FAQs

The sale of your business is most likely going to be one of the most complex and major transactions that you will be involved in, save for buying and selling your own house.

A simple rule is – the more ground work you do prior to going to market the more likely you are to find a buyer and close a deal.

In general, this ground work falls into a couple of main categories:

• Vendor Due diligence – conducting vendor due diligence by collating all relevant information and documents, reviewing these and identifying gaps or issues likely to impact a transaction or the value of the business and identifying how to deal with or rectify those issues
• Preparation of a data room – collating the documents and information identified in the vendor due diligence process and establishing an electronic data room for potential purchasers to obtain access to as part of their initial consideration of the deal
• Structuring discussions – getting legal, tax and accounting advice relevant to the sale process – this will help with structuring of the deal
• Preparing the sale document – once vendor due diligence and structuring discussions have been finalised, you should instruct a lawyer to prepare an initial draft of the sale document.

Going through these stages is essential to the potential overall success of your transaction.

This is because sale transactions are about creating and maintaining momentum.  The more groundwork you have done prior to going to market means that you are already going to be aware of:

• how best to structure your sale
• the key issues likely to be identified by the purchaser – and more importantly, how best to deal with them
• issues that may impact value and how they can be rectified or mitigated
• issues that need to be resolved prior to going to market, or at least prior to closing your sale

Doing your homework properly will also mean that you will be able to coordinate and manage the purchaser’s due diligence process more efficiently.

All of this will enable you to create engagement with the purchaser.

Engagement creates interest, interest leads to offers, offers lead to sales…

The main advantages for a person selling their business using a share sale are:

• generally easier to manage and document
• generally fewer consents from other parties required
• fewer issues with employees and existing contracts
• unless you agree otherwise, all of the liabilities associated with the business are transferred to the purchaser when they buy the shares.

The primary disadvantages for a seller of a share sale are:

• generally more detailed due diligence undertaken by the purchaser to understand the nature of the company’s historical activities
• commonly purchasers require more warranties and protections in a share sale than in a business sale

It may also mean that a purchaser requires part of the purchase price to be retained, or paid following completion of the warranty period, as a form of security.

The advantages for a seller of a business sale include:

• it may be a convenient structure to divest a business unit that is conducted as part of a broader business activity
• may be able to obtain better purchase price because there may be no reduction for tax or other liabilities associated with a share sale

The disadvantages for a seller of a business sale include:

• they commonly require more consents from third parties to give effect to the transfer or assignment of assets – i.e. landlord consents to assignment of shop lease, financier consents
• they generally requires additional cost and paperwork to get all of the necessary ancillary documents and consents agreed with the relevant counterparties
• you continue to be the owner of the company – therefore any retained liabilities of the business must be discharged using either the purchase price received for the sale or other means

If you are selling your business, you should require any potential purchaser to sign a confidentiality deed protecting your confidential information that you share with the purchaser as part of their due diligence process.

This is particularly so when your business is built on proprietary intellectual property that you have developed.

You should expect to see any confidentiality deed include obligations to:

• maintain the information confidentially
• keep information safe and secure – using reasonably security measures
• not disclose, use or reproduce confidential information except for the permitted purpose
• take steps to prevent disclosure
• return the information at the end of the process if no deal is closed
• not engaging with current clients or staff – unless expressly permitted.

The short answer is “No” – you don’t need a terms sheet or heads of agreement to sell your business.

However, they can be useful for commercial reasons.

It is common for parties when they start discussing a potential sale of a business, to set out some of the general commercial terms of the proposed sale – purchase price, warranties, liability etc.

Endeavouring to set out the key commercial terms of a transaction in a terms sheet can be a useful exercise to assist the parties to identify and agree on the main commercial points of the deal before proceeding to document it properly.  These terms sheets can be binding or non-binding – whichever, it is important that the parties are very clear on the legal position between the parties.

If you are negotiating a terms sheet or preliminary agreement, you should seek legal advice before signing or agreeing to it.

A terms sheet may:

• set out a timetable for the transaction, including when and how the discussions may terminate
• provide that the parties enter into exclusive discussions – as a seller you may want to lock in the purchaser to only discussing a sale with you, so that you won’t undertake all the work only to be left at the end with no deal because the purchaser has agreed to buy another business
• discuss due diligence requirements – including liability for expenses
• map out potential transaction structures – share sale or asset sale
• specify indicative prices or ranges
• stipulate some non-compete requirements (i.e., the buyer will not compete with the seller in the seller’s market), non-solicitation obligations (i.e. the buyer will not approach the seller’s staff / material suppliers, with offers of employment or contracts) obligations.

If you are looking to sell your business, there is lots of preparatory work to be done – preferably before you go to market.

This ranges from engaging accounting, financial, tax and legal advisors to help you identify the optimal structure for the sale to getting all of the documents and information that a purchaser is likely to request through its due diligence process.

The types of information and documents that will ordinarily be requested include:

• Financial information
• Details of the assets used to conduct the business – physical assets, contracts
• Material contracts – leases, supply agreements, customer contracts
• Property – freehold, leasehold, licences
• Environmental issues – licences, liabilities
• Intellectual property – trademarks, patents, licences
• People
• Information technology
• Data security
• Corporate / related party transactions
• Regulatory compliance
• Litigation

This depends on how the parties agree to sell the business – asset sale or share sale (see above “I want to sell my business – how can I do that?).

If the parties have agreed on a business sale, then the parties will normally negotiate and sign a “Business Sale Agreement”.  The parties may also need to sign other documents called “Deeds of Assignment” or “Deeds of Novation” to give effect to the transfer of individual assets – for example, shop leases, contracts etc.

If it is a share sale, then the document will be a “Share Sale Agreement”.  This will be the main document – in general the only other documents that need to be signed are simple share transfer forms and alike.

Like most things in modern business, there are standard form documents available from online businesses for either business sales or share sales.

This approach may appear to be cost-effective and time efficient, but invariably these documents are not entirely “fit for purpose” or are unlikely to deal appropriately with all of the issues relevant to the transfer of the business assets or shares.

We recommend that you obtain legal advice on the drafting and negotiating of any sale document.

Whether it is a business sale or a share sale, there will be a number of common clauses that should be included in any sale agreement.

Conditions precedent

These are the steps that the parties determine are either legally or commercially required to be completed before the parties are legally obligated to complete their transaction.

These are commonly things like:

• consent from landlords to assign leases from the seller to the purchaser or consent to the “change of control” in the company that conducts the business in a share sale transaction
• consent from contract counterparties
• releases or consents from financiers in respect of their interests in the business assets or the company being sold.

Conduct of business

It is fairly standard for the buyer to require the seller to maintain and preserve the assets and / or conduct its business in the normal way subject to some limitations.

These may include restrictions on the seller or the company from:

• entering into or terminating any material contracts (unless consented to by the buyer)
• selling or encumbering any of its assets
• incurring any expenditure over a specified amount
• altering its capital structure

These are included to help ensure that the business that the purchaser has reviewed as part of its due diligence and the value it has determined as part of the purchase price negotiations, is preserved.

Warranties

A warranty is a statement in a contract made by a seller to the purchaser about the condition of the business or assets.

Warranties are, in a sense, a means of reallocating risk between the seller and the purchaser. Purchasers will seek warranties from the seller so as to prevent any loss of value to their investment post-completion.

Most business sale or share sale agreements will provide that the seller “represents and warrants” as to the accuracy of certain statements about the status of the assets, the business or the company (as applicable).

If, after the sale has completed:

• it becomes apparent that the subject matter of a warranty given by the seller was incorrect; and
• the buyer has suffered some loss as a result of relying on that statement

then the buyer may be able to commence a breach of warranty claim to recover that loss.

It will be common for the parties to agree certain limitations and requirements for the commencement of any warranty claims by the buyer. These may include:

time limitations – for example, any claim must be made within 12 months of completion;

de minimis claims – only individual claims above a specified threshold can be brought by the buyer;

aggregate threshold – only once the total of all claims exceeds a specified threshold, can the buyer make any claim;

capped liability – the seller’s liability is capped at a certain amount (frequently expressed as a percentage of the purchase price);

excluded loss – any losses claimed by the buyer may exclude “consequential losses”.

The seller will seek to limit any potential claims by “qualifying” its warranties by:

• what it has disclosed to the buyer prior to completion; or
• what the buyer could have found by undertaking certain searches of public registers.

There are many different ways that the parties to a business sale can agree to structure how the purchaser pays you for your business.

Upfront payment / deposit

Of course, the simplest and likely most common structure, is by way of a single payment at completion.

You might want to ask the purchaser to pay a deposit on signing the sale agreement in order to provide some certainty that the sale will proceed – i.e. that they will be committed to ensuring that any conditions precedent are satisfied.

This is also a way of ensuring that you are compensated for the time and cost you may incur in getting the business ready for sale and negotiating a sale agreement in the event that a sale does not proceed to completion for various reasons.

Deferred consideration

Where the purchaser’s financial and legal due diligence identifies some inconsistencies or concerns that they do not believe can be adequately mitigated through conditions precedent or warranties (see below) they may propose paying some of the purchase price in instalments post-completion as an alternative to either reducing their purchase price or not proceeding with the sale.

These are often referred to as “delayed consideration or “earn outs”.

This structure might also be useful when the parties are unable to agree on the value of the assets or company but want to conclude a deal.

If an earnout is considered, then the parties will need to consider:

• What is to the total purchase price potentially payable by the buyer?
• What is the earnout period?
• What are the triggers for the earnout to be payable – that is the financial measurement methodology to be used (revenue, EBITDA)?
• How often are earnout payments to be made?
• What happens if there are material adverse events, such as financial shocks beyond the control of the parties?

Due diligence findings can often be used as an important bargaining tool. This is particularly so when the seller has presented a rosy picture of the business, emphasising its successes but not paying enough attention to its potential faults, in order to justify a high asking price.

Scoping your due diligence

While a comprehensive due diligence process is the best way to identify material issues that may impact your decision to purchase the business, or on what terms, not everyone can afford to review everything in a new business.

Some businesses are simply too big to dig into, and report on, every aspect of the business. Sometimes your resources and time may be limited. You may also not want to go and review all aspects of a business before you are more committed to the transaction.

If time and money are limited, you should sit down with your advisors and try to scope out what you want to be reviewed.  Focus on reviewing those aspects of the business that are likely to have a material impact on the bottom line in terms of value and operations if there are issues.

Focus on key areas upfront

Rather than reviewing all areas and issues upfront, you could stagger your review.  In this way, once you have reviewed those areas that you consider are essential or material to the business, and that review doesn’t throw up anything that will derail the transaction. Then you can expand the scope of your diligence to other issues / areas to give you a more detailed understanding of the business.

Get under the bonnet – understand the numbers

While it is not a legal matter, a first step should be to review (in detail) the seller’s historical financial statements and financial metrics.  A good accounting advisor is normally central to this process.  You should check any qualifications or assumptions in the financial statements and see if they are reasonable.

In addition to looking at past performance, you should also review the reasonableness of the target’s projections of its future performance.  These projections will likely inform their expectations for the value of the business.  If so, you will need to review them and see if they are reasonable based on past performance and subject to likely future events.

Understand the nuts and bolts of the business

Pretty much every business needs three things to conduct its operations:

• physical assets
• contracts
• people

The key thing that you, as a purchaser, must make sure of is that after completion you have everything you need to run the business.

While it might sound trite, one of the things a prospective purchaser should do first is really get into the business and understand its key drivers and inputs and how they relate to its outputs – what it makes, what it sells.  You should identify:

• What physical assets it uses in the production process?
• How does it secure the rights to use or be supplied with those physical assets?
• What intellectual property does it use in its business processes?
• What people are required to conduct the business – employees, contractors, consultants?
• Are their business premises owned or leased? If leased, how long for, what are the terms of lease?
• Are the physical assets owned by the company? Or are they leased and / or subject to financing from banks who have rights over the asset?
• Is the “IP” needed to run the business owned or licenced? If licenced, can you use the licence in the future?  What are the limitations in the licence in using the IP?
• How do they secure all of the inputs needed to build their products or provide their services?  Are there contracts in place with material suppliers?  What are the terms of these contracts?

What are the key areas for review?

As discussed above, every business is different.  Therefore, what areas need to be reviewed during due diligence will be specific.

There are a number of key areas that you should consider reviewing as part of your due diligence process, including:

• Material contracts
• Property – freehold, leasehold, licences
• Environmental issues – licences, liabilities
• Intellectual property – trademarks, patents, licences
• People
• Information technology
• Data security
• Corporate / related party transactions
• Regulatory compliance
• Litigation

Summary of due diligence outcomes

The main outcome of your due diligence will be the identification of the key risks associated with the business that you think should be dealt with in the sale agreement to ensure that you are comfortable with the deal as a whole

There are two main ways to buy a business –

1. You can buy the shares in the company (or companies) that hold the assets that are used in the business you want to purchase through a share sale.
2. Alternatively, it might be preferable for you to simply buy all of the assets used in the business from the seller (an asset sale).

Both structures have pros and cons – depending on your perspective, the complexity of the business and, often, tax and accounting impacts for both parties consequent on the agreed structure.

Share sales

A share sale is generally fairly simple – you just buy all of the shares in the company that owns the business assets.

You will need to review and sign a “Share Sale Agreement” or “Share Purchase Agreement” to do this.

This document provides that you, subject to getting any necessary consents or other steps required by the parties, will purchase all of the shares in the company currently held by the seller.

Once the sale is complete, you will own the company, and therefore the business.

While structurally simple, there are complexities for you as a purchaser. Buying a company or group of companies means that you will inherit all of the liabilities of those entities – known and unknown.  Therefore, as a purchaser you should ideally undertake a comprehensive due diligence process to identify all of the key risks and liabilities that you will be acquiring.

The main advantages of a share sale are:

• generally easier to manage and document
• generally fewer consents required
• fewer issues with employees and existing contracts
• unless you agree otherwise, all of the liabilities associated with the business are transferred to the purchaser when they buy the shares.

The main advantage to a purchaser of a business sale are:

• control over which assets / contracts you want to acquire (as opposed to a share sale where you ordinarily acquire all the assets held by the company even ones you may not need)
• existing liabilities of the business are generally retained by the seller
• you may be able to integrate the new business into your current operations

There are many “structures” that you can use to buy a business.

You could buy the assets of a business in your own personal capacity.  However, this would expose you directly to potential claims against the business and your own personal assets could be at risk.  In many instances, other businesses may not want to work with you because of the absence of a company entity as their counterparty.

Using a company is a common and prudent structure to purchase a business.  This structure:

• reduces (but does not remove) the risks of claims being made against you personally during the operation of the business
• may provide better tax outcomes;
• provides greater flexibility in obtaining financing
• facilitates different ways that you can sell down your interest in the business or exit when it is time

Other investment and operational structures such as trusts, or combinations of companies and trusts, may be appropriate. These should be discussed with your legal and other advisors prior to signing any sale agreement.

A seller will most likely ask you to sign a confidentiality deed to protect the confidential information shared with you as part of their due diligence process.

Similarly, if you may want the seller to keep the terms of your discussions confidential, then you should ensure that there is an appropriate confidentiality deed in place.

You should expect to see include:

• maintain the information confidentially;
• keep it safe and secure – using reasonably security measures –
• not disclose, use or reproduce except for the permitted purpose;
• take steps to prevent disclosure;
• return the information at the end of the process if no deal is closed;
• not engaging with current clients or staff – unless expressly permitted.

The short answer is “No” – you don’t need a terms sheet or heads of agreement to purchase a business.

However, they can be useful and it is common for parties when they start discussing a potential sale of a business, to set out some of the general commercial terms of the proposed sale – purchase price, warranties, liability etc.

Ordinarily a draft terms sheet or “HOA” will be prepared by the seller and provided to you are part of the initial information flow, or at least once you have engaged in the due diligence process.

If you receive a draft document this should give you an opportunity to flag any material commercial issues that you have identified from your due diligence work.

Where there are serious issues that cannot be resolved at this stage of the process by the parties, it is most likely that they will be able to proceed with the remainder of the transaction process.

If you are negotiating a terms sheet or preliminary agreement, you should seek legal advice before signing or agreeing to it.

A terms sheet may:

• set out a timetable for the transaction, including when the discussions may terminate;
• provide that the parties enter into exclusive discussions – as a buyer you may want to lock in the seller to only discussing a sale to you, so that you won’t undertake all the work only to be left at the end with no deal because the seller has agreed to sell to someone else;
• discuss due diligence requirements – including liability for expenses;
• map out potential transaction structures – share sale or asset sale;
• specify indicative prices or ranges;
• stipulate some non-compete requirements (i.e. the buyer will not compete with the seller in the seller’s market), non-solicitation obligations (i.e. the buyer will not approach the seller’s staff / material suppliers, with offers of employment or contracts) obligations.

This depends on how the parties agree to sell the business – asset sale or share sale (see above “I want to buy my business – how can I do that?).

If the parties have agreed on a business asset sale, then the parties will normally negotiate and sign a “Business Sale Agreement”. The parties may also need to sign other documents called “Deeds of Assignment” or “Deeds of Novation” to give effect to the transfer of individual assets – for example, shop leases, contracts etc.

If it is a share sale, then the document will be a “Share Sale Agreement”. This will be the main document – in general the only other documents that need to be signed are simple share transfer forms and alike.

Firstly, of course you need to read it.  Read it in detail.

Secondly, get a lawyer to review it for you.

Thirdly, work with your lawyer to review and amend the draft sale agreement to reflect what you believe is an appropriate allocation of the commercial risk in the transaction.  This means working through your due diligence findings and amending clauses or inserting clauses to address the issues that you are most concerned with following your due diligence.

These may be things like:

• conditions precedent to ensure that important contracts will be in place after completion of the sale
• warranties that you will be acquiring everything required to run the business that you have reviewed as part of your due diligence
• specific clauses called indemnities from the seller in relation to key risks that you have identified and do not consider you should be at risk for post-completion.

1. Many varied forms, but some core concepts
In basic terms, an indemnity is a clause in which:

• a person (the indemnifier);
• promises to another party (the indemnified party);
• that they will hold them harmless, or will reimburse them, against specified losses (liabilities);
• if the conditions of the indemnity are triggered.

2. Indemnities shift commercial risk between parties

Indemnities, by their nature, are powerful contractual clauses that may have significant implications for commercial parties.

Importantly indemnities shift civil or contractual liability of the indemnified party to the indemnifier.

3.They are the backbone of most liability regimes

Contract parties often endeavour to establish specific liability regimes. Parties frequently use indemnities to make the party best able to manage a particular risk responsible for the consequences of that risk materialising. Sometimes they are just the result of the bargaining position of the parties.

4. Independent obligation, distinct from guarantees

An indemnity is an independent obligation to make good specific losses incurred by the indemnified party. They are different, in legal terms, from guarantees.

In practical terms they mean that the indemnifier has to pay costs that ordinarily the indemnified party would have to pay.

5. Indemnifier be ware

The shifting of risk caused by an indemnity is a material issue to consider by both parties, but primarily by the indemnifier. If required to give an indemnity, you should exercise due caution understanding all the potential implications and outcomes for your business.

6. Potential for easier, broader claims

Indemnities can make claims easier (as opposed to breach of contract claims) primarily because indemnity claims are generally easier to prosecute than contractual claims.

7. Clear drafting is vital

It is critically important that the scope of an indemnity is drafted in clear and precise terms. It must unambiguously capture the categories of loss and liability intended to be the subject of indemnification.

This is because the scope of any indemnity is found in the words of the relevant clause. However, that meaning is determined by reviewing them with reference to the contract as a whole. Therefore, each indemnity must be considered separately.

8. Can be interpreted narrowly

Indemnified parties should be aware that indemnities are generally interpreted narrowly. That is, if there is a doubt as to the scope of an indemnity, it should be resolved in favour of the party giving the indemnity.

Most contracts, particularly those that are medium to long term contracts, will have a “force majeure” clause in them.

Force what?

“Force majeure” is a term borrowed from French law.  It is a way of giving a party temporary or permanent relief from liability where that party is prevented from performing obligations under a contract due to causes beyond their control.

A force majeure clause does not operate to relieve the affected party from a breach constituted by its failure to perform.  The effect of a force majeure clause is to provide that the failure to perform was excused, so that it is cannot be characterised as a breach of contract.

In practice it means that if the terms of the clause are triggered by specified circumstances, the party affected by those circumstances can be relieved of their obligations under the contract that are restricted or prevented by those circumstances.

An example definition of “force majeure” is set out below:

“Force Majeure means any circumstance that is not within the reasonable control (whether directly or indirectly) of the party affected by the circumstance (Affected Party) but only if and to the extent that:

• despite the exercise of reasonable diligence, it cannot be prevented or avoided, or removed by the Affected Party;
• it prevents or materially delays the Affected Party’s ability to perform its obligations under this agreement,
• the Affected Party has taken all reasonable precautions, due care and reasonable alternative measures in order to avoid the effect of the event on its ability to perform its obligations under this agreement (and mitigate the consequences of it); and
• the event is not the direct or indirect result of the Affected Party’s failure to perform any of its obligations under this agreement.