Over the years RJP has advised countless clients selling their companies, helping them to achieve the maximum sales price for their hard work and to reduce capital gains tax liabilities. Time and again, we see the same issues crop up and threaten to scupper the deal. In some cases, they can actually result in the sale falling through.
With the economy in its current difficult state, if you find a buyer willing to pay a decent price for your company, you need to try and hold onto them. In this article we consider what clients considering a business sale can do to make sure there are the minimum number of issues within their company that may result in a reduction in the sale price, or in a sale falling through.
So, what are the most common deal breakers as we’ve experienced them?
#1 Poor statutory record keeping
Believe it or not one big reason why sales are jeopardised is because the business owners have not properly maintained company secretarial records. This often seems like unnecessary red tape at the time for a small business, but bad statutory record keeping sends a warning message to prospective buyers that there might be other accounting or reporting issues to watch out for and demonstrates a certain level of ‘sloppiness’ to be avoided. The most common examples of mistakes here include a failure to properly record share movements and keep full historical records, no formal minute taking at the annual general meetings and shareholder dividends being paid without the issue of formal dividend vouchers.
#2 Negotiating warranties
When buying a company, the acquirer takes on responsibility for all the liabilities of that company which arise after the purchase, even if those liabilities relate to past events, which may of course occurred long before they took ownership. The selling shareholders will therefore be expected to provide personal warranties to confirm there are no ‘skeletons in the cupboard’ and that they will take responsibility for any such ‘skeletons’ that later emerge. A due diligence process undertaken by the purchaser will seek to identify anything that might affect the future profitability and smooth operation of the company, and typically will include a certain level of negotiating as to what is and isn’t included in the warranties provided by the selling shareholders. This may in turn impact on the sale price.
As a selling shareholder, you will want the sale price to be as high as possible, and the personal warranties that you provide to be as low as possible. To achieve this, it will be important that the company you are selling is as ‘clean’ as possible and that it can clearly demonstrated to be so. Scenarios that can impact upon this are poor accounting records, tax reporting, company secretarial records and record keeping generally, together with any potential tax liabilities that might arise, for example in relation to contractors who could be reclassified by HMRC as employees - status issues such as this are a common problem.
To ensure you don’t fall foul of these issues it is good practice to undertake independent pre due diligence checks before putting your company on the market, to ensure you are in the strongest possible position.
#3 Aggressive tax planning
HMRC is clamping down heavily on what it regards as tax avoidance with a series of initiatives and campaigns designed to root out offenders. Employment Benefit Trusts (EBTs) are a case in point and although commonly used as a tax planning vehicle and perfectly legal, HMRC has declared that it now regards this type of planning activity as aggressive and potentially an example of tax avoidance. EBTs are a form of discretionary trust, which seeks to reward employees by making payments that favour certain employees or their families and does so in a way that either defers or completely avoids PAYE, NICs and other taxes. In an attempt to close down loopholes, the Government unveiled new legislation in the 2011 Finance Bill, with the result that the operation of EBTs is now more complex.
Tax planning which is viewed by HMRC as aggressive will always result in significant personal warranties being required from outgoing shareholders, such that they bear the responsibility for any future tax liabilities which arise in relation to the planning they have undertaken. It should also be borne in mind when entering into such arrangements, that they may deter a potential purchaser who wishes to steer clear of such arrangements.
#4 Ensure your company charges a market rate for services
This is an issue that is usually identified during the due diligence process and it might sound incredible but has been problematic for a number of clients we have worked with. If it becomes apparent that a company has been successful in gaining customers but has not been charging market rate prices for its services, then a larger company looking to make a purchase is going to find it very difficult to raise prices in line with market trends and maintain the existing customer base. This will significantly impact the sale price therefore it is important if you are considering selling at some point, (and of course for other reasons) to conduct regular reviews ensure you are pricing your products or services in line with competitors, and to have formal policies in place to cover regular incremental price increases with customers.
#5 Staffing and succession problems
Company sales can also fall through for what is usually the very reason the company in question was successful in the first place - a talented founder and key staff. Ask yourself, how integral are you and your core employees to the future success of the business? Especially in the short to medium term? All too often, founders fail to appreciate how the company will run without them being involved, which presents a big worry to prospective buyers. In a similar way, companies reliant on one of two big customers for a large proportion of their revenues send similar warning signals to purchasers, and are another factor behind failure rates. If certain staff members or customers are critical to the company’s business, this needs to be carefully managed and planned for, with appropriate long term contracts if possible for clients, and perhaps share options for staff based on final business value achieved.
Overall, our advice to shareholders who are thinking of selling is to ensure they involve accountants early on in the process. From conducting pre due diligence audits to helping to agree favourable heads of terms, getting the right advice will mean you are in a good position to achieve maximum sale proceeds, undertake tax planning and also, as experience has shown, can help to ensure the deal is actually completed.