THE LEGAL TRANSFER PROCESS
A Brief Guide of the legal process for purchasers, courtesy of Lockett, Loveday, McMahon Solicitors, Manchester.
The process of purchasing a business is not just simply 'signing on the dotted line' and walking away - there are a number of important steps which must be taken and matters to be considered before a sale contract is even seen.
The least risky method of purchasing a business, for a prospective purchaser, is through the acquisition of business assets, rather than shares. The reason for this is that if shares are purchased in a Company, all its assets, liabilities and obligations are acquired (even those the purchaser is not aware of).
If business assets are purchased, only the assets (and liabilities), which the purchaser agrees to obtain, are acquired. Business assets, will typically include the goodwill, stock, equipment and an interest in property, where this is Leasehold or Freehold. As well as the commercial considerations, there are important tax considerations to be taken into account when structuring a purchase. Such advice should be sought from an accountant well versed in transactions of this type.
There are a number of steps which typically make up the acquisition process, these are as follows:
1. Due Diligence
Due Diligence is an essential part of the acquisition process as far as the purchaser is concerned, since a purchaser will wish to learn as much about the business before committing itself to terms it may not otherwise have been willing to, had it had a full understanding of the business.
In respect of small businesses, the process in most cases constitutes a short form assessment of the business, dealing with various aspect of the business, including:-
- if the seller own the business assets, particularly its property and equipment which are often subject to leasing arrangements or bank security;
- the terms and conditions of employment, this is particularly important due to the Transfer of Undertakings Regulations 2006, which basically imposes an obligation on the purchaser to take on all employees on the same terms;
- licences and consents required to carry on business; and
- condition of the business premises.
The purchaser's advisor will usually proceed by gathering all the information already given to the purchaser and then issuing an information questionnaire to the seller.
2. The Sale Agreement
The purchaser's solicitor will usually prepare the initial draft of the Business Purchase Agreement to ensure sufficient warranty and goodwill protections are contained in the Business Purchase Agreement.
A typical Business Purchase Agreement is likely to include the following sections:-
A) Conduct of the business prior to completion
Although in most situations it will be appropriate for exchange of contracts and completion to be contemporaneous there may be occasions where a delay is unavoidable, and the purchaser will wish to make sure that during this period the business is carried on in the normal course and that no significant decisions are made or, if they have to be made during this time, they are not made without its consent.
Conversely, a seller will be unwilling to allow the purchaser to run the business during this period because of the risk that the transaction does not complete.
The typical approach taken to address these problems is that the seller retains management of the business but that the purchaser will want to know that business is being carried on as normal, with no unusual transactions being undertaken, and therefore safeguards for both parties are written in allowing them to carry on the business in the normal course but prohibiting unusual activity, e.g. purchase of a major piece of equipment.
B) Consideration (i.e. amount being paid by the buyer to purchase the business)
There will usually be a payment of cash on completion, however, an additional payment will be made for stock as and when a figure has been decided by the seller and buyer. If the purchaser is experiencing difficulties raising all of the purchase price in time for completion, then it may be appropriate to request that some of the purchase price is deferred. This will allow the purchaser to fund the deferred element through the profits of the business going forward.
C) Warranties
In agreeing to buy the business the purchaser will have relied upon various representations. Because one of the most well established rules of English Law is ‘Caveat Emptor' or ‘Buyer Beware' the purchaser will want protection to ensure that the representations and assumptions it has relied upon are correct and that it can recover its loss if they prove not to be correct.
The various representations and assumptions relied upon are usually included in a schedule to the Business Purchase Agreement as express representations and are known as warranties.
Warranties provide a double purpose for the purchaser, in that they provide a mechanism for the purchaser to reclaim part of the purchase price post completion if any of the warranties prove to be untrue and this has caused loss to the buyer, it is also a means of getting information on the business.
Amongst the most common areas covered by the warranties are:-
- ownership of the Assets;
- insolvency of the seller;
- accounts
- contracts;
- employment; and
- property.
D) Restrictive Covenant
One of the main assets that will be transferred on a business sale, will be the goodwill of the business. Therefore, it is essential goodwill is adequately protected. Restrictive covenants are given by the Seller to the Purchaser and fall into three basic categories: non-solicitation of customers, non-solicitation of employees and non-compete.
The covenants will usually run for a period of 1-2 years after the sale and will apply to an agreed area i.e. within a 15 mile radius of the business premises. (or less in densely populated areas e.g. London.)
3. Property
Depending upon the nature of the Seller's interest in the Property, there are three ways that the Property may transfer to the Purchaser:-
(i) Acquisition of the Freehold
If the Purchaser is acquiring the freehold or long leasehold title to the Property along with the business, the Property transfer will normally be completed simultaneously with the business transfer.
(ii) Assignment of the business lease
Where the Seller holds the premises under a commercial lease (as opposed to a long lease at a ground rent), the Lease will be assigned to the Purchaser when the business is transferred to the Purchaser. Prior to completion of the assignment, it is necessary to obtain the Landlord's consent, usually in the form of a Licence to Assign. It is therefore advisable to check the assignment/underlet provisions in the Lease and for the Seller to approach the Landlord during the early stages of negotiations.
It is also worth noting that the Purchaser must observe and perform the covenants contained in the lease, no matter how onerous they may be.
Particular note should be taken of the unexpired residue of the term (i.e. how long the lease has left to run). Although business tenants are protected by the provisions of Part 2 of the Landlord and Tenant Act 1954, which gives them the right to a new tenancy on similar terms, there are exceptions. For example, the Landlord can recover possession of the Property on the grounds that he wishes to redevelop or that he requires the Property for his own use. Furthermore, it is possible to "contract out" of the 1954 Act. If the Lease is contracted out, the Tenant has no right to renewal.
(iii) Granting of New lease
In this situation, the Landlord and the Purchaser must first agree on the terms of the new Lease. The parties will normally instruct a local surveyor to negotiate Heads of Terms on their behalf, as they will have a more extensive knowledge of the local rental market and what constitutes a reasonable rent. Once Heads of Terms have been agreed, solicitors are instructed to draft the necessary documentation. Once a purchaser's offer has been accepted it is essential that the terms of the new lease are agreed as soon as possible. Lack of agreement in respect of the new Lease will cause significant delays and frustration for both the seller and purchaser.
If the Lease is nearing the end of the contractual term, it may be prudent for the Seller to surrender the Lease and the Purchaser to enter into a new Lease with the Landlord.
The advantage of taking a new Lease is that the Purchaser is able to negotiate terms that better fit it's requirements, whilst the disadvantages are that it is, generally speaking, a more time-consuming process than taking an assignment of the existing lease and the associated professional fees are likely to be higher. A new lease may also be subject to Stamp Duty Land Tax.
NOTE: This summary is published for information only. It provides only an overview of laws and regulations in force at the date of publication, and does not represent legal advice. No action should be taken without seeking professional advice from a solicitor of this firm. Neither the authors, nor the firm can accept any liability or responsibility for loss occasioned by any person acting or refraining from action as a result of any material contained in it.
