FAQ on Company Acquisitions
Below are some FAQs relating to the acquisition of a private limited company in England and Wales. There are a number of complexities and nuances which can arise, particularly on larger transactions but the information below, whilst relating essentially to a more straightforward transaction, refers to principles which apply to all transactions. Needless to say the information given is of a general nature and you should not act or refrain from acting in reliance on that information without specialist legal advice on the particular circumstances.
Q: Should we acquire the shares or just the assets of the target company?
A: There are pros and cons for either method but as with many aspects of the acquisition of a business this tends to be tax driven. Usually the shareholders of the target company wish to dispose of their shares in order to avoid a potential double tax charge on the sale of assets. From the buyer's perspective there are sometimes tax losses in the target company which can be utilised and there are issues such as stamp duty which could be significant if the assets include a land or buildings with substantial value. However, one major consideration is that the buyer would normally be taking on all the liabilities of the company, which are not always obvious, and it is essential that a very thorough due diligence exercise be undertaken (see below). This is why it can often be attractive to a buyer to try to acquire certain assets and try to leave behind the liabilities in the company itself but even here there may be some liabilities which will pass in any event, in particular, if the essence of the business is being acquired the TUPE regulations will apply in respect of employees.
Q: How do we calculate the price?
A: This is part science and part art. There are various accounting methods of valuing shares but inevitably you will have the financial position of the company assessed by your accountant. There are intangibles such as the goodwill of the company which may be more difficult to value and as with most other transactions the matter ultimately comes down as to how much you are willing to pay and how much the seller is willing to accept. There can also be a certain element of 'earn out' where the final amount payable to the seller depends on the future performance of the company.
Q: What if figures cannot be finalised until after the intended completion date?
A: It is not uncommon for there to be adjustments to the price depending on the financial position of the target company on the completion date. This may be on the basis of the value of a single asset such as stock which will need to be valued or it could be of a more general nature with an accountant certifying the financial position of a company once all relevant information is to hand. The share sale agreement will specify a formula by which any adjustments to the price are to be calculated.
Q: How do we pay for the company?
A: There are three basic means of payment – shares, loan capital and cash.
Shares - Whilst there is nothing to prevent an unlisted company from issuing shares for an acquisition, in practice sellers are not normally willing to accept such shares as there is no ready market for them. Also, the buyers may not wish to have their controlling position in the company diluted. Therefore, the issue of shares as payment for the acquisition of a private company is uncommon.
Loan notes - A loan by the seller or some other deferred payment is often included as an alternative to cash on a private company sale. From the buyer's perspective it has the advantage of deferring payment without absorbing any bank credit facilities (although it might still be relevant for borrowing limits) particularly if the rate of interest is lower than the rate which would otherwise be payable on a bank loan. The terms of any loan such as the events of default and dates for repayment need to be considered carefully.
Cash - This is the most commonly used consideration. Care needs to be taken that there is no breach of your borrowing limits or other covenants.
Q: Can we use company funds or assets to fund the purchase?
A: From 1 October 2008, the general rule that it is illegal for a company to give financial assistance for the purchase of its own shares no longer applies to private limited companies. However, directors will still need to consider whether a financial assistance:-
(i) is “likely to promote the success of the company for the benefit of its members”;
(ii) will involve an unlawful reduction of the company’s capital; or
(iii) is otherwise vulnerable to challenge as a transaction at an undervalue under the insolvency legislation.
Q: What is meant by due diligence?
A: This is a term commonly used to describe the investigation into the affairs of the target company. Whilst this is primarily a financial and legal investigation, it may also be a business one e.g. checking out the quality of the company's customer book and also a physical one on the condition of assets such as buildings, plant and machinery. The investigation will be wide ranging across the assets and liabilities of the company, the title to property and equipment, taxation issues, potential claims and the employees. As to the extent of the investigation this will depend on the circumstances of the transaction, for example, on a management buyout the buyers may not feel the need to carry out such a thorough investigation because of their familiarity with the company. Nevertheless, it is strongly recommended that any investigation be as thorough as possible to unearth those skeletons which will often be lurking. Whilst it may be tempting to take a short cut on due diligence, this is generally a false economy.
Q: Is there any way of protecting ourselves against future problems?
A: It is usual to require warranties which are promises given by the seller on various matters relating to the company's position. These may be simple ones such as representing that the company has no actual or threatened litigation against it, to complex ones relating to the company's tax affairs. The warranties are often qualified by reference to a disclosure letter which is a statement signed by the seller setting out the material information disclosed to the buyer. If within the warranty period a liability arises which is covered by a warranty but was not disclosed by the seller then a claim will arise. Warranty claims are often limited by both time and amount. To give more weight to the warranties it is recommended that a buyer negotiate that part of the sale price be retained in an escrow account to meet any claim. As the seller will wish to have the retention monies released to them this will also help in ensuring that the seller co-operates during any handover period.
Q: What happens to the employees?
A: If it is the shares of the company which are being acquired, the employer, which is the company, will not change and the employees will continue to be employed. If assets are acquired then if there is a transfer of an “economic entity” the TUPE regulations will apply and the employment contracts of the relevant employees will be automatically transferred to you. It is possible that employees can be made redundant but only on economic, technical or organisational grounds but if this is envisaged great care needs to be taken particularly as any dismissal purely by reason of a transfer of ownership is automatically unfair. As part of the due diligence exercise investigation should be carried out into the position of staff and for example, whether key staff will remain after the takeover and whether there any existing or potential claims. You would probably also wish to make sure that the employees have suitable contracts with the relevant restrictive covenants where appropriate. You might want to factor the costs of potential liabilities including redundancies into the price.
Q: How do we aid the smooth transfer of control of the company's business?
A: Apart from the usual business skills in making sure that key staff and customers are treated correctly you might also want to consider continuing to employ the seller on the basis of a consultancy/service contract, assuming that they have been involved in the day to day management of the business. These contracts are normally on a fixed term basis although it is not uncommon for a seller to get itchy feet and look to leave before the contract expires, but this may not be a problem once the new management regime of the company has bedded in. It is important to note that a seller as an employee of the company would have usual employment rights.
Q: Can we prevent the seller from competing with the company?
A: Yes, provided that any restriction imposed on them is reasonable to protect the company's interest. It is usual to include restrictive covenants in the share sale agreement and they would be defined by reference to time, geographical area and type of business, the extent of which depends on the factors such as the type of company, the nature of its operations and the area which it serves.
Q: What if there are a number of buyers acting together by way of a joint venture?
A: It is usual for there to be a shareholders/joint venture agreement to regulate relevant matters between the buyers/investors. As to what is covered will depend upon the particular circumstances but typically would include matters relating to the provision of funding (by way of capital or loan or both) share allocations and whether there are different types of share carrying different rights. If there are minority shareholders, provisions which prevent the majority shareholders from abusing their dominant position and if there is a sleeping or venture capitalist type partner, requirements for the provision of information and for board representation. It is also common for there to be pre-emption rights giving other shareholders the right of first refusal should one of them wish to sell their shares, and to restrict circumstances under which the shares can be sold to third parties.
Q: What tax issues arise?
A: As mentioned in the answer to the first question company acquisitions are often tax driven. It is essential that the tax implications are considered at an early stage. The issues are too complex to cover here in detail and very much depend on the particular circumstances relating to the company and to the parties, for example, whether the seller or buyer are resident for UK tax purposes. Aspects to be looked at include whether shares or assets are being acquired, what reliefs are available to the seller, VAT, stamp duty, CGT and corporation tax (please see table below). From your perspective as a purchaser your general aim would be to ensure that the company is in as good a tax position as possible and that any tax losses or benefits are used efficiently. It may be necessary for tax clearances to be obtained from the Inland Revenue. You would normally require a tax covenant from the seller giving you an indemnity against undisclosed tax liabilities.
|ASSET PURCHASE||SHARE PURCHASE|
|Stamp Duty||Payable at a rate of up to 4% on the transfer of UK land and buildings, depending on their value. Other assets typically transferred are not subject to stamp duty.||Payable at the rate of 0.5% (rounded up to the nearest £5) on the transfer of shares if purchase price exceeds £1,000.|
|Double tax charge||For corporate sellers, tax will often be payable twice: firstly, by the seller on the disposal of the assets, and secondly, by its shareholders on the extraction of the sale proceeds.||The shareholders of the target company will receive the proceeds of sale directly, thus avoiding a potential double tax charge.|
|Tax deduction for cost of assets||Tax deductions will normally be available in respect of the cost of goodwill and stock and in respect of the cost of plant and machinery (capital allowances).||Not available.|
|Assets sold at a loss||If assets are sold at a loss for tax purposes, the seller may be able to use these losses to reduce tax payable by it.||Not available.|
|Trading losses||Not available, although a pre-sale hive down of the assets to a company could be considered.||Trading losses in the target company will generally be available to be carried forward provided there is not a major change in the nature or conduct of the trade.|
|Acquisition cost||The purchaser obtains the assets at current market-value. On a subsequent sale of the assets the profit will be calculated only by reference to the increase in value following acquisition.||The assets remain with the target company and continue to retain their original acquisition cost.|
|Substantial shareholdings exemption for corporate sellers||Not available.||A gain on a share sale is exempt from corporation tax where, throughout a continuous period of not less than 12 months beginning not more than two years before the sale, a corporate seller holds at least a 10% interest in the target company.|
|VAT||Transfers of assets that comprise a business (or part of a business) being transferred as a going concern are not subject to VAT. Care should be taken when 'cherry-picking' assets, as the transfer may thus not qualify.||Share sales are generally exempt supplies for VAT purposes.|