The Why
There are multiple motives behind a company's decision to acquire another business. These motivations encompass eliminating competition, gaining control over a segment of the supply chain, benefiting from economies of scale, extending operations into a different industry, or capitalizing on the tax losses present in the targeted company.
At the Commencement
Once a potential buyer has determined its intention to acquire, several factors need to be taken into account. These include the nature and scale of the business to be acquired, the amount the buyer is willing to pay, and the means by which the acquisition will be financed. This could involve issuing new shares, utilizing existing cash reserves, or securing bank funding. Generally, the process of acquiring a private company or business requires three to six months for completion.
There are two primary scenarios in which the acquisition process may begin. First, the seller or their advisors may initiate contact with potential buyers. Alternatively, the prospective buyer may proactively approach the owners of a strategically valuable business that is not currently on the market for sale. In the context of a management buy-out (MBO), the management team may be approached by the current owners or become aware of the owners' intention to exit, prompting them to consider purchasing the company themselves
Squad Up
For a successful acquisition, it is crucial to form a team of knowledgeable advisors to oversee the process. The specific composition of this team, including lawyers, accountants, and corporate finance advisors, will vary depending on the specific deal at hand. It is important to note that advisors who have been previously engaged by the buyer for routine matters, such as lease preparation or auditing, may not be suitable for the proposed transaction. In the case of a management buy-out (MBO), the company's current lawyers may be representing the seller(s), necessitating the involvement of a different law firm to represent the management team
The Purchase
Business acquisitions can take two forms:
a share purchase; or
a business and asset purchase.
In a share purchase, the buyer acquires the share capital of the target company, while in a business and asset purchase, the buyer obtains a package of rights, assets, and assumes certain liabilities associated with the part of the business being acquired.
Both structures have their advantages. Acquiring the business and assets of a company is often preferred by buyers because they can select which liabilities to assume, whereas in a share sale, the buyer inherits all the liabilities of the target company.
However, there is an exception when it comes to employment. In a business and asset sale, the employment of individuals assigned to the acquired business automatically transfers to the buyer, along with associated liabilities and relevant collective agreements. Any termination of employment in connection with the transaction is considered unfair dismissal.
If the acquisition is structured as a business and asset sale, both the buyer and the seller have a legal obligation to consult with recognized trade unions or elected employee representatives of the affected employees. It is important for the buyer's legal advisors to have expertise in employment law, to guide the buyer through this process effectively.
A benefit of a share purchase for the buyer is that they don't have to individually identify and transfer each asset required for the business's continuation; they can acquire everything in a comprehensive package. Additionally, the buyer may be able to take advantage of any available tax losses in the target business.
In practice, the choice of transaction structure is often influenced by external factors. For instance, a share sale may not be possible if there are minority shareholders unwilling to sell. Tax considerations may also drive the decision, with the most favorable tax treatment for the party with greater bargaining power becoming the deciding factor. Share sales are common in management buy-outs (MBOs) or when the sellers are individuals seeking a clean break and exit from the business.
Setting the price
Determining the value of a business is more of an art than a science. The price a buyer is willing to pay for a business is subject to negotiation between the buyer and the seller(s), and it is influenced by various factors. These factors include the buyer's motivations for acquiring the business and their future plans for it. If the business is being sold through a competitive tender or auction process, the seller's motivation for selling and their future plans also play a role. In some cases, owner-managers who want to exit the business may be willing to accept a lower price in exchange for a quicker process and a clean break.
Corporate finance advisers, who can be part of an accounting firm or specialized corporate finance entities, can assist in valuing the business. They can also help potential buyers in securing financing for the acquisition by utilizing their network of contacts.
Keeping things under wrap
Prior to receiving any information about the target company, a potential buyer is required to sign a confidentiality agreement, also known as a non-disclosure agreement (NDA). This requirement applies even if the buyer is the existing management team. The purpose of the confidentiality agreement is to prevent widespread knowledge of the proposed sale within the business or the broader market, as this could potentially unsettle or demoralize employees and impact relationships with customers and suppliers.
By signing the confidentiality agreement, the buyer is legally obligated to utilize the information provided solely for the evaluation of the target company and not for their own personal gain. Furthermore, the buyer must maintain the confidentiality of the information received and the existence of the transaction itself.
Heads of Agreement
Typically, the next step in the acquisition process is for the buyer and seller(s) to establish heads of agreements (HoAs) that outline the key terms of the deal upfront. This can be a simple letter from the buyer to the seller(s), or a more comprehensive document drafted by their legal or corporate finance advisors. The purpose of the HoAs is to identify any areas of disagreement that could potentially hinder the deal at a later stage, after significant time and expenses have been invested.
While the provisions concerning confidentiality and exclusivity are generally legally binding, other provisions in the heads of terms may not be enforceable due to their lack of detailed specifications required for a viable contract. The HoAs will cover all the primary aspects to be addressed in the acquisition agreement and will serve as the basis for the initial draft of the share purchase agreement or business purchase agreement. These heads of terms will also guide the subsequent in-depth negotiations.
Usually, the buyer's legal advisors are responsible for preparing the initial draft of the acquisition agreement.
In general, HoAs typically encompass the following key points:
The headline price and its calculation method. While the price often relies on a profit-based multiple, asset-based valuations may be more suitable for certain businesses. Alternatively, a locked box structure can be utilized, where the price is determined based on a specific set of accounts prepared prior to completion. The buyer verifies these accounts, and the seller(s) are restricted in the amount they can extract from the business (referred to as "leakage") between the date of those accounts and the completion of the acquisition.
The target company should ideally have no outstanding debt that the buyer needs to assume. It should also be cash-free, without excess funds that the seller(s) would want to withdraw. Moreover, the target should possess a normalized level of working capital (sufficient cash, debtors, stock, etc.) to ensure the business can continue operating without requiring a significant cash injection from the buyer, typically for a 12-month period.
The structure of the price payment. For instance, whether it will be fully paid in cash upon completion (which is relatively uncommon), if there will be deferred payments, or if non-cash considerations such as the issuance of shares by the buyer to the seller(s) will be part of the purchase price.
Price adjustments, particularly in share sales. Completion accounts, prepared after the acquisition, may be used to verify the financial position on the completion date. The price may be adjusted based on whether the actual financial position differs positively or negatively from the anticipated position
Please note that these points are a general overview, and specific details may vary depending on the circumstances of the acquisition
Other important considerations to address in the HoAs include:
Determining which sellers will provide warranties, specifying their respective liability proportions, and any limitations on their liability.
Deciding if there will be any indemnities based on the findings of the buyer's due diligence.
Identifying whether any sellers will remain employed in the business after the acquisition's completion and specifying the duration of their non-competition obligations.
Addressing exclusivity and costs. Typically, the seller(s) grant the buyer an exclusivity period to negotiate the deal, during which the seller(s) agree not to engage in discussions regarding alternative deals with third parties. This helps mitigate the risk of the buyer investing time and money into the acquisition process, only to have the seller(s) accept a better offer later on.
Having a well-defined strategy from the beginning is crucial for a successful acquisition. Engaging experienced legal advisors early on to handle and negotiate the deal on behalf of the prospective buyer, ensure adherence to deadlines, and keep all parties on the buyer's side informed should not be underestimated. This approach can potentially save costs in the long run.
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