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The Legal Side to Selling Your Business - Due Diligence Process

View profile for Christopher Buck
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Recently I co-presented a workshop with Colin Howe of Hillier Hopkins.

I handled the legal part of the workshop where we spoke to a number of business owners – keen to understand how to value their businesses and know what is involved in selling a business.

For my part, I explained what happens from a legal perspective once a seller has decided to sell; has obtained a valuation along the lines discussed by Colin and has found a buyer willing to pay the asking price. (Colin has written a guest post for us based on the insights he shared in that session – read more here.) In this post I share what I shared with the attendees on the day…

What is the Due Diligence that is carried out in a sale of a business?

“Due Diligence”, from a legal perspective, is the process by which a buyer investigates what they are buying by making a series of enquiries of the seller in order to support the value they have been asked to pay and to find out if there are any matters which should be used as a platform to negotiate the price.

Due diligence can be seen by knowledgeable buyers as a key part of any transaction.  However, there is a certain amount of value in business owners considering the aspects that are usually covered - because this helps them protect and build value in both the short and long term.

How important is planning?

My view, based on my experiences as a commercial legal advisor, is that planning can serve to make the sale process run smoothly and avoid price negotiations; thereby achieving a maximum return on the seller’s time and investment.  In some instances, planning can also provide interim benefits leading up to an exit.

What are the elements I would suggest a seller focuses on in planning his/her sale?

The following aspects are what I would suggest to a seller in helping him/her to prepare for the sale process:

1.  Contracts

In the first instance, my advice would be to put contracts in place. This way you are turning any informal deals into formal written contracts, on reasonable terms.

Interim benefits:

(a)   By putting (for example) terms for clients or suppliers in place this can assist internal processes such as credit control since having terms in place affords an opportunity to be more robust in recovering monies from bad payers.

(b)   For longer term supply or purchasing projects, attempt to negotiate suitable terms with legal advice and avoid agreeing onerous terms.  This is because buyers will be wary of such terms because they are likely to inherit these and the target’s position under them.

(c)   With standard terms of supply or purchase - put them in place and train sales and purchasing staff on incorporation to win what us lawyers call the “battle of the forms”. (I say this because you can have well drafted terms but they will mean little if they are not properly incorporated into a contractual relationship.)

Notes: The “battle of the forms” is a common situation which often occurs during the negotiation of terms between businesses, each of which wants its own standard terms and conditions to be incorporated into the contract and which they seek to achieve by printing their terms on documents passing between the parties. 
 
In practice, this often means that the last set of terms despatched before acceptance or performance – the last shot fired so to speak – will prevail.

2.   Appointment of agents and distributors

An agent is a person who negotiates or concludes a contract between a business and a customer in return for commission and, whilst there can by many advantages to engaging them (including using their local knowledge), a buyer will be wary of inheriting exposure to claims in respect of agents.

In respect of claims a buyer might inherit, the Commercial Agents (Council Directive) Regulations give agents the right to compensation when their appointment is terminated or when they reach a suitable retirement age (which is 65).  Whilst it is not legally permissible to exclude this right, with legal advice exposure to such claims can be mitigated.

A distributor is a person who buys goods on their own account from a supplier for resale to customers.  In this scenario, there is no contract between the supplier and a customer as the involvement of the distributor means there are different levels in the supply chain.  This means that United Kingdom and European competition law can be relevant.

Competition law impacts upon what terms in a distribution agreement are enforceable and the inclusion of certain blacklisted terms (which can include certain pricing provisions) can potentially render an entire agreement void and unenforceable.

A buyer will be wary of inheriting breaches of legal requirements such as these which make the terms of the agreements it will inherit unenforceable; so it can be important to get things right.

3.   Litigation

In respect of litigation, the uncertainties involved and the prospect of inheriting liabilities is likely to affect the view of any buyer.  The approach should therefore be to mitigate rather than litigate.

Putting in place contractual protection as discussed previously will reduce exposure and will please any buyer.  Litigation can be a disruption and many litigants quickly become frustrated with the process, so there is also an interim benefit of avoiding business disruption and lost management time to be had.

In busy and challenging times, standard terms are often given a low priority by businesses and may only be given detailed consideration when a dispute arises, by which time it may be too late; so businesses should try to avoid making the common mistake.

4.     Intellectual Property

Firstly, business owners should consider what intellectual property they have and which is integral to their business.

Secondly, they should then consider what steps to take to best protect it and take those steps; most businesses have branding which they invest in for example, and this can be easily protected by way of a registered trade mark to stop others using it.

This is important because any buyer wants to know that what they are buying is properly protected.  Any buyer also wants to know that the seller owns what they are selling so they take good title; so businesses should make sure they own what they pay for.

A recent survey found that 74% of businesses could not correctly identify the owner of copyright when using a consultant.  When engaging outside parties in areas such as brand creation, website design, software development, etc., the work they produce will be protected by copyright and, notwithstanding the fact they are paid for their services, ownership lies with the consultant rather than the commissioner.

This legal position can, however, be easily reversed by way of a written assignment; so businesses should deal with the issue upfront as it can be costly to argue over the issue afterwards.

I hope that was a helpful guide for you on the legal aspects to the business sale process.

Would you like an informal discussion as a buyer or seller?

If you didn’t manage to come to the presentation we delivered on this subject and would like to talk about your thoughts on your own businesses value for sale, or if you are looking to buy a business – please feel free to contact me. You can ask a question below in the comments section; email me; call me on 01908 660 966 or tweet me.

We offer a free legal healthcheck service to identify anything which might be a legal issue in a business, so if you like would like to informally discuss whether any of these areas may be relevant to you then please feel free to get in touch.

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