The Legal Sale and Purchase Processes

Those involved in owning and running businesses often find that a major transaction (including a sale and purchase of a business) is a highly stressful time for them.
At a time when they already have responsibilities for successfully trading their underlying business – they find themselves needing to engage with transactional lawyers in what appear to be highly time-consuming legal processes, and whose aims may seem unclear.

This position can be particularly annoying, because it often seems to those involved, that the legal processes are delaying the completion of the transaction - which the interested party principles believe they have already agreed upon.

Evolution Capital's aim is to ensure that the legal process involved in a transaction is an integral part of the sale and purchase process - with the aim of ensuring a smooth progression of the overall transaction - so as to efficiently and economically take the interested party principles from initial discussions through to completion.

That aim is considerably assisted if the interested party principles have an opportunity to consider and understand why the legal elements of a sale process have evolved to be as they are.

The Pre-Sale Process

It is an accepted part of the marketing of a business for sale but those involved in the process on the ‘sell side’ will want to "keep their cards as close as possible to their chest". The seller will want to provide just enough information as is required so as to whet the appetite of the prospective purchaser, while not wishing to create any legal obligations – including any possible liabilities relating to its description of the business to the prospective buyer.

Unlike the legal protections which apply in (say) sale and purchase arrangements between retailers and consumers, there is very little protection generally afforded to a buyer of business assets under English law. This position is best noted in the relatively well-known English maxim of "Caveat Emptor"- or in more colloquial English – "Buyer Beware".

A buyer is generally entitled to redress for the effects of misrepresentations which may be made by a seller to the buyer with the aim of inducing a sale. However, if a seller of business assets is aware of an actual or potential problem with their business, they are generally fully entitled to stay silent upon that issue (i.e. there is no obligation to disclose the perceived problem to the prospective buyer).

The general position in English law, is that if a buyer purchases a "pig in a poke" – Or in more formal language, a business which is ‘not all that it was thought to be by the buyer’, then any recourse against the seller is likely to be severely limited. This will be particularly so because a well advised seller, as part of the legal process involved in the sale and purchase, will generally be successful in seeking not to be legally bound by most pre-sale statements regarding the business that it might have made to the prospective buyer, often as part of the process of the seller seeking to encourage the buyer to make a generous offer for the relevant business.

If this general position in English law is not addressed, then the likely result will be that the buyer is subject to some element of risk that the business which they are proposing buying is not worth what the buyer proposes paying for it. That element of risk would then generally need to be factored into the price that the buyer proposes paying – effectively by a reduction in the purchase price that the buyer might be minded to pay for the business, if it could satisfy itself that the business was all that the buyer believed it was.

Accordingly, while there remain transactions in which effectively a buyer merely hands over the offered purchase price and ‘hopes for the best’, because the seller would generally wish to elicit an offer from the buyer of as high a price as possible for the business being sold and purchased, it is generally the case that the seller agrees to give some element of comfort to the buyer as to the full worth of the business which the buyer proposes to purchase.

Two main legal processes, Due Diligence and a Warranty (and Indemnity) Protection Process, have evolved with the aim of giving the buyer comfort as to the worth of the business they are buying – and thereby allowing the buyer to offer more for the business than in a situation when the buyer is required to bear an element of risk as to the worth of the business it is buying.

Having given a general outline to the legal sales and purchase processes in next month’s article I will detail the two main legal buyer protection processes and describe the aims and potential effects to each party.

http://www.evolutioncapital.com/news-articles/the-legal-sale-and-purchase-processes#.U3M4UXZLrkZ

Business Sale and Purchase – The Legal Process – What's Involved and Why?

Those involved in owning and running businesses often find that a major transaction (including a sale and purchase of a business) is a highly time consuming (and consequentially stressful) time for them.

At a time when they already have responsibilities for successfully trading their underlying business – they find themselves needing to engage with transactional lawyers in what appear to be highly convoluted legal processes, whose aims may seem unclear.

This position can be particularly annoying, because it often seems to those involved, that the legal processes are delaying the completion of the transaction - which the interested party principles believe they have already agreed upon (and indeed have – in principle / ‘subject to contract’).

Equitable Law's aim is to ensure that the legal process involved in a transaction is an integral part of the sale and purchase process - with the aim of ensuring a smooth progression of the overall transaction - so as to efficiently and economically take the interested party principles from initial discussions through to a successful completion.

That aim is considerably assisted if the interested party principles have an opportunity to consider and understand why the legal elements of a sale process have evolved to be as they are.

The Pre-Sale Process

It is an accepted part of the marketing of a business for sale but those involved in the process on the ‘sell  side’ will want to "keep their cards as close as possible to their chest". 

The seller will want to provide just enough information as is required so as to whet the appetite of the prospective purchaser, while not wishing to create any legal obligations – including any potential liabilities relating to its description of the business to the prospective buyer.

Unlike the legal protections which apply in (say) sale and purchase arrangements between retailers and consumers, there is very little protection generally afforded to a buyer of business assets under English law. 

This position is best noted in the relatively well-known English maxim of "Caveat Emptor"- or in more colloquial English – "Buyer Beware". 

A buyer is generally entitled to redress for the effects of misrepresentations which may be made by a seller to the buyer with the aim of inducing a sale. 

However, if a seller of a business is aware of an actual (or potential) problem with their business, they are generally fully entitled to stay silent upon that issue (i.e. there is no obligation to disclose the perceived problem to the prospective buyer).    

The general position at English law, is that if a buyer purchases a "pig in a poke" – Or in more formal language, a business which is ‘not all that it was thought to be by the buyer’, then any potential for recourse against the seller is likely to be severely limited. 

This will be particularly so because a well advised seller, as part of the legal process involved in the sale and purchase, will generally be successful in seeking not to be legally bound by most pre-sale statements regarding the business that it might have made to the prospective buyer, often as part of the process of the seller seeking to encourage the buyer to make a generous offer for the relevant business (pursuant to ‘teasers’ which often comprise ‘pre-sale bluster’).

If this general position at English law is not addressed, then the likely result will be that the buyer is subject to some element of risk that the business which they are proposing buying is not worth what the buyer proposes paying for it. 

That element of risk would then generally need to be factored into the price that the buyer proposes paying – effectively by a reduction in the purchase price that the buyer might be minded to pay for the business, if it could satisfy itself that the business was all that the buyer believed it was.

Accordingly, while there remain transactions in which effectively a buyer merely hands over its offered purchase price and ‘hopes for the best’; generally - because the seller would generally wish to elicit an offer from the buyer of as high a price as possible for the business being sold and purchased, it is generally the case that the seller agrees to give some element of comfort to the buyer as to the full worth of the business which the buyer proposes to purchase.

Two main legal processes have evolved with the aim of giving the buyer comfort as to the worth of the business they are buying – and thereby allowing the buyer to offer more for the business than in a situation when the buyer is required to bear an element of risk as to the worth of the business it is buying.

The desired result should be to allow the respective parties to legally agree the ‘best deal’ that can be realistically achieved between them.

The Due Diligence Process

The first of these legal processes is known as ‘due diligence’. 

This process broadly involves the buyer (prior to entering into a legally binding agreement) asking the seller a range of questions in relation to the prospective business which is proposed to be bought, followed by the seller both answering those questions (as fully and accurately as it can), and the seller producing supporting documentation (and any other evidence) to support the answers given to the questions asked.

The buyer will need to carefully consider the answers given and documentation (and other evidence) produced – so as to ensure that there are no perceived issues for the buyer with business proposed to be bought.

The Warranty (and Indemnity) Protection Process

The subsequent (although accompanying) process is known as ‘warranty (and indemnity) protection’. 

Warranties (and indemnities) are a set of contractual statements (and promises) in relation to the business being bought, which the buyer asks the seller to make as part of the legal agreement(s). 

At their simplest, warranties (and indemnities) may effectively be a statement by the seller that they have fully and accurately answered, and provided all documentation (and any other evidence) in response to the due diligence process.

Generally a buyer will ask for warranty (and indemnity) protection in as all-encompassing a format as possible, and the seller will seek to qualify those requested warranty (and indemnity) protections by way of a disclosure letter which seeks to set out pertinent factual position – with the result that the buyer becomes fixed with knowledge of that factual position and loses their right to potential redress in relation to matters which are disclosed to it.

The Aims and Effects of Due Diligence and Warranty (and Indemnity) Protection

For the buyer, the process of undertaking due diligence and obtaining warranty (and indemnity) protection, allows it to gain some comfort and protection as to the worth of the business which it is proposing to acquire. 

This in turn allows it to consider paying a full price for the assets, comfortable in the knowledge that it has reduced a certain element of the risk involved in the transaction.

The interested party principles should be made aware (in early course) that it is highly likely that the due diligence process and the warranty and indemnity protection process will require them to devote considerable time and effort to achieving the desired outcome of the maximum achievable purchase price (for the seller) and comfort and protection for the buyer as to the business that they are buying (thus allowing them to offer such a purchase price).

Because Equitable Law's aim is to ensure that the legal process is an integral part of the overall sale process – this should have the effect of ensuring a smooth progression of the these legal processes as part of the overall transaction – and thereby efficiently and economically progress the interested party principles from agreement in principle upon a transaction through to a successful completion

Occasionally these legal processes bring to light (prior to a legal agreement being reached) a situation that is an issue for the buyer (and – in many cases – that the seller was not envisaging would be an issue for the buyer).  These legal processes allow buyer and seller to discuss the relevant problematic issue prior to entering into any legal agreement and thereby to seek to resolve the issue by any number of possible negotiated approaches which can be taken (e.g. adjustment to the proposed sale and purchase price, contractual adjustment of which party bears a risk of a potential liability crystallising etc.).  The hoped for end result is a much fairer and more reasonable ‘deal’ with the ‘right’ sale and purchase price being paid for a ‘correctly perceived’ business.          

If notwithstanding these processes, the business which is transferred is not that which was indicated as part of the due diligence process, and as such position is contractually supported by the warranties (and indemnities), then the buyer will generally have a potential contractual recourse against the seller pursuant to the terms of the sale and purchase agreement.  

The warranties (and indemnities) in such circumstances can accordingly be considered to be a means to adjust the purchase price to the ‘right’ sale and purchase price which would have been paid, if the buyer had been able to accurately understand the situation of the business that they were acquiring.

It is so as to hopefully avoid the necessity for such ‘post deal price adjustment discussions’ that the interested party principles (and their advisors) should focus upon these legal processes as an absolutely crucial part of successfully achieving the completion of the transaction.

    

March 2014

DanielRobertJohnson     (Skype – V.o.I.P. & I.M.)

Dan.Johnson@EquitableLaw.com

Principal & Business Law Solicitor

+44 (0) 7788 537 187     (U.K. Cellular / Mobile Tel. – Inc. ‘Facetime’)

Equitable Law (Dan Johnson) Advises Management On A MBO Transaction

Equitable Law (Dan Johnson) are delighted to announce that they have advised a management team upon the successful completion (in late November 2013) of a management buy-out (M.B.O.) of the emerging economy property development business that they have run for the last few years.

The details of the transaction are highly confidential, but the relevant members of the management team acquired the underlying business for an undisclosed GBP £ Eight Figure Amount consideration - to be paid by collection of unrealised profits and redemption of loan notes over the next eighteen (18) months.

The transaction represented a typical 'deal' with which Equitable Law has advised and assisted over recent years - representing an underlying business (founded relatively recently by a U.K. entrepreneur) which has grown rapidly as the U.K.'s position at the centre of the world's time zones has made it a natural base for a business which raises money in distant capital rich areas of the world (the Far-East) and uses that capital to develop property in similarly distant emerging economies (in South America).

We wish the management team well and (within the bounds of confidentiality) we would be delighted to discuss our experience in advising and assisting with this transaction.     

Equitable Law Advises The Rainbow Seed Fund Upon The Creation Of Its New Segregated Synthetic Biology Portfolio

Equitable Law is delighted to announce the successful completion of its legal advice and assistance to its long established client, the Rainbow Seed Fund in relation to the creation of its new ten million pounds sterling (GBP £10m) segregated 'Synthetic Biology Portfolio'.

Synthetic biology is the design and construction of novel biologically based parts, devices and systems, as well as the redesign of existing natural biological systems for useful purposes.  It has a number of potential applications within the bio-based knowledge economy.  These include: industrial biotechnology, bioenergy, bioprocessing, novel materials and biosensors.

Synthetic biology is one of the eight (8) great technologies highlighted by the UK government as areas of wide-ranging significance and potential economic importance, in which the UK’s research base is particularly strong.

Further details are available at :- http://midven.co.uk/news/midven-to-manage-synthetic-biology-enterprise-fund/

Dr. Andrew Muir, Partner of Midven, the manager of the Rainbow Seed Fund commented - "We are delighted by Equitable Law's assistance with the expansion of the fund by way of the creation of the new portfolio of the fund.  The fund has now trebled in size since Dan Johnson started to assist the Fund and we thank Dan (and his team) for their continued support to the fund".    
 

Christmas 2013 - Chosen Charity - ATLEU - Anti-Trafficking and Labour Exploitation Unit

As is our habitual practise, we will not be sending Christmas cards / greetings this year - but will instead be making a donation to our chosen charity and pro-bono supported organisation, the Anti-Trafficking and Labour Exploitation Unit - atleu.org.uk

ATLEU is a newly established charity providing legal representation to victims of trafficking and labour exploitation. ATLEU assists victims to obtain safety, recovery and redress against their persecutes.  ATLEU delivers a comprehensive and dedicated service to victims helping them find legal solutions to their complex problems.  This includes advising victims on their immigration status and assisting them to apply for asylum or other forms of lawful residence; securing appropriate and safe accommodation, financial support and treatment from local authorities, the Home Office or other statutory bodies; and obtaining compensation from their traffickers or the state.

Guide to Contract Negotiations With Investors - Early Stage Venture Capital Deals

Dear All,

Please feel free to review the annexed:-

http://www.entrepreneurhandbook.co.uk/guide-to-contract-negotiations-with-investors/

The text of which should be :-

Entrepreneurs - Contract Negotiations with Investors

Having found an investor proposing to invest in your business, your attention needs to turn to the documentation that you are likely to need to reflect your agreement.

Firstly – Make sure that you have a clear understanding of the outline terms of investment (prepare a non-legally binding ‘Heads’ or ‘Term(s) Sheet’ - that you both agree with).

At the very least, your investor is going to want to see that their ownership interest (in shares) is properly documented as issued in the investor’s name.  This (in itself) involves a certain amount of paperwork- although it is not unheard of for an investor to subscribe to shares merely on the basis of the broadly standard constitution of an English limited liability company (i.e. the Companies Act’s – ‘Model Articles of Association’).

http://www.companieshouse.gov.uk/about/modelArticles/modelArticles.shtml

However, if your investor is to hold a minority stake, and / or not be ‘hands-on’ (i.e. actively involved on a frequent basis) with the company in which they are investing, it is likely that they will seek some element of agreed investment documentation to protect their interests. 

As a founder of the business - you want their money, such that you may find yourself presented with a ‘take it or leave it’ proposition.

The worst thing you can do in such a situation - is simply accept the terms on offer, particularly if you are not to consider them in any detail (with the aim of seeking to know what you are agreeing to).

Budgeted Legal Review

The problem is that in early-stage / venture capital type investment transactions, the sums of money being invested are generally quite modest and do not leave much of a budget for legal advice on the proposed investment documentation.

Accordingly, an investor’s initial position is generally to resist the founders taking legal advice on investment documentation – largely because it is the investor’s money which directly or indirectly is likely to be paying the legal fees. 

However, as a founder you should seek to persuade the investor that such an attitude is counter-productive, and that it is much better for you to gain a full understanding of (and agree to) the detail of the investment documentation you are proposing entering into - if a sound on-going relationship is to be created between you.  

Lawyers (like many other in service industries) tend to base their charges upon the amount of time which they spend considering and advising upon matters that they are consulted in relation to.  Experienced lawyers should be able to agree with you an (estimated or) budgeted fee for work to be undertaken (in light of what interested parties consider to be sensible for the work). 

Having set your budget for legal review, make sure that you get the maximum value out of the legal advice you receive.  For example if your budget only buys a limited amount of time from your legal adviser, make sure that they take you through the documentation (on a ‘page turn’ basis) so that you fully understand the terms which you are being asked to agree to.  A good adviser should know and have seen the format of such documentation before, know what is reasonable market practice (and what is not), and know the issues which need to be explained to you.  If there are any commercial / legal terms which you have objection to, often the most effective way to resolve the issues is to discuss matters directly between the founder and the investor – with the hope that a compromise position can be found.

As founder you need to be aware that an investor has a range of legitimate protections that they will reasonably require in the documentation (e.g. that their likely minority position will not be abused by your continuing majority control of the company in which they are investing).

Certain other provisions might seem unfair to you at first glance, but with appropriate revisions and careful drafting, you may well be able to accept them.  Falling into this class of provisions might be the well-known "leaver provisions", whereby if a founder were to leave the company at some point in the future, your shares become capable of re-acquisition by the company etc.  The investor will want to know that you will continue to be actively involved in the business – thereby protecting their investment on an on-going basis.  If you cease to be involved in the business in the future, it is arguably fair that you should potentially receive the value which you have created to that point in time, but arguably not that you should be able to continue as a ‘sleeping partner’ in the business.

Having accepted that the investor may well have legitimate reasons for wanting appropriate documentation, interested parties should then aim for the documentation to be drafted and settled efficiently and cost effectively.  Legal documentation (in the writer's opinion) should generally be drafted on a basis of being fair and reasonable. 

Generally, the investor’s lawyers will prepare the documentation (although it is possible for the company to give instructions for the lawyers to prepare what is intended to be market practice documentation - which is intended to assist with the taking of investment, and which are designed to be sensible even-handed documents between the parties).

Generally, the investment documentation will comprise (i) articles of association and (ii) an agreement (often variously described by a combination of the words ‘investment’, ‘subscription’ and/or ‘shareholders’ agreement).

Articles of Association

Every company has articles of association – often comprising the Companies Act’s ‘Model Articles’ (with small amendments), which are generally adopted by default upon incorporation. 

Articles of association can be considered as akin to a ‘club constitution’ – legally comprising a binding agreement between the company and the shareholders from time to time. 

Such a document can be quite impenetrable to a layman – and largely for this reason, in certain early-stage investments, specifically drafted articles of association are not prepared. 

However, if new articles or revisions to the articles of being proposed, you should treat this document as the primary document which you first review. 

Lack of familiarity with articles often means that people choose not to read that document – and for this reason (and the reason that certain share-based rights are more easily enforced through the articles of association) – many of the more onerous provisions in investment arrangements are often included in the articles.

‘Subscription and Shareholders’ Agreement

The other document which is generally utilised as part of the investment arrangements is a separate written agreement – generally a much more accessible document (for those who deal with the same) – and prepared in the format of a private agreement between the founder and the investor (generally with the company also a party).

Model Documentation

The internet has assisted such arrangements in many ways, including the fact that early-stage venture capitalists – and others active in the market - now have easy access to basic documentation which is considered to be market standard.  One example of this is the early-stage venture capital documentation produced by the British Venture Capital Association (B VCA) and which is widely available on the internet : –

http://www.bvca.co.uk/assets/features/show/Modeldocumentsforearlystageinvestments

Before you enter into investment arrangements, it may be useful for you to try and review the articles and the investment agreement at the link above, so that you can understand the type of arrangements which you may be subject to.  Please note however that the documentation set out above is quite detailed and complicated, and there are a number of less accessible but nevertheless widely recognised documentation (often based upon the above documents) that lawyers can easily gain access to.  Use of standard (or recognised) documents greatly assists with a rapid and efficient investment, and hence - one drafting approach is to ensure that a particular set of model documentation is used in preparing drafts and then reviewed by lawyers (with the amendments proposed made to the standard documentation clearly show).  This removes a lot of time from the consideration process, so that the detail can be focused upon by those who review the documentation.

The above review only "scratches the surface" of the subject – but we hope that it gives you an understanding of the process and documentation you are likely to need to be subject to.  If you would like to discuss matters further, please do not hesitate to contact the writer so as to do so.

Dan.Johnson@EquitableLaw.com

Principal & Consultant Business Lawyer

(+44) 07788 537 187         (U.K. Mobile / Cellular Telephone)

Equitable Law is a London based (but nationally and internationally focused) boutique legal consultancy firm, providing the business law advice and assistance services of Mr. Dan Johnson.

To find out more, please visit :- EquitableLaw.com