Getting ready for the sale process
What do you need to consider?
The key to moving forward efficiently to the completion of a sale is having your house in order. Below are some key issues to consider.
Your management team and professional advisors
The quality of the management team is crucial, and the buyer will, to a great extent, see the transaction as an investment in the team staying on, so you will need to choose your team carefully from the start. You'll need to ensure that, in addition to all-round strength, the individual members of the team have the different capabilities and attributes required in the key business areas and that each justifies their inclusion on merit.
The typical positions that need addressing, depending on the specific business, include:
- Chief Executive Officer - a leader with strategic vision, ambition, drive, and clarity is important in uniting the team and driving the business forward.
- Chief Financial Officer – will need to demonstrate intimate knowledge of all accounting information, be competent in forecasting and budgeting, and understand how changes in the business environment impact results and budgets.
- Chief Technology Officer – will require the vision and business acumen to align technology-related decisions with the company's strategic objectives.
- Chief Operating Officer – needs a clear and practical understanding of the business, people, and operations, including legal matters, as well as being able to control unit economics, production costs, and capital expenditure.
- Sales/Business Development Director – a key driver of revenues and potential new business who is results-driven and capable of motivating others.
Getting the right management team on board is crucial, but so is making sure they are rewarded, motivated, and retained. Their remuneration and incentive structure, whether options, equity, or bonuses, should be carefully considered. Equally important is making sure the business is protected with appropriate service contracts for key management, including provisions around IP protection and to prevent management from competing if they leave the business.
Choosing the right professional advisors (including accountants, corporate finance advisors, W&I brokers, etc) is also key to the success of a transaction, and the management team might also need their own advisors. We can help you get the right ones in place.
Preparing the business
During the sales process, the buyer will want to learn as much as possible about you, your team, the company, its products, and your business plan (and perhaps the wider market). As part of this due diligence, a buyer will require those in the know, usually the management team, to disclose information so that they can make an informed assessment of the value and potential of the company. Legal due diligence will form only a part of this exercise.
The financial and tax due diligence will also be key, and there will also typically (depending on the nature of your business) be commercial, IP, insurance, technology, and ESG due diligence exercises undertaken at the same time. Problems, or even potential problems, could lead to a reduction in the value of your business or even the transaction going off the rails completely.
The disclosure process can be a difficult, stressful, and time-consuming exercise, but you can avoid a lot of headaches if you and your team are prepared for it and problems are dealt with in advance. One of the best ways to prepare is for your own lawyers to undertake due diligence before the buyer (a process called 'vendor due diligence') so that issues can be identified and ironed out where possible and otherwise presented in the most favourable light to the buyer. Even if the sale does not proceed, this can be helpful to the business going forward.
At the same time, you also need to dedicate sufficient time to running the business. It's important that performance continues to be in line with expectations during the sales process to ensure you receive the best possible valuation.
Areas to focus on to smooth the process of the transaction include:
Commercial relationships
Formally documenting the terms of key commercial relationships, such as those with suppliers, customers, agents, and distributors, will give potential buyers clarity and confidence in what they are investing in and underpin the business plan. Having complete and signed copies of those terms is important, and ideally, these would be prepared or reviewed by the company's lawyers.
Key contracts
You should review and appraise the contractual basis of strategically important financial commitments, supplier arrangements, and revenue-generating relationships (eg property and equipment leases and customer contracts) so as to understand the degree of flexibility available to change strategy or manage costs, the reliability of revenue streams, and the effect the transaction may have on them.
In particular, you should check if these contracts can be terminated or amended, require notification, or permit your counterparty a right of first offer or refusal if a buyer takes control of the company (a 'change of control' clause). If there is a change of control clause, this may require careful handling depending on the counterparty and importance of the contract. Understanding what's out there and considering how best to deal with it (before the buyer unearths it) can help to avoid delay and disruption.
Intellectual property, know-how, trade secrets, and brands
Putting in place measures to manage and protect these assets from infringement or onward disclosure is essential. Buyers will want certainty that the company either owns or has the right to use any IP relevant to the business and will expect a company to be able to articulate clearly:
- Who was involved in the development of your IP and the contractual conditions under which it was developed. Defective IP ownership provisions almost always need fixing before closing a sale, so undertaking a review in advance will help smooth the process (and avoid a situation where the deal is being held up or jeopardised by one or two missing signatures from lost or intransigent former employees).
- What open source software (OSS) or copyleft components are contained in, distributed with, or used in the development of your IP and the terms governing their use. Certain OSS licences require, as a condition of use, that changes to the code are made available free of charge for use by others in a collaborative manner. Increasingly, buyers are using Black Duck scans or equivalents to identify OSS in software code, which often means a remediation process is needed. A comprehensive register of all OSS used by the business should be kept.
- How the company manages infringement risk. In particular, has the company properly registered all of its registrable IP (trade marks, patents, and design rights), and does it have in place a process for monitoring, identifying, and resolving possible infringements? Where possible IP infringement has been identified, this should be adequately resolved by the business ahead of any sale. For unregistrable IP (eg trade secrets), can the company show appropriate procedures to prevent its dissemination?
Disputes
Actual and potential disputes and investigations (whether litigation, arbitration, or regulatory investigation or intervention) should be monitored, assessed, and managed to minimise their impact on the value of the business. While you might not be able to avoid or resolve a dispute before the sale process begins, it's important to conduct a proper assessment of relevant risks and to maintain clear records of decision-making processes. Showing the risks have been properly considered and addressed and being able to explain and evidence the current position, and that advice has been sought where appropriate, will be important to getting a buyer comfortable.
You should also consider key compliance-related risks in relation to the 'failure to prevent' offences (ie in relation to bribery, tax evasion, and economic crime) and ensure that adequate and reasonable procedures are in place.
Employment and immigration
You should maintain good employee records, such as by formally documenting employment and service contracts and regularly updating the company's policies and employee handbook. In particular, disciplinary and grievance policies should be implemented and employee relations issues dealt with in accordance with these, with detailed records of any claims kept to enable a buyer to assess potential liabilities.
An area of particular focus in a buyer's due diligence will be around the classification of independent contractors and self-employed workers. Misclassification presents a number of risks, including the individual having employment status for tax or employment purposes, so it's important that documentation and working practices are put in place to reflect the correct status of such individuals. You should also ensure compliance with the off-payroll working rules where independent contractors are engaged through personal service companies.
Regular overtime, commission and bonus pay calculations should be factored into holiday pay (both during employment and payment of accrued but unused holiday on termination). Failure to do so can create an exposure to claims for backpay dating back for two years, which can be a concern for buyers. Holiday pay liabilities are also often excluded from cover under W&I insurance policies.
From an immigration perspective, employers are required to check that UK-based employees have the right to work in the UK in advance of the commencement of their employment. Buyers will want to see that you've carried out these checks, so make sure your records are complete.
Options
Where tax-favoured (eg EMI or CSOP) options have been granted and will be exercised in connection with the sale, buyers will want comfort that the company has followed HMRC rules and guidance in granting such options and operating the scheme. Any failures in this respect can affect, or result in the loss of, capital gains tax treatment and/or other tax-favourable treatment for optionholders, with their option exercises instead being subject to income tax and national insurance contributions on the full gain. Buyers pay particular attention to this because it will likely give rise to a requirement for the company to withhold those amounts (with a risk of penalties or interest for failing to do so) and a corresponding national insurance liability for the company.
Issues to consider include:
- A review of historical grants – do you have copies of appropriate HMRC valuations, fully executed option agreements, and, where required, screenshots evidencing timely and complete HMRC notifications and filings?
- An assessment of previous option exercises – has the company used a general discretion to allow the early exercise of options (eg to facilitate a secondary sale on a funding round)? Was the exercise in line with the rules, and were Section 431 elections signed by UK tax-resident employees no later than 14 days from the acquisition of the shares?
- An analysis of the scheme rules and option terms – can unvested options be accelerated in connection with the sale without jeopardising their tax-favoured treatment? Would existing shareholders be supportive of that? Consider whether that presents any issues with what has been promised to optionholders.