The acquisition of a business requires informed choices to be made about many vital and strategic matters, including the manner in which the acquisition should be structured and the protection of confidential information. How these issues are addressed can have important consequences for all of the parties involved and for the long-term financial performance of the business being acquired. In this article we provide an overview of the preliminary steps of an acquisition leading up to the acquisition agreement.
INTRODUCTION
An Acquisition is a transaction whereby an individual or company ('the Purchaser') acquires control over the assets of another company (the 'Target Company') and there are essentially two ways in which it may be effected.
First, it may be effected directly by the Purchaser acquiring the business of the Target Company by purchasing certain of its assets and liabilities (an 'Asset Purchase'). Assets and liabilities must therefore be listed and the business defined in detail so that the parties can agree on those assets and liabilities which are to be transferred to the Purchaser. An Asset Purchase may prove to be laborious and time consuming. The benefit of this method to the Purchaser is that the risk of assuming unwanted liabilities is small.
Secondly, it may be effected indirectly by the Purchaser obtaining control or management of the Target Company by acquiring shares in the Target Company (a 'Share Purchase'). Upon a Share Purchase, the business of the Target Company continues uninterrupted by the transaction and in the absence of contractual provisions to the contrary, all of the Target Company's contracts with third parties such as customers, suppliers and employees continue unaffected by the transfer. Similarly, the Target Company's liability to third parties subsist. The Purchaser must therefore examine carefully the extent of the Target Company's liabilities. The risk of this method to the Purchaser is that of taking on unseen and unknown liabilities together with the business.
THE PRELIMINARY CONFIDENTIALITY AGREEMENT
The first step in the acquisition process is the identification of the Target Company by the Purchaser which is largely a commercial matter for the businessman. Once the Target Company has been identified, preliminary negotiation will commence. The parties will be seeking to decide in principle what price the Target Company might be prepared to accept and the Purchaser might be prepared to pay. At this stage the discussions are likely to be vague and non-committal.
For discussions to progress, however, the potential Purchaser needs to make a more thorough investigation of the business. On the other hand the Target Company will be wary of competitors who may be merely on a fishing expedition and is hesitant to disclose too much information in the event that the transaction does not proceed to a conclusion. To meet the somewhat divergent needs of the Target Company and the Purchaser the parties may choose to enter into a confidentiality agreement whereby the Target Company agrees to make certain information about the business available to the Purchaser and the Purchaser undertakes to keep that information secret. The agreement is often prepared in a letter form and usually will contain:
- a definition of confidential information;
- the obligation on the part of the Purchaser to keep the information secret and to use it only for the permitted purpose;
- the circumstances in which the Purchaser is permitted to disclose; and
- a provision for how the information is to be treated if the deal is aborted.
LETTERS OF INTENT
After the negotiations have progressed to a certain stage, if only to reassure each party of the other's commitment to pursuing the transaction to a conclusion, parties may choose to enter into a letter of intent. The objective of the letter of intent is to highlight the main points agreed between the parties and the basis on which they are prepared to proceed. As such it will usually contain:
- the names of the parties;
- what is being sold i.e. shares or assets;
- the price or the method for calculating same;
- the duration of the letter of intent - i.e. a drop-dead date by which time if the transaction has not concluded, parties are free to walk away;
- a confidentiality clause;
- a 'lock-out' clause i.e. an undertaking by the Target Company that for a defined period it will not entertain any offers from other proposed purchasers;
- a provision governing liability for costs and expenses;
- legal effect; and
- governing law.
DUE DILIGENCE
Even after entering into a letter of intent, the Purchaser's knowledge of the Target Company may still be limited to information which is within the public domain; what he has learnt through direct dealings with the Target Company and what initial information the Target Company has released to him. Generally, a Purchaser would be unprepared to enter into a binding contract without first investigating the financial, commercial and legal condition of the business. He would need to determine whether he is committed to concluding the proposed transaction; on what terms; at what price (same may require re-negotiation); what are the peculiar risks he may be exposed to upon acquisition (in respect of which he may seek warranties and indemnities from the Target Company in the acquisition agreement). He would want to conduct what is commonly called a 'due diligence'.
To properly inform a decision to acquire, the Purchaser's due diligence should focus on the following basic information:
- corporate details of all group companies;
- details of the target's business and trading practices;
- detailed accounting information on each group company and consolidated accounts;
- details of all of the Target Company's loan facilities and security;
- the terms and conditions of the Target Company's employees with special reference to pensions;
- title to the Target Company's assets;
- insurance;
- any pending litigation, disputes or investigations;
- environmental planning and safety concerns;
- the taxation position of the Target Company; and
- material contracts to which the Target Company is a party.
For obvious reasons, the extent of the due diligence will be more extensive in the case of a Share Purchase than an Asset Purchase. Given the wide range of information that a Purchaser will be seeking from the due diligence, its relative success or failure will depend on the peculiar expertise of the team conducting same.
Notwithstanding the time, financial and confidentiality constraints that will beset every Purchaser, he will be well advised to include in his due diligence team personnel with expertise in law, accounting, intellectual property, employee benefits, environment, health and safety and business and trade.
It would be prudent for a Purchaser to engage these professionals early in the due diligence process to assist in the preparation of a due diligence questionnaire for completion by the Target Company. The questionnaire should be as exhaustive as possible on the issues highlighted above. Upon completion of the questionnaire by the Target, the due diligence team should meet and check the replies carefully to identify those points which remain outstanding for follow up. Thereafter, it may be necessary for the team to conduct a data room examination of the Target Company to verify the responses to the questionnaire and to follow up on any outstanding items. The Data Room procedure will usually be prescribed by the Target Company. Upon submission of a report by the due diligence team, the Purchaser then has to make the ultimate decision whether he wishes to conclude the acquisition and on what terms. Once he wishes to proceed to conclusion, it is will be necessary for an acquisition agreement to be drafted and executed.
An Acquisition Agreement will usually be structured in one of two forms depending on the business goals to be achieved, and will quite commonly contain the following clauses:
Definitions and Interpretation
The first clause is usually a definitions and interpretations clause. This assists the drafting of the agreement and facilitates its interpretation. In the case of an asset sale, the most important definitions are those which define the business itself, the information, assets and liabilities and employees relating to the business, which are to be transferred to the Purchaser or retained by the Seller. In the share sale the most important definitions may be the share price, the Target's financial statements, its net assets and its net profits.
Agreement for Sale
The second clause is usually the Agreement for Sale clause. In the asset sale it will deal with the segregation of assets to be transferred to the Purchaser and those which are to be retained by the Seller.
In the share sale it will stipulate the shares which are being sold, that they are free from encumbrances and will include a waiver of pre-emption rights by the Vendor.
Purchase Consideration
The next clause will set out the purchase consideration. In an asset sale the purchase consideration may be a total cash sum which is allocated to the various classes of assets to be transferred. In determining that allocation, tax considerations are of paramount importance.
In a share sale, the purchase consideration may be both cash and shares. On closing, the Seller might receive a fixed amount of cash and the allotment to him of a certain number of shares. Thereafter, the Seller might receive future payments of cash calculated as a percentage of the Target's net profits over a stipulated period subsequent to closing.
This clause may also include a provision for a price adjustment to be determined, inter alia, by reference to completion accounts prepared after closing.
Mechanics of Completion
It is important in any acquisition agreement to set out clearly the mechanics of completion. In the asset sale, this clause will address the transfer of title to the assets and the requisite consents to be obtained from third parties such as customers and suppliers.
In the share sale it will deal with the completion of share transfers; the resignation of existing directors and auditors of the Target; the delivery of the statutory books of the Target and the deeds relating to the Real Property and the holding of the requisite board meetings to finalize the transaction.
Representations, Warranties and Indemnities
This very important clause will set out each of the matters, which the Seller warrants are true and accurate. A prudent Purchaser will seek warranties as to ownership of assets, sufficiency of assets for running the business, the Target's trading practices and financial position, its customers and suppliers, insurance, properties, banking arrangements, taxation, employees and compliance with industry-specific legislation.
For his part, the Seller will seek his own protection by preparing a disclosure letter in which he qualifies the warranties and to which the warranties clause will be made subject. The Seller may also require the Purchaser to mitigate and may insert a limit to the third party claims.
Employees
In the absence of legislation providing for the automatic transfer of employees upon a business transfer, this clause will need to specify those employees who will continue their employment with the Purchaser and on what terms. It will deal with any accrued holiday entitlement and redundancy of certain employees.
Pensions
The issue of pensions and its treatment in any acquisition is sufficiently important and complicated to have a separate clause dedicated to it.
Restrictive Agreement
An otherwise very lucrative acquisition may be rendered completely worthless unless the agreement includes a restrictive agreement whereby the Seller agrees (for a stipulated period after completion), not to disclose to any person information concerning the business; not to solicit, interfere with or endeavor to entice any former client, customer, employee or any other person in the habit of dealing with the Target and not to engage in a similar business.
Apportionment
This Clause is more common in an asset sale. It is a transitional provision which provides for the apportionment between the parties of such periodic payments as utility charges, remuneration and PAYE made before completion but relating to periods after completion.
Governing Law
The agreement will stipulate a governing law, the selection of which is likely to be an issue only in the case of an international acquisition.
Miscellaneous
Finally, the agreement may contain a general provision regarding such matters as regulation of publicity, return of documents, notices, assignability, binding effect of the agreement on either party's successors and assigns and costs.
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.