As an entrepreneur, building your business is often your only focus. Product development, marketing, recruitment and cash-flow are key drivers. The legal issues often take a back seat. They can be sorted out later. By the time you have an offer on the table (always subject to due diligence), it can be too late to sort out these problems and the buyer will reduce the price because of them or even walk away from the deal.
Alternatively, working with a lawyer and accountant familiar with company sales, you could identify and deal with the problem areas before you begin marketing your company for sale. We set out below some of the typical corporate and commercial problems which company owners have presented to us.
- Resolving Shareholders’ loans or the share capital. It is common for Founders and investors to have agreed to adjust the share capital or to treat loans as part of the share capital or even to have oral agreements about what should happen on a sale, but not to have actually dealt with the legal issues around this. Often, there is no written record of what was agreed. Ignoring the proposed sale, this is dangerous for one or the other party (often both), but can create major tax problems at the point of sale. It is not necessarily free to implement these earlier oral agreements, from a tax perspective, even if everyone is agreed. Any shareholder dispute will decimate the price, or cause the buyer to walk away.
- Articles of Association and Shareholders’ Agreement. You may need to adopt new Articles of Association and, perhaps, a Shareholders’ Agreement, to address pre-emption rights in relation to the ordinary shares and “drag along”. These can avoid any shareholder simply selling their shares to third parties without first offering them to the existing shareholders and allow the majority to force minority shareholders to sell with everyone else (on the same terms). Founders are often surprised that minority shareholders can refuse to sell if there is no agreement in place. This means that they could hold you to ransom or simply cause the buyer to walk away (see “shareholder dispute” point above).
- Employee Shareholdings. You may wish to create an EMI scheme (or a series of agreements) to motivate employees to grow the business or have promised them a share of the proceeds on sale. If this is not dealt with at least two years before a sale, the tax consequences can be horrendous. You might think you can make good on your promises out of your taxed proceeds by making gifts (and you can), but the employees will almost certainly be taxed on those gifts at their highest marginal rate. Effectively, the net sum they receive is likely to have borne tax of (at least) 57%. This assumes your tax rate is 10% by reason of Entrepreneur’s Relief. Sorting things out early could reduce the total to only 10%.
- Data Protection. Have you registered the company with the Information Commissioner (Data Protection Act)? It is amazing how often young businesses have not done this and after the publicity around GDPR last year, there can be no excuse. Failure to register is the least of the problems in this area, the maximum fine for breach of the Act is now £20 million and if you are not registered, you are not compliant. Even if you do fully understand and comply with your obligations under the Act, any buyer will find it difficult to believe if you have not filled in the on-line form and paid the (very reasonable) registration fee.
- Bribery Act. You need to adopt a suitable policy on bribery and corruption (and provide training for all management, so that they know what the policy is). Failure to comply with the requirements of the Act can open the Board to criminal charges for the behaviour of employees and agents in an overseas subsidiary of another subsidiary (however many intervening companies there may be). Limited liability does not help you here and, if you have not dealt with this, a buyer will build in a large charge (reducing the price) to deal with compliance and the risk of fines.
- Prevention of criminal facilitation of tax evasion. As with the Bribery Act, the Criminal Finances Act 2017 introduced a positive obligation on Boards to create policies and procedures (including training) to prevent employees of the group (be they never so distant), from facilitating tax evasion and in the absence of appropriate policies, procedures and training, under this Act the Company can be criminally liable for the criminal behaviour of the employees and agents working for subsidiaries and is at risk of an unlimited fine. If policies and procedures are not in place, we can be sure that a potential buyer will build in a significant buffer to cover the potential liability and (as above) dealing with compliance.
- Standard Terms and Conditions. Consider adopting standard terms and conditions of business for customers and suppliers. There may be a need for some training or manuals on the basic law of contract for those using these. In the past you may have used some contracts “cobbled together” (we often hear) and we need to ensure that these were not unlawful copies (of someone else’s IP) or replace them with new, more appropriate, terms. Many businesses operate without standard terms which means that the contract is covered by the general law. You may set out basic issues in communications with the customer, but these are unlikely to cover issues of liability (is there any limit?), what happens if the customer does not pay on time, choice of law (if the customer is overseas) and many other issues.
- Intellectual Property. Is your intellectual property (such as copyright, trademarks and patents) properly protected? Are your trademarks registered? Do you own or have licences to use copyright material? Have you registered any patents or patent licences used in your business?
- The Statutory Registers. Sometimes known as the company books, the Companies Act requires each company to keep a register of Directors, Secretaries, Members and other matters at its registered office or to notify Companies House if kept elsewhere. Failure to keep these registers is a criminal offence punishable by a fine and a daily default fine. They are also the company equivalent of the Land Registry for land. So, in theory, are the definitive ownership register. Companies House is not where ownership is recorded. It is often the case that there are no company books or, if they exist, they are very out of date and the history recorded may reveal problems (such as a purchase of own shares which did not follow corporate procedures and was void). Ensuring that the books are up to date and in order and do not show any such problems can avoid major problems on a sale. If there are any subsidiaries are they all properly registered, with completed company books and are all registrations at Companies House up to date? Subsidiaries (especially name protection companies) are often registered in the wrong names (directors or shareholders of the main company) and can have all of the problems mentioned above.
- Legacy Agreements. Are there any old option agreements or rights of first refusal or similar agreements (overage agreements on land) affecting the company? You may have entered into contracts at the dawn of the company’s existence which you might think are no longer relevant, but the counterparty (especially when they hear that you are contemplating a sale) may disagree. Any such old documents or even oral contracts need to be addressed before they come out of the woodwork during the sale process. Problems with the ownership of the company or its assets might be able to be addressed in a number of ways. Not having an answer to the problem when a buyer asks what the position is, is a sure way (at least) to a reduction in price.
- Non-arm’s length deals. Are there any contracts with related parties of the directors or shareholders of the company which are not on fully commercial terms? These need to be put in writing (if not already) and made into commercial contracts capable of being enforced after the sale. It is often the case that property is occupied by a company, but owned by one or more of the shareholders without a formal lease being in place or that intellectual property is owned by the founders, but informally licenced to the company. Depending upon the nature of the asset or service, differing solutions may be required to render the company saleable. A formal lease to occupy property may be fine, but a buyer might require ownership of key intellectual property (at least in the relevant jurisdiction) in order to proceed.
- Asset Register. Do you have an up to date asset register of all assets owned in the business? This would usually need to be produced to a potential buyer.
- Pensions. Is there any SIPP or pension scheme associated with the company? If the company is operating a pension scheme (especially a defined benefit scheme) then we would need to consider that from the point of view of a potential buyer. You might need to convert the scheme into a defined contribution or a personal pension, so as to take responsibility for it out of the company.
- Competition Law. Is the company party to any agreement to restrict competition? Have you agreed with any competitors not to open shops within a certain distance of one another or fixed prices (either within a specific area or by reference to a particular supplier or group of suppliers)? While some agreements which restrict competition can be lawful, others can attract very large fines and could be void, so seriously affecting the company’s business.
- Succession planning (at a business level). What are you doing about training future managers? At this point we are beginning to encroach on employment law issues, which is a whole other article.