Sometimes it’s nice to have a surprise. Normally that time is around birthdays and, of course, now at Christmas. But when a surprise comes at the time you are selling your business that surprise is not normally welcome, unless the buyer is offering to pay more. More money in your pocket is not the surprise we’re talking about here. The one we’re talking about is the sudden realisation that there’s an awful lot to do and think about when it comes to selling a company. And not just completing the sale of it but doing it successfully, which means with as little chance as possible that you spend the years ahead looking over your shoulder for fear the buyer is going to be standing there asking you to return some of the money that paid you because they’ve got a claim against you. There are a number of ways you can reduce the chance of a valid claim against you and so the theme of this article is preparation and engagement. In both respects they apply to you, the seller.
Firstly, we are focussing on share sales in this article, rather than asset sales such as the sale of a lettings book. In a share sale the buyer steps into the shoes of the seller. This means they take on all of the liabilities of the company. Because of this, and as the law gives the buyer very little in the way of protection, the buyer has to find out as much as it can about the company before the sale of it completes. The seller is not under a general duty to disclose information to the buyer so the buyer will have to ask questions about the company. And if you think about all of the things your agency does, the buyer’s questions will be extensive. They will range from disputes, complaints, employment contracts, contractual arrangements, financial, tax, data protection, IT systems, intellectual property, and of course Covid and the measures you took around that as regards to furloughing of staff and taking out government loans, to name but a few.
Firstly, we are focussing on share sales in this article, rather than asset sales such as the sale of a lettings book. In a share sale the buyer steps into the shoes of the seller. Michael Budd, Longmores Solicitors.
These questions will probably be at least between 30 and sometimes 40 pages long. Not only will you need to answer the questions, certain of your answers will need to cross-refer to relevant documents, which you will need to provide to the buyer. Of course, this means you are going to need to be organised. You could be in a situation where you are running the business, dealing with staff, getting new business, perhaps resolving complaints and doing all of the things you normally do on a daily basis, but on top of all of that you do not want to be answering page after page of questions many of which you don’t really know the proper answers to along with hunting for documents to accompany your answers.
You can avoid that stress, and delay to the sales process, if you prepare for the sale. You will also look good in the eyes of the buyer. If they think you are disorganised they will be suspicious of you which means they may agonise over the sales process, suspicious that the business is not well run. And if you do not answer the question fully enough the buyer will ask them again and they will also ask further questions about the answers and documents you have given them.
So, how do you prepare for this onslaught of questions? The answer is to obtain a due diligence questionnaire (DDQ) from your lawyer and speak to your accountant to get the financial information together. The DDQ will be very similar to the one the buyer will send to you. When you obtain the DDQ go through it and get the information together, probably store it in the cloud and produce an index. Lots of the questions in the DDQ will be very specific and will expect you to know about the contents of the documents. We cannot underestimate how much of a task being on the receiving end of the due diligence process it is. That is the first time-consuming exercise for you.
The next time-consuming exercise is disclosure. It is another area in which you can be most involved in limiting your liability. It is probably the single most significant aspect of the sales process over which you have the most direct influence. As we have said, the law offers little protection to the buyer so, in addition to discovering all it can about the company through the above due diligence process, the buyer will demand lengthy warranties from the seller concerning the state of the company, its assets and liabilities.
A warranty is a statement that a particular state exists. For example, one of the warranties might state that there have been no complaints made to the Property Ombudsman which remain unresolved. There will be page after page of warranties, and it will feel like going through the due diligence process again. Which is why many sellers will say, “I’ve already done this, the buyer knows everything” thinking, completely incorrectly, that if the buyer knows about the company because of the due diligence process there is nothing more for the seller to do. The problem is the way sales of a company are structured is that if you give the warranties to the buyer in the mistaken belief that the buyer already knows it all, you’re going to have a breach of warranty claim on your hands. This error on the part of sellers is one of the reasons why there are warranty claims. This leads us to talk about disclosure, it is rather like the answering of due diligence questions but the difference is it will relieve you of liability if you do it properly.
How do you prepare for this onslaught of questions? The answer is to obtain a due diligence questionnaire from your lawyer and speak to your accountant.
To explain further. If a warranty is untrue the buyer will have a claim for breach of warranty against you if you have not said how and why the warranty is untrue. However, if you know that a warranty is untrue you can avoid liability by telling the buyer.
Back to the above complaints example. Let us say that you have had two complaints made to the ombudsman which are pending. Instead of amending the warranties to make an exception for those two complaints it is usual that the share agreement provides that warranties will apply “except as disclosed” in a disclosure letter. This is a letter from you to the buyer detailing matters which would amount to a breach of warranty. So, in that letter you specify what the complaints relate to and provide as much detail as you can about them and in doing so the buyer cannot claim breach of warranty against you. We cannot emphasise the importance of detail and that is discussed next.
Full, fair and accurate?
The buyer and the seller will need to agree a standard of disclosure. Generally, this could mean a matter is “fairly disclosed”, “fully and fairly disclosed” or “fully, fairly and accurately disclosed” or, more simply, that the matters are ‘disclosed’ against the warranties. Each of these formulations, and there are some others, may be more or less onerous for you. You should try to keep the agreed standard of disclosure as simple as possible. From your perspective, the ideal standard should probably be just to matters ‘disclosed’, but a buyer is likely to demand a higher standard than that, perhaps disclosures which are “fair, with sufficient detail to identify the nature and scope of the matter disclosed”.
The word “fair” has a legal meaning in this context. The disclosure will need to be full, clear and unambiguous so as to effectively bring the potential breach of warranty to the attention of the buyer. The disclosure will need to be sufficiently precise, so that it is fairly and clearly apparent from the disclosure that it would qualify the particular warranty.
If you agree a high standard of disclosure the chances of failing to disclose in accordance with the standard is increased which will lead to a greater chance of warranty claims. In order to meet the demands of a high standard of disclosure you are going to have to be more detailed and explanatory in your disclosures. To ensure the disclosure process is carried out properly, and that disclosures meet the agreed standard of disclosure, the clearer and more specific the disclosure, the less likely that the buyer will have a claim. To achieve this, you will to need to spend much time and effort going through the warranties and making the required disclosures.
As frustrating as this process can be, taking the time to deal with it properly will reduce the chance of a valid warranty claim by the buyer and so help ensure you keep as much of the sales proceeds in your bank account as possible.
Michael Budd is Partner and Head of Company Commercial at Longmores Solicitors