Written by Rory Graham on 20th July, 2017
This note is intended to help the shareholders (owners) of a private company limited by shares understand a key part of the process of selling those shares to a potential acquirer or investor. It sets out, in headline terms, the main points on which the potential buyer will seek information as part of the due diligence exercise, so that the sellers can endeavour to collate the relevant material and to anticipate problems. Of course, much of what is in this note is relevant to the buyer/investor.
It is not a substitute for detailed and specific legal advice on a particular transaction. It assumes that the corporate target for the acquisition is registered in England and Wales – if there are overseas subsidiaries or joint ventures etc, these need to be considered in addition.
before talking to a potential buyer:
- Are you using a financial advisor to find potential buyers/investors? If so, are you clear about their remit and the financial terms (eg retainer vs commission) – don’t forget about VAT on fees.
- Do you need advice on personal or corporate tax (eg relating to reliefs from Capital Gains Tax)?
- Do you need advice on personal or corporate employment matters (eg the terms of the shareholders’/directors’ employment or engagement; the workings of any option schemes or agreements; any terms which are triggered on a change of control)
- Do you have a confidentiality agreement (also known as a non-disclosure agreement or NDA) in place with advisors and potential buyers?
- Consider who is going to pay the sellers’ various fees for professional advisors – can any part of these be properly charged to the company or deferred until completion and deducted from the sale proceeds?
preparing for due diligence:
- You will be required to warrant the accuracy and completeness of the information you disclose as the buyer will state that it is relying on this information in deciding to proceed and to set the price (subject of course to negotiation). Therefore think about who is to be responsible for compiling and indexing the data and how far you are prepared to take responsibility for its accuracy.
- Is your potential buyer going to require a “virtual” data room, in which event you need to scan all relevant documents?
- Note that in the following lists, there may be overlap between sections (eg a customer contract could also be a software licence) so the indexing process has to allow for cross-referencing.
due diligence checklist – what the buyer is likely to require to see:
incorporation and corporate organisation:
- the certificate of incorporation, memorandum and articles and all changes to any of them since incorporation (NB should be on the Companies House website)
- if the company was incorporated before the Companies Act 2006, there may be other checks to be made
- all significant filings since incorporation: eg resolutions changing the share structure, name, charges etc
- all filed accounts (NB financial due diligence will of course extend beyond the filed accounts to cover management accounts, banking details, overdrafts and other facilities etc)
- details of directors and other officers and shareholders (+ shareholdings – including any shares held in trusts etc)
- organisation chart
- all similar documents and information relating to any subsidiaries etc
- all shareholders’ agreements or similar and any other documents (whether filed or not) which affect the way the company is organised, such as options or provisions triggered in the event of a sale/investment
- details of auditors, accountants, solicitors etc
- details of your products/services and price list
- details of all active customer contracts (+ copies in all cases), including maintenance/support arrangements and consultancy etc agreements
- details of any standard form customer contracts
- details of any retailer/distribution contracts
- details of any licences to customers/others (may be covered by the above)
- do you give any guarantees?
- are there any unusual terms in any contracts (eg unlimited liability other than for IP infringement)?
- have you given any customers credit?
- details of current negotiations/pipeline
- details of all contracts with suppliers (NB more focussed on suppliers/licensors whose products/services are a dependency for your products/services, rather than utilities etc)
technical and IP:
- details of all copyright material owned by the company (eg software, documentation, source code), whether forming part of products/services or used internally – including where in a group structure such rights are held
- details of how such copyright came about (eg who created it and when and under what terms, have there been any assignments of copyright from third party developers etc)
- details of other copyright used by the company (eg desktop/office software and, more importantly, third party code etc incorporated into your products services) plus copies of all licences etc
- details of all copyright material provided by the company to third parties (whether by licence, SAAS, distribution etc) and all relevant contracts/licences
- where any of the company’s products or services have been protected by patents or patent applications have been made, full details of these (and copies of the relevant filings etc)
- if the company has either licensed in third party patents or granted licences or other rights in relation to its patents, details of these (and relevant licences etc)
- details of all brands owned/used by the company and of any registrations in any jurisdictions
- details of any third party brands used by the company (plus relevant licences) or licensed to third parties by the company
- details of any other relevant registered or unregistered IP rights (eg semiconductor, database or design rights) used, owned or distributed/made available by the company
- details of any trade secrets/proprietary knowledge or technical processes on which the company relies and details of how they were obtained and to whom, if anyone, they have been disclosed
- details of any databases (eg customer/supplier) the company holds and details of any relevant data protection registrations, policies etc
- details of domain names and web sites
- details of any intra-group licences/arrangements relating to the use of IP
- details, from the above, of any arrangements which are unusual, eg involve exclusivity of any sort or which could be affected by the proposed sale/transaction
- details of any source code escrow arrangements
- details of any challenges/disputes etc relating to any of the above
- update (or create!) an asset register of all fixed and office assets, noting any which are leased or financed in some way – include IT assets and vehicles etc.
- in relation to IT assets, note all operating systems and other software (may already be addressed under IP above)
- make a list of current stock (and note that there will probably be a stocktake on completion)
- list all real property (freehold, leasehold, tenancies etc) and produce all related documents
- details of all insurance policies and of any historical or outstanding claims
- are there any environmental issues related to the business (eg disposal of hazardous materials, including in IT kit)?
- do have you appropriate health and safety policies and are there any records of breaches/incidents?
- list all staff, noting names, addresses, DOB, starting date, whether employed or contracting, full or part time, salary/pay (including commission, incentives, bonuses etc)
- set out the locations of all staff and confirm which group company is the employer
- set out details of any share option schemes and how they relate to the staff members
- list all benefits by reference to the staff members (eg health, car, loans etc)set out any pension arrangements by reference to staff members (including contributions and any company pension schemes)
- give details of any current/pending disputes (including any current redundancy or other termination discussions)
- give details of any union or similar group
If you were buying the company, what other issues would occur to you? Some examples of headline topics follow:
- problems which are not yet disputes – eg recurring problems/complaints with your products or services
- do you have in place all policies and practices required to enable you to comply with any relevant regulatory regimes? Depending on your industry sector and activities, these could include health and safety; environmental; equality/diversity; financial services; data privacy; anti-corruption and export control regimes.
- can you demonstrate compliance (this goes beyond having a policy, but showing that staff are properly educated and trained and that the policy is policed and enforced)? Note that increasingly government departments and major corporates require you to comply with such regimes as a condition of contracting for products and services.
- What about overseas contracts? Are there specific issues in relation to certain jurisdictions (eg withholding tax, local labour law, registrations, data privacy etc?)
- Tax: have you filed all due returns in all relevant jurisdictions and paid all taxes due? What about VAT and National Insurance Contributions? Who is paying any stamp duty in relation to the transaction (it should be the buyer)? Although your tax advisors should be able to deal with these issues, note that usually there will be a separate set of tax warranties and indemnities in relation to the business.
- Consents and approvals: are any consents required before you can sell the shares? Consider the internal approval process and any external bodies which may have rights in relation to the deal or who may have an effective veto (because, for example, they have a right to terminate a deal on change of control). Does the proposed transaction have any competition law implications (for example, will it increase the buyer’s market share?)
- Finance and accounting: as noted above, the buyer will want to see all financial records, both audited and unaudited. Your accounts should be able to support you on this, but again bear in mind that you will be asked to warrant the accuracy of the documents, some of which may still be subject to revision.
The above list of questions covers most of the topics usually addressed, but of course the nature of the business will dictate the emphasis of the buyer’s due diligence. We have seen due diligence questionnaires with over 1,000 individual questions!
The aim should be to collate the answers and supporting documentation such that the process of due diligence is as painless as possible, not least that:
- the shareholders are clear about the information on which the buyer will make its decision whether to proceed and on what basis
- any problems or issues are known about in advance, so that the sellers can either deal with them or ensure that, when it comes to warranting absolutes (eg “There is no current or pending litigation in relation to the company”) any necessary qualifications and disclosures of information can be made and defended.
When it comes to recording the buyer’s assumptions in the share purchase agreement (also known as a sale and purchase agreement or SPA), the aim should be to give warranties (ie binding statements of fact) only in relation to those matters of which the shareholders have knowledge and which are within their control, and to avoid giving broad statements or hostages to fortune (for example as to future performance).
Where the due diligence process throws up potential issues, the buyer may try to reduce the purchase price or to insist that some of the money is retained to cover any potential claims in relation to the warranties; only being paid over after a certain amount of time (say 18 months) has elapsed, and net of any claim amounts. The sellers will naturally wish to resist this, and having clear data and supporting evidence will assist in negotiations on these points.
The essence of the due diligence process is to try to avoid surprises – for either the sellers or the buyer – so that the price can be as definite and unqualified as possible, with as little continuing or contingent risk for the sellers as can be achieved.
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This note is prepared for clients and contacts of the firm and does not represent legal advice on any specific matter
© 2017 Coffey Graham (UK) Limited