As a business owner you may have recently purchased or started the business with the intention of spending many happy, and perhaps some not so happy but hopefully successful, years working to secure yours and your family’s future.
Whether you’re at the point of buying or selling a business you’ll know that the success or failure of a business will depend on hard work and the investment of time, effort and money.
As solicitors we understand business planning and a small amount about finance (but it is not our forte). We notice time after time through years of experience that when clients come to sell their business things which should be well established are not as they should be. For example, the company property may be in the name of the owners rather than the business, liabilities are not protected against with good limitations of liability clauses in contracts, litigation or potential litigation is outstanding, written contracts with suppliers or customers may not be in place, and employment disputes may be bubbling up under the surface. Quite simply, issues arise which could have been avoided with some careful planning.
Even the largest and well established of businesses have issues underlying or lurking in the background which may only become apparent when an owner is looking to sell. The solutions are two-fold; examine the legal risk to your business as early as possible, and run the business as if you were going to sell it tomorrow!
When selling a business, an important first step is to ensure that all the legal due diligence questions that a purchaser will ask are addressed. As solicitors advising clients daily on these issues in businesses that are not yet for sale, it occurs to us that the best advice is to use our extensive due diligence questionnaire and go through each issue to ensure your business is legally fit for purpose.
Questions are asked about:
1.) Business Constitution
Is there a shareholders agreement, partnership agreement in place? We can appreciate that when you commence a business you are focused on the delivery of a product or service, but the best time to resolve issues such as when the business is to be sold, pre-emption rights, exclusion clauses, binding sale clauses, push and pull, drag along and tag along rights is when issues are in the future and are not pressing.
For example, in a House of Lords case two long standing friends and equal shareholders decided that they would transfer shares to one of the shareholder’s sons. The inevitable happened and the father and son excluded the minority shareholder from the business. The case ran and ran and incurred thousands of pounds in legal costs, but the issues that arose could have been resolved in advance with a well drafted shareholders agreement that dealt with minority protection rights and provisions on how the business should be valued on retirement sale. It is always easier to agree and resolve these issues when the parties are not warring. This is perhaps an extreme example, but serves to illustrate the point that proper planning and a well drafted agreement will avoid future problems.
2.) Company Books and Records
It may be our experience but company records (statutory books including shareholder and director registers) are seldom up to date, or in the worst case scenario are not available. For example there may even be a shareholder that should no longer be in place, such a shareholder may have a claim to receive sale monies on a sale. Rather than letting the situation continue it may better to deal with these issues in advance before it becomes an expensive problem. Again, this is a straightforward issue to resolve but if left to fester can affect value.
Are contracts of employment in place? Are the contracts adequate to cover the employment risk? Simple provisions should be considered including confidentiality, valid and binding restrictive covenants preventing or deterring employees setting up in competition, soliciting clients or other employees and ultimately undermining the businesses.
Are grievance procedures in place and properly communicated to all employees? Where they are in place it is essential that the business follows these procedures. Even where these procedures are followed we cannot exclude the risk of employment disputes and tribunals. Employment claims can be a huge cost to a business with costs up to £100,000 including legal costs. A simple and cost effective solution is to insure against this risk and ensure that you have peace of mind that contracts, processes, policies are in place. Else have a cost effective package known as ‘Else Protect’ which includes a fully inclusive insurance policy and provides access to qualified employment experts all for an affordable monthly charge.
Simple, but often forgotten issues need to be addressed for example; How is the business conducted? What rights are maintained and obligations adhered to?
Prior to sale, disputes and litigation should be settled. Businesses should also consider adequate provisions in their accounts to provide security to a Purchaser that the dispute or litigation is funded.
Who owns the business property, the business or the owners? In many cases, Else can effect a transfer of property from an owner to the business. In some cases it may be more tax efficient to transfer the property to a pension fund, something definitely worth thinking about.
6.) Intellectual Property
Has the business protected its intellectual property? Intellectual property are those rights that arise in inventions, business names, logos, works, methods of doing business, software or other creations it includes trade marks, copyright, patents and design rights.
Businesses trading for even a short period develop goodwill in the name or mark of the business. It is surprisingly inexpensive to register a trade mark and this can be one way of ensuring that the goodwill created is protected for the business.
Furthermore, a business should ensure that it does not give away its intellectual property in its work or products by ensuring that it retains ownership of rights in its agreements with customers and in the contracts of employment with its employees.
A business that takes steps to protect its intellectual property will ultimately secure more value in the business at sale.
7.) Supplier Sale and Purchase Contracts and Contracts with Clients
Are these contracts on the business’ own standard terms and conditions or agreements? It is fundamental to address provisions such as payment terms, duration, termination rights and liabilities in contracts with your suppliers or clients. For example, long payment terms in your agreements with clients could adversely affect the business cash-flow, or alternatively a supplier agreement without adequate rights to terminate can leave the business trapped with inefficient or poor performing suppliers.
For a business in which the main assets are its contracts with its clients, it is useful to ensure that on a business transfer that the contracts do not simply terminate. A business should also ensure that it can transfer the rights and obligations to a successor. Else can advise as to what provisions should be included or excluded.
Are your agreements with those that introduce your business to customers, or distribute your products to customers correctly drafted? Without careful drafting of your agreements with agents the business may be liable to pay large compensation payments on termination. Alternatively, there are anti-competitive restrictions that can effect distribution agreements including price setting provisions. Both aspects need careful consideration and drafting.
Is the relationship between the HMRC and the business healthy? Is the business up to date with its tax liability to the HMRC? Has the business correctly accounted for the plethora of business taxation? For example PAYE, VAT, Corporation Tax.
Consideration should be made to the impact of personal taxation as well as business consideration, in particular in the run up and after a sale of a business. For example, an individual may qualify for entrepreneurial tax relief if that individual is a director or secretary of the company and has held that position for at least two years. Both the business’ accountants and the personal accountants of the owners should be consulted throughout the life of the business to maximise tax efficiencies.
9.) Bad Debt
What is the debt owed to the business by its clients? What is the businesses bad debt figure?
Debts owed to the business is ultimately an asset of a business. Bad debts (when the debt has been determined as unlikely to be paid off) are seen ultimately as losses to a business. It’s obvious that both can affect the value of a business. Managing debt starts with good due diligence of customers and suppliers, and continues with good contractual provisions.
Else can offer its existing clients monitoring services for their troublesome or suspect business clients. The service provides a warning in the event of poor solvency or financial strength of businesses falls.
Whilst warnings may be given it may be too late, as financial strength may be measured on the basis of old information and previously submitted accounts. Therefore, it is essential to mitigate the risk of bad debt by investigating the financial stability of clients and/or suppliers. This can include requiring references, to requiring the latest or interim accounts. Alternatively, where concern is found, Else can advise and draft guarantees for the performance of obligations, specific liabilities for all future debt or otherwise under an agreement.
A pro-active approach to debt is imperative. Strong contractual provisions in your agreements or terms and conditions including payment terms of 30 days or less, interest on late payment, ability to suspend on late or non-payment and an ability to recover third party costs of recovering outstanding amounts can all help to manage and mitigate the risk of bad debt.
This is not an exhaustive list and some issues if ignored may never impact on the sale price of the business or affect its operation effectiveness or solvency. However, woe betide those who leave the above issues and many more to the time at which the business is sold. After all, one of the biggest times in life for business owners is the time at which they sell their business, and only careful planning will ensure the best possible value of return at the sale of the business.
How Else can help
Else can offer a complete in-house service to business clients including corporate and commercial, debt recovery and commercial property. In addition, with a strong Wills and probate department we can also ensure that business owners’ families are correctly catered for in the long run. For your [free no obligation] legal risk due diligence review, please contact us on 01283 526200.