Selling a business? Make sure you clear out any skeletons first

The importance of preparing for buyer due diligence when you plan to sell your business

The importance of preparing for buyer due diligence when you plan to sell your business
The importance of preparing for buyer due diligence when you plan to sell your business

Preparation is the key to success with most things in life and is particularly important when you are trying to attract a buyer for your business. This is because any potential acquirer will almost certainly want to carry out pre-purchase checks to ensure that your organisation is legally and financially sound, and it is not saddled with unacceptable debt or unquantifiable liabilities.

The process of carrying out these checks is known as buyer due diligence and it is the outcome of this process that will usually determine whether or not the proposed purchase of your business will proceed. It will also influence the final price that the buyer is willing to pay.

Given its pivotal importance, it is crucial that buyer due diligence is handled with care and that wherever possible you appoint an experienced solicitor in advance of any sale being agreed. They can help you to get ready for the process and will help to head off any potential problems.

Regrettably, many business owners delay consulting a solicitor until the terms of a proposed sale have already been agreed and the due diligence process is about to begin. This can be a false economy, as there may be issues within the business which concern the buyer and which lead them to reduce their offer, some or all of which could have been addressed had a lawyer been consulted just that little bit earlier.

Why it pays to seek legal advice early

A lawyer who is used to dealing with business sales will have a good idea of the sort of enquiries that a buyer is likely to want to make and the issues that could set alarm bells ringing, provide a negotiating point, or even put your proposed sale at risk of collapse.

By seeking legal advice at an early stage, you can tap into this insight and use it to your advantage. You can prepare for the due diligence process, for example by:

  • Compiling the information and documents that you are likely to need, so that as soon as a request from the buyer is received you will have everything;
  • Identifying whether there are any aspects of your business that could be a cause for concern and, if so, taking remedial steps to address them before due diligence;
  • Determining the parameters of any warranties or indemnities that you are prepared to give in respect of risks which cannot reasonably be mitigated; and
  • Drawing up a confidentiality agreement which will enable you to ensure that the buyer and their advisors keep any commercially sensitive information secure and only use it for the purpose of determining whether or not the purchase should proceed.

Eliminating potential risk factors

Of particular importance is the advance warning that a lawyer can give you about potential problems within your business, which might lead to a prospective deal being scuppered or a previously agreed sale price being substantially reduced.

For example, it may be that not everyone working within your business has a written contract of employment, or that not all senior personnel are bound by a restrictive covenant preventing them from working for a competitor for a set time after their employment ends. This may be off-putting to a potential purchaser who will be concerned about continuity of key personnel and the risk of employment disputes which would be difficult and costly to resolve in the absence of appropriate contracts.

A lawyer who is instructed before due diligence takes place could help you to sidestep this issue, by supporting you to consult with employees and senior personnel to ensure that the required documentation is put in place and on mutually acceptable terms.

Likewise, a lawyer could also help you to address:

  • Poorly drafted contracts with customers and suppliers that fail to clearly set out your respective rights and obligations;
  • Poor internal credit control measures which mean that you are carrying an unnecessarily high amount of debt; or
  • A lack of appropriate risk management controls which leave you unacceptably exposed to the threat of regulatory action or which heighten the likelihood of you being successfully sued.

Areas of your business that are likely to be scrutinised

While every business sale is different, the key issues that most buyers will want to investigate and on which early legal input will usually be required include:

  • How your business is structured and who owns any property or assets that you are proposing to sell, and if there are any constitutional or operational documents of which the buyer ought to be aware;
  • Whether any bricks and mortar property are held on a freehold or leasehold basis, the ease with which such property can be transferred into the buyer’s name and how you propose to deal with any mortgages or secured loans;
  • Whether any plant or machinery is owned or subject to lease or hire purchase;
  • The extent of your intellectual property rights and the steps you have taken to ensure that these are adequately protected against unlawful infringement, i.e., via the registration of appropriate trade marks or patents, or by the assertion of copyright and design rights;
  • The details of all supplier and customer contracts that you have and the ease with which these can seamlessly be transferred to the buyer should the sale proceed;
  • The number of employees you have, the terms on which they are employed and whether they all have written, up-to-date and signed employment contracts;
  • The details of any staff policies, procedures, or handbooks that you have in place;
  • The nature and scope of your employee and directors’ pension scheme(s);
  • Whether your business books and records are up to date, including any statutory books or records that you are required to keep and maintain;
  • Whether your accounts are in order or reveal something that might be of concern, such as a lack of adequate provision for the repayment of a director’s loan or for the settlement of any known or anticipated corporate liabilities;
  • Ensuring your accounts are up to date and, if appropriate, filed with Companies House;
  • Whether your tax affairs are in order and you are up to date with any payments due to HMRC, for example in respect of VAT, PAYE, or corporation tax;
  • Confirmation you have all authorisations and regulatory approvals in place that are needed in order for you to operate legally within your chosen sector or industry; and
  • Whether you have appropriate insurance, e.g., to cover buildings and contents, business interruption and the risk of you being sued by employees, customers, suppliers, or members of the public.

Your buyer will also want to investigate and understand the nature of any actual or prospective litigation risks that you may face. For example, as a result of a customer threatening to sue you for breach of contract, a former employee claiming that they have been unfairly dismissed, a competitor alleging the unlawful poaching of staff or a regulator giving notice of their intention to launch an investigation which could result in you being fined or having an important permission or authorisation revoked.

Contact us

For further information and advice on the sale or purchase of a business, and specifically on due diligence related issues, please contact Olivia Chalmers in our Corporate Commercial Team on 01733 882800 or email info@hcsolicitors.co.uk.

Olivia Chalmers LLB, Associate

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This article has been prepared for general interest and information purposes only; it does not constitute legal advice and should not be relied on as such. While all possible care has been taken in the preparation of this article, no responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by the firm or the authors.