UK: How To Assess And Maximise The Value Of Your Business For Sale

Last Updated: 2 August 2011

Valuing a business is an important prerequisite to selling a business. However, many business owners and directors do not know how to value their business. Some have wildly optimistic aspirations for sale value that mean they will never be able to sell the business. At the other extreme, some simply do not realise the value of their business and close the business down when they choose to exit.

Either way, a sense of realism is required to set expectations and a target value for the business, and establish a plan to maximise the value of the business on the eventual sale.

Three stages of selling a business

This White Paper looks at how to assess the value of your business and maximise the value of your business for sale. There are three sections:

1. How to value your business: An explanation of business valuation techniques designed to help you determine a guidance value for your business, either for sale now or for what it could be worth in two to five years' time should you implement a certain growth and preparation strategy.

2. How to maximise the value of your business: A review of our "Maximise the Value" checklist for enhancing value in a business, and identifying what your business would ideally look like when it is ready to market.

3. The process of selling a business: The stages of a typical business sale transaction, negotiating the best deal, how to prepare for due diligence, and what a business buyer needs to see in the sales memorandum.

1. How to value your business

It is important to remember that the true value of a business is what someone will pay for it. The value of any one business will be different for each buyer and type of buyer. By and large, buyers fall into three main categories:

  • the strategic buyer of a business
  • the financial buyer of a business
  • the asset stripper.

The strategic business buyer will be interested in the return on investment obtainable from the business through synergies with their current business, e.g. reduction of staff and overheads. This is the best type of business buyer as they will value your business largely ignoring indirect costs.

The financial business buyer will be interested in the return on investment they could receive from the business if it were to run on the same basis as it does now. Note that although the strategic buyer will be more flexible on the price they are prepared to offer, they may well negotiate on the same terms as a financial buyer in the absence of competition.

The asset stripper will be looking at the value of your business assets on an individual basis, and will not be looking to the future other than at the price at which they can sell the individual assets. Clearly this is not the most desirable buyer for your business, and they are normally only involved in distressed business sales.

Business valuation techniques

Whatever type of buyer they are, prospective buyers of a business will use various business valuation methods. Commonly used business valuation techniques are:

  • multiple of earnings value
  • multiple of turnover value
  • net book value
  • forward-looking business model value
  • simplified discounted cash flow value.

Each business valuation method calculates both a lower-end and an upper-end figure. Where your business sits within the valuation range will depend on the strength of your business and the responses to our "Maximise the Value" checklist (see below).

  • Multiple of earnings value

The multiple of earnings valuation is the most universally used business valuation method and is often the point of reference for other business valuation techniques. It can be used to value businesses in most industry sectors.

The business valuation is based on the earnings a buyer will be able to extract from the business before interest, tax, depreciation and amortisation (EBITDA). The valuation of the business is therefore a function of the EBITDA and a multiplier.

The multiplier used depends on both the industry sector and the size of the business being valued: the larger the business turnover, the higher the multiple. For example, and as a very rough guide, the multipliers for a typical professional services business are as follows:

ANNUAL TURNOVER

MULTIPLIER

Less than £400,000

1.0 to 1.5

£400,000 to £2 million

1.5 to 3.0

£2 million to £5 million

3.0 to 5.0

£5 million to £10 million

6.0 to 8.0


The adjusted net earnings will depend on the type of buyer.

For the financial buyer business valuation, the adjusted net earnings figure is adjusted to reflect the owner's takings and benefits less the cost to the new buyer of employing a replacement general manager. The cost of bank interest and depreciation is also removed from the overheads, as this can also be considered as additional profit potential for the buyer.

For the strategic buyer business valuation, the adjusted net earnings figure is further adjusted to take account of the savings that a strategic buyer could reasonably benefit from. These can include costs of premises, insurance, industry membership subs, advertising, IT costs, staff, accounting and legal.

  • Multiple of turnover valuation

This business valuation method is often used for serviced-based or consultancy businesses where there is regular ongoing revenue generated from an existing client base, particularly where there are established service contracts or retainer agreements in place.

As the name suggests, the value of the business is simply calculated as a multiple of the annual turnover of the business. In some cases, the turnover will be adjusted to reflect just the turnover that is derived from the contract agreements or regularly repeated client needs. For example, in assessing an accountancy practice, a buyer would look principally at the fees earned through annual tax returns and other HMRC requirements that their clients have to comply with.

Again as a rough guide, the typical ratios for consulting businesses range from 0.7 to 1.3, depending on the size and strength of the ongoing business.

  • Net book value

The net book value (NBV) calculation is used mainly for manufacturing or engineering sector businesses where there are relatively significant tangible assets in the form of machinery and/or buildings.

This business valuation method looks at the net book value, which is the sum of your assets less your total liabilities. This figure is then adjusted to reflect the current economic reality, taking into account items such as the real current value of your fixed assets, the value of your debtors to the purchaser, and goodwill.

The value of the goodwill will often be the most contested by the buyer, but can be evaluated and/or justified using the multiple of earnings technique described above. The net book value can also be thought of as a minimum base price.

  • Forward-looking business model value

This business valuation technique looks at the future business model that a buyer might reasonably expect to apply. A reasonable annual growth in revenue and costs is projected, based on your current operation but adjusted to reflect:

  • the current position in the economic cycle
  • the costs that a strategic buyer will incur compared with a financial buyer, as described on page 4.

We also add in the acquisition costs the buyer will incur, for example legal fees, relocation costs and post-acquisition marketing costs.

We then look at the return based on the fact that most buyers will aim to recover their investment within three years.

We consider the cumulative earnings before tax after three years, and further discount this to account for the risk taken by the buyer to achieve improved sales and profitability. Indeed, the buyer is likely to consider that any increased sales and profitability are achieved through their own endeavours.

  • Simplified discounted cash flow value

This business valuation method is based on the sum of the dividends forecast over a certain period of time in the future, plus a residual value at the end of the period. The value today of each future dividend is calculated using a discounted interest rate, which takes account of the risk and the time value of money. This method is usually the most complex way of valuing a business, as it depends heavily upon the assumptions about long-term business conditions.

We use a simplified calculation model for the discounted cash flow valuation. The key assumptions and reasoning behind this business valuation are as follows:

  • The predicted annual dividend is assumed to be the total takings that the buyer could expect to withdraw from the business. The figure is based on the director's dividend plus remuneration and other benefits.
  • It is assumed that the purchaser will continue to achieve this level of income.
  • A personal tax of 30% is then applied to the dividend in order to represent the final value to the buyer.
  • The discounted interest rate assumed is 10%, which is a typical bank loan rate.
  • No residual value at the end of this time is assumed.

The discounted, taxed dividends are then summed over a certain number of years, depending on the nature and size of the business. For example, and as a very rough guide, the multipliers for a typical professional services business are as follows:

ANNUAL TURNOVER

NUMBER OF YEARS

Less than £400,000

3

£400,000 to £2 million

5

£2 million to £5 million

10

£5 million to £10 million

15


Asking price considerations

In determining the bottom-line negotiating position and the asking price, it is worth considering the type of investor or organisation that may be interested in your business. The value of a business to different individuals or companies will vary, depending on their sales objectives and level of marketing presence/expertise, and whether they are financial or strategic buyers.

You may achieve an increased deal value if you accept a deferred payment or earn-out arrangement, which effectively allows the buyer to finance the business acquisition initially. It will also show the buyer that you have confidence in the future potential of the business. Having said this, you will also need to have confidence in the buyer's ability and intentions to grow the business.

For professional services companies, the value of the business will be mainly based on the prospective buyer's perception of the goodwill, which can vary significantly. To maximise the level of goodwill, you will need to demonstrate the stability of the sales, their level of contractual obligation, and the consistent quality of service as a means of maintaining them.

Whatever asking price the business is advertised at, the purchaser will expect to negotiate this downwards. Therefore it is worth pricing the business slightly higher than your expectation for the final deal value.

2. How to maximise the value of your business

The worth of a business hinges upon how much profit a buyer can make/extract from it and is balanced by the risks involved. The business profitability based on the sales, costs and asset values is only the starting point. It is intangible factors such as key business relationships and contracts with local businesses or trade partners that may provide the most value to a potential buyer.

As discussed earlier, where your business sits within the upper and lower limits of the valuation range will depend on the strength of your business. The following "Maximise the Value" checklist will help you prepare your business to attract optimum offers.

"Maximise the Value" checklist

The recommended actions for maximising the value of your business fall into five categories:

(1) sales and marketing

(2) operational

(3) financial

(4) legal

(5) on point of sale.

Maximising the value of your business through sales and marketing

  • Diversify client revenues

Reduce dependency on your top one to three clients. As a guideline, no one client should represent more than 15% of your revenue.

  • Ensure that the revenues and sales process are not dependent on you

Ensure that someone else within the business is able to perform the complete sales function, from initial enquiry through bid and quote to winning the contract.

Businesses that depend on the owner to win new sales (or indeed the strong relationship between the owner and existing clients to maintain recurring business) will represent a major risk to buyers.

If you do not have a sales process, develop one. Have one full-time member of staff attend initial sales meetings with clients and take on your current roles in the process.

  • Maximise the proportion of your revenue generated by service contracts

Maintenance contracts, service contracts or retainers represent regular guaranteed income with little further sales effort for the buyer. As such, they represent significant inherent value.

Moreover, as you will be in touch with your clients on a regular basis, these contracts in turn are like to generate further project work.

  • Maximise the duration of your maintenance contracts

This will allow buyers more time to get to know your clients before the next renewal. Contracts that have a 30-day notice period or are due to expire within a month of the sale will be viewed as higher risk, and thus will be valued less by the buyer. Aim for at least a six-month rolling contract.

  • Align your pricing and service with industry standards

Don't be the cheapest – buyers will not be able to offer a better package to your clients and therefore will find it more difficult to transfer the contracts.

Your clients' key concern is continuity of service. An ideal buyer will be from a similar or adjacent sector, with a service offering and ways of operating that are similar to yours.

  • Market your products or services to a broad range of industry sectors

Create a client base that covers a broad range of sectors, including both private sector and local authorities, thus reducing its exposure to a downturn in any particular sector.

  • Grow your business

Buyers will pay a premium for businesses that are growing, not stagnant or with decreasing sales. Develop a comprehensive sales and marketing plan to increase your general activity and spread of clients.

  • Leave room for a buyer to expand the business

If a significant portion of the business is recurrent work from the existing client base, this leaves room for the business to expand through additional marketing activities. You should highlight how you believe expansion could be achieved.

Maximising the value of your business through operational aspects

  • Make sure the business functions without you

A good buyer is not looking to buy a job. Ensure that day-to-day issues are not down to you to resolve. The more time you spend on day-to-day activities in the business, the less value it represents to the buyer. If the buyer has to work full time in the business then they will have to pay themselves a salary.

  • Pass on your technical expertise to the business

Consider how a new owner without as much experience or technical know-how as you will run your business. Recruit or promote a suitable successor, put a management structure in place, or as a last resort consider providing ongoing consultancy.

By opening up the availability of your business to buyers that are not in the same sectors, you will increase the number of potential buyers and will therefore increase the number of offers.

It will also pay to develop a handover plan to transfer the business relationships to the buyer in an ordered way that will not disrupt your clients and cause them to consider other suppliers.

  • Make sure the business has suitable accreditations and company policies

Accreditations and company policies such as ISO quality certification, health and safety policy, personnel and training policy don't just add credibility to the ongoing strength of your business: they prove that the right systems are in place to manage the business without the owner.

Preferred Supplier status with your key customers is also a valuable asset that should be marketed to a potential buyer.

Maximising the value of your business through financial elements

  • Forecast your next year's revenue and profit

A buyer will almost always argue the price based on the performance of your business to date rather than the future they are buying. Your task is to sell them your business on its strength as an ongoing concern. If you can provide your annual forecast backed up by an order book and justifications for the remaining assumptions, this will draw the buyer's attention to the future revenue and potential for growth.

  • Produce monthly management accounts

Put in place a management accounting system that can tell you month by month the revenue, costs and profits from each client and revenue stream. This will add credibility to your forecast for the following year. A clear presentation will show buyers that the business is under control. Use a recognised accounting system.

  • Know – and be able to show – where your revenue is derived from

Divide out your revenue by service provided and by client. You need to be able to prove that your business is not over-dependent on one client. Again, a clear presentation, for example using pie charts, will show buyers that the business is under control.

  • Ensure that your clients settle past due payments

Make sure your clients are up to date with their payments and continue to pay within your invoice payment terms. Buyers will not want to take on clients with a history of late payment.

  • Make your accounts transparent

Maximise profitability, ensure all revenue is recorded, reduce non-core expenditure, and remove private assets. The fewer adjustments needed to assess the total earnings that a buyer could achieve, the more credible the business valuation.

  • Take any spare cash out of the business

Take any spare cash out of the business and leave only sufficient cash for working capital. This money is what you have earned, so take it; do not let it complicate the sale.

Maximising the value of your business through legal aspects

  • Review your contract documentation

Ensure that your client, supplier and employee contracts, as well as your standard terms and conditions, are clear and not open to dispute or potential claims. We recommend that you have your contracts reviewed professionally.

  • Ensure that client contracts are in place for all work undertaken

Ensure that all work undertaken is covered by contract and your standard terms and conditions. Try to reduce your obligations and risk of penalties.

Documented evidence of the work you are undertaking adds credibility and more certainty to the ongoing business in the eyes of a buyer. It will also enable the buyer to identify clearly the level of service being delivered and their ongoing liabilities.

  • Ensure that employee and supplier contracts are in place

One of your key assets is your staff, and the buyer will want to be confident that they will stay with the business after your departure. A good track record of staff retention, together with appropriate contracts, will do much to satisfy the buyer of the ongoing commitment of the staff to the business.

Maximising the value of your business on point of sale

  • Be prepared to sign a non-compete agreement on completion

Buyers will need to be assured that neither you nor your partners or employees will approach your clients for business after the sale.

  • Be prepared to offer an earn-out deal

Business vendors will frequently seek an outright one-off payment from the buyer. However, in many instances, in order to maximise the deal value it is advantageous to consider an earn-out settlement.

By agreeing to such a deal and thus effectively financing part of the acquisition, you will give the buyer confidence in the ongoing stability and profitability of the business. As a result, you are likely to achieve a higher overall deal value.

Moreover, if you are prepared to negotiate an element to the deal that is contingent on future earnings, this may help unblock deal negotiations where the buyer does not recognise the future potential of the business.

See the deal from the buyer's viewpoint

In conclusion, as with all acquisitions the buyer is looking to make an investment, not to buy more work. Think of your business from the buyer's point of view, make it easy for them to see how they can make a return on their investment, and you will achieve the optimum value for your business.

Remember, the best deals are when both sides win. Help the buyer to make a success of your business.

Finally, first impressions are key. Make sure you present a professional image. A tidy office and a smart brochure will indicate that your business is organised and run efficiently.

3. The process of selling a business

No two business sales are the same; each will have different challenges. However, a typical transaction will involve the following selling process.

1. The business vendor decides to embark on an exit strategy through the sale of their business.

2. The business vendor puts together a business sale team, i.e. legal representative, accountant and business broker.

3. The business vendor selects a business broker appropriate to the nature of their business.

4. The business vendor arranges a meeting (initial appraisal) with the business broker and decides whether to:

  • embark on a period of implementing improvements to the business's performance and structure (business grooming), or
  • start the selling process straight away.

5. Once the business vendor and business broker decide it is the right time to sell, a letter of engagement is signed in order to retain the business broker to market the business.

6. The sale preparation process starts and the business vendor provides all necessary documentation (accounts, asset lists, etc.).

7. The business broker prepares a business valuation report to identify the bottom-line deal value, possible deal structures and appropriate asking price and marketing strategy.

8. The business broker prepares the marketing brochure (sales memorandum and full information package).

9. The business vendor signs their approval for both the business valuation report and marketing brochure.

10. The business broker works with the business vendor to make sure all supporting documentation is ready for buyer enquiries and the eventual due diligence process.

11.The business broker proceeds with marketing the business.

12. The business broker manages all buyer responses and enquiries (buyer management):

  • Buyers are qualified for their suitability. 
  • Each buyer signs and returns a non-disclosure agreement (NDA) or confidentiality undertaking before receiving any detailed information.
  • The sales memorandum – an overview of the business structure, products and services and financial performance – is provided to the buyer.
  • Any buyer questions are directed to the business broker. 
  • The business broker arranges a meeting between the business vendor and the buyer, either at the business premises or at a discreet location.
  • The full information pack (financial statements, asset lists, etc.) is provided to the buyer. 
  • Any further questions and meetings are managed by the business broker.

13. The buyer submits an offer to the business broker.

14. The business broker reviews the offer with the business vendor to decide the appropriate response.

15. Further negotiation takes place as necessary, mediated by the business broker, until an offer is accepted (negotiation and mediation).

16. A heads of terms agreement is drafted by the buyer's and/or vendor's legal advisors and signed by both parties.

17. The transaction process now begins, coordinated by the business broker (transaction management).

18. The buyer starts the due diligence process with their legal advisor and accountant.

19. The business broker works with the business vendor to ensure all necessary documentation to support the due diligence is made available in a timely fashion.

20. The business broker liaises with the legal advisors and accountants of both vendor and buyer to ensure that the deal process remains on track and that any issues are resolved effectively.

21. Once due diligence is completed, the sale and purchase agreement is prepared by the buyer's and/or vendor's legal advisors and signed by both parties.

22. Contracts are exchanged and the deal is completed.

The business is sold. It is time to relax and enjoy the fruits of your hard work.

The sales memorandum

The sales memorandum needs to give the buyer enough information to enable them to decide whether to arrange a meeting with you and make an offer.

It should not give away the essence or intellectual property of how you run your business. However, it should enable the buyer to assess the position of your business relative to the questions in the "Maximise the Value" checklist.

The contents typically include the following items.

1. Key points

This part is normally a one-page summary of the business: what it does, staffing, premises, turnover and profit. It is used to generate interest in your business but contains no direct information on the identity of your business.

2. Business overview

The business overview provides the buyer with a brief history of the business, its successes, the reasons why it makes a good investment, and what is included in the sale of the business.

3. Products and services

Much like your own marketing material and website, this section details the services provided by your company and the benefits to the end customer, thus demonstrating why it is a viable ongoing business.

4. Staff and management structure

Buyers will wish to know about your staff: the basis of their employment (permanent or contract, full or part time), their qualifications, experience and time served with the company. Therefore this section will contain a summary of this information. It will also explain the business owner's role in the business.

5. Location and premises

The following information will be required:

  • Rent: £X per year
  • Rates: £X per year
  • Duration of lease/tenure: X years, with Y years still to run
  • Date of next rent review:
  • Area/size: X m2
  • Number of desks: X.

6. Financial performance

This will be the most important section for the buyer. Buyers are not generally given access to the accounts until they have met with the business vendor. This section will, however, show the buyer the headline figures for the last three to four years, i.e.:

  • turnover,
  • gross profit
  • adjusted net earnings.

The net profit shown in your accounts is not necessarily a true reflection of the earnings that a buyer could extract from the business. It is therefore advisable to calculate and show a figure for adjusted net earnings. This will depend on the type of buyer, as explained on page 3 under the heading Multiple of earnings value.

First, the net profit is adjusted to show the potential earnings for a financial buyer. The adjusted figure reflects the owner's takings and benefits less the cost to the new buyer of employing a replacement general manager. The cost of bank interest and depreciation is also removed from the overheads, as this can also be considered as additional profit potential for the buyer.

The net profit is then further adjusted to show the potential earnings for the strategic buyer, taking account of the savings from which a strategic buyer could reasonably benefit. This can include costs of premises, insurance, industry membership subs, advertising, IT costs, staff, accounting and legal.

It is also recommended to provide the following information to prove the ongoing strength of the business:

  • forecast revenue for the following year
  • revenue split by client and product or service
  • Revenue for the last three months to date compared with the same period last year.

7. Future developments and opportunities

The future earnings of the business are being sold to the buyer. This section therefore explains the various potential means to grow and expand the business. It may be helpful to consider what you would do if you were taking over the business.

8. Reasons for sale

Buyers will want to be assured that you are not wishing to sell the business for any hidden reason such as liabilities, large indemnity claims or serious risks to the business that only you would know about, and that you will not start up a similar business and take back your clients.

Retirement and emigration are usually deemed to be understandable and acceptable reasons for selling a business. If you intend to pursue other unrelated projects, it is advisable to explain what they are. A general desire for a change, while perhaps understandable, will raise suspicions if not expanded on.

9. Basis for sale

For larger businesses, with a turnover of more than £500,000, it is generally advised to invite offers. For smaller businesses, state the asking price and terms, for example:

  • £X for assets and goodwill plus stock
  • £X + net asset value for sale via share transfer.

Keys to a successful business sale

  • Present your business as an investment.
  • Make it clear how a buyer can make a return on their investment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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