What do corporate lawyers do when buying a company?
In this issue of Strictly Boardroom we look at the role of corporate lawyers in a company purchase where the lawyers are acting for you, the buyer.
It assumes that the individual shareholders selling the company (the sellers) have accepted your indicative offer for the entire issued share capital of their UK private limited company. Your lawyers have given you a fee quote for handling the transaction and you’d like to know what they’ll be doing for you. Whilst every deal is different, their explanation should go something like this.
Taking time to understand your reasons and objectives – Corporate lawyers broadly fall into two camps – documenters and advisers. The first camp will provide an execution-only service and document exactly what you ask them to – which may, of course, be all you want. The second camp will endeavour to understand, in detail, your reasons and objectives for making the acquisition (and, ideally, the sellers reasons and objectives in selling to you). In the heat of the deal, this understanding will make them much better able to advise you on the judgment calls you will be required to make along the way. Good documenters need technical skill. Good advisers need technical skill and many years of experience.
Checking the engagement letters of your advisers – The engagement letters of your professional advisers (accounting, corporate finance, due diligence and legal) are important legal contracts. Legal advice on them should cover the scope of the work being undertaken, the fees being charged, the timing of payment, any proposed limitations of liability and what is to happen if the deal does not complete.
Negotiating confidentiality agreements – Although confidentiality agreements tend to be more for the protection of disclosing sellers than for receiving buyers, the wording should be of real concern to you, particularly in qualifying the time and scope of your duty of confidentiality and in keeping your identity and interest confidential.
Providing input on your proposed heads of terms – The proposed heads of terms (effectively your offer letter or term sheet) is an important document in any acquisition as it kicks off the transaction process and sets out your position on the financial and legal structure of the deal. It should re-confirm that the transaction is a share purchase (not an asset purchase) and set out the price being offered and whether any part of it is to be deferred or linked to future earnings. It should detail any conditions that must be met prior to completion, a suggested transaction timetable and your requirements for an exclusivity period. Exclusivity periods are designed to give you some assurance that you can invest time and money with advisers and in conducting due diligence without the threat of the deal being pulled from under your feet at any moment. Once both parties have had a chance to take advice and sign off the heads of terms the deal is properly under way. Heads of terms are generally not legally binding (except in respect of confidentiality and exclusivity) but they can carry significant weight in the formal negotiations and so should not be rushed.
Managing the legal due diligence process – Generally, the first draft of the share purchase agreement is prepared by your lawyers and sent to the sellers’ lawyers for approval. To enable the agreement to be prepared, your lawyers will send the sellers’ lawyers a detailed list of questions about the business. The aim of this ‘enquiry memorandum’ is to get a proper understanding of the business and to help formulate a due diligence plan. The enquiry memorandum asks for full details of all the assets and liabilities of the target company, including information about employees, disputes, litigation, properties, contracts and intellectual property rights (IPR). It is your lawyers job to work with you to make sure that the right questions are asked, to scrutinise and challenge the answers given and then to include appropriate clauses, conditions, warranties and indemnities in the draft agreement. The objective is to make sure, as far as you ever can, that there are no hidden problems likely to prevent you getting the deal you have bargained for. To avoid exchanging large volumes of documentation and data by email or post, sellers usually establish an online dealroom where documentation is posted in a secure password-protected environment accessible only by you and your professional advisers. Running alongside this legal due diligence process, you will no doubt want to conduct other due diligence on the target company, including a review of financial and tax data and processes, pre-authorised discussions with staff and customers, auditing IT and other systems and verifying assets that you consider important to the deal.
Drafting and negotiating the share purchase agreement – The share purchase agreement is the main transaction document and it is the job of your lawyers to draft it so that it reflects the agreed heads of terms and protects your position before sending it to the sellers’ lawyers for approval. For example, they will include provisions to restrict the sellers’ activities following the acquisition to protect and preserve the goodwill of the company’s business. They will also include appropriate warranties (contractual promises) and appropriate indemnities (promises to reimburse) from the sellers. Warranties aim to protect you from false statements made by the sellers which result in you suffering material loss, by giving you a right to bring a claim for breach of warranty to recover such loss. So, for example, if a warranty states that the company has validly exercised the break clause in one of the company’s factory leases and this turns out to be incorrect (and the lease is still an ongoing liability of the company) this may well have affected your decision to buy the company or, at least, the price you would have been prepared to pay. A claim for breach of this warranty could be brought against the sellers and, if successful, entitle you to compensation for your loss. Indemnities differ from warranties and are designed to protect you against a known risk that you refuse to accept and which the sellers are prepared to cover if the risk subsequently materialises. Much of the negotiation of the share purchase agreement revolves around the nature and form of these warranties and indemnities and any limitations as to when and how claims can be brought. The final form of the agreement should reflect the bargaining strength of the parties but, more often than not, it will reflect how skilfully the lawyers play their client’s hands. Warranty and indemnity insurance can play a role in unlocking transactions where the parties have reached an impasse in relation to these negotiations.
Reviewing the sellers’ disclosure letter – Another key transaction document is the sellers’ disclosure letter. This letter is the sellers’ opportunity to disclose to you any issues relating to a specific warranty that could cause the sellers to be in breach of that warranty. As you become aware of each disclosed issue, you will have a number of options. You could take the disclosed issue on the chin (and go ahead regardless) or seek a specific indemnity from the sellers in relation to it or request a retention from the price (until it is resolved) or knock something off the price now to cover the risk. The job of your lawyers is to help you determine if the disclosed issue is a real and material risk and, if so, how best to deal with it in the negotiations. The approach to each disclosure will be determined by the value of the risk to you and how material the issue is to your decision to buy.
Reviewing and approving the funding documentation – Few buyers can fund the purchase of a company out of cash reserves and most need some form of external funding. This may come partly from the sellers in the form of deferred consideration and, if so, loan notes for this will need be to negotiated. Beyond this, most external funding tends to be a mix of private equity, bank loans and asset-based lending. Private equity will be the subject of our next article so we’ll assume it is not involved here. Having worked with your financial advisers to line up the funding required for the acquisition and the ongoing working capital, your lawyers will review and advise on the documentation to ensure it does not impose any unusually onerous or unreasonable obligations on you or your directors and shareholders. If several different funders are involved, an inter-creditor agreement may be needed to cater for the priority which the funders have over each other. Finally, if the target company has loan facilities in place, the parties will need to decide if they are to continue post-acquisition or be repaid on or before completion.
Dealing with pre-completion consents, documentation and procedures – Completion of the purchase of the company may be dependent on the parties securing consents from banks, regulators, other authorities and potentially certain customers and suppliers. New insurance arrangements may need to be put in place, internal consultations will need to have been considered and any required HMRC tax clearances secured. As well as the share purchase agreement and disclosure letter, there will be other ancillary documents to finalise such as stock transfer forms, indemnities for lost share certificates, shareholder resolutions and minutes, board resolutions and minutes, resignations, settlement agreements, service agreements, powers of attorney, deeds of release, internal and external deal announcements, shared IPR licences, Companies House filings, retention arrangements, completion accounts procedures and completion statements. Your lawyers will work closely with you and the other parties to ensure all ducks are in a row to enable completion to take place.
Handling the completion process – And so, completion day arrives and all parties assemble, with their advisers, to execute the documentation, complete the transaction, transfer the completion funds and deal with the practicalities required for a smooth and effective transfer of ownership and control. It can be a long and tiring day with lots of waiting around as last minute issues are ironed out and documents have a final check before signing. So make sure you get a good night’s sleep beforehand and breakfast like royalty.
For the sellers, this may be the end of their long journey. For you, of course, the fun is only just beginning.