendor agrees to provide and the Purchaser agrees to request warranties, indemnities and representations appropriate for a transaction of this size. 15. Advisors, fees and costs The Parties agree to instruct early on appropriate advisors to complete a transaction of this size in the timescale proposed. Each party shall be responsible for their own advisors fees and costs incurred in the transaction. 16. Exclusivity and deposit The Vendor agrees to provide exclusivity to the Purchaser up to the target date for completion, subject to reasonable progress being made by the Purchaser. During such exclusivity the Vendor or their advisors will not before completion discuss, negotiate or provide assistance to any third party who may be interested in the Business. 17. Terms English law will govern these Heads of Terms and the sale and purchase agreement. Vendors signature Purchasers signature
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Guide: Legal Aspects of a Business Sale

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