Introduction

Are you a first time seller or buyer who wishes to sell or buy an existing business? If the answer is yes, read our mergers and acquisitions guide.

Mergers and acquisitions (M&A) is the term given to commercial transactions where companies combine or purchase other companies with the aim to generate growth. Whilst the terms ‘merger’ and ‘acquisition’ are often used interchangeably, it is important to note that they have different meanings. A merger is guided by the benefits of continuity and combination of two or more existing businesses forming a new legal entity, whereas an acquisition involves a company buying the assets or shares of another company with the intention of taking over the acquiring company and establishing itself as the new owner.

This guide focuses on the acquisition aspect of mergers and acquisitions and sets out the key steps involved in the process, including discussion and negotiation, investigation, risk management and transaction management.

Pre-Contractual Stage in Mergers and Acquisitions

Term Sheet
Prior to entering into a binding agreement, the parties, being the seller and the buyer, discuss the core aspects of the transaction in detail and negotiate the terms. This is achieved by entering into a term sheet, also known as a “letter of intent”, “heads of terms” or a “memorandum of understanding”. The purpose is to outline the key commercial terms agreed between the parties, such as the purchase price (and how it is to be paid), the valuation and any assumptions underlying the purchase price, the main conditions for entering into the transaction, a proposed timeframe and transaction process, legal documentation, and any other matters pertinent to the transaction.

A term sheet is a non-binding document that simply acts as a framework for negotiating and drafting legal documents. Whilst the parties are not expected to comply with the term sheet and are free to re-negotiate the terms, it shows the parties’ intention of entering into the transaction and makes it more challenging for a party to attempt to change the terms of the transaction at a later date.

Due Diligence for mergers and acquisitions
Due diligence is a process where the buyer investigates the company they are acquiring, known as the target company (Target) by first setting out the questions it requires the seller to respond to in a formal questionnaire. The seller will be expected to set up a data room (a physical or virtual space to store relevant information about the Target) and submit documentation in response to the buyer’s questionnaire.

It is in the buyer’s interests to know as much as possible about the Target and its affairs in order to make a complete assessment of the Target and its liabilities. However, if the seller fails to make such issues known, it will usually be liable to the buyer after the acquisition for any losses which ensue to the buyer, on the one hand, and in the seller’s interests to assist that. This stage is also critical for the buyer as it furthers their understanding of the Target’s business and helps them to identify potential issues that could impact the value of the Target. See Understanding the due diligence process in a business sale deal for further information.

Legal Documents for Mergers and Acquisitions

Share Purchase Agreement
Assuming that the buyer is purchasing the shares of the Target (the alternative being to buy the ‘business’ or trading assets of the Target) the key agreement forming the essence of the transaction will be a share purchase agreement. Drafted by the buyer’s solicitors following due diligence, the purpose of the agreement is to govern the ways in which the shares will be transferred to the new owner and will contain the key provisions including but not limited to:

Consideration: This concerns the price of the shares, timing of payments and any adjustments to the purchase price. Whilst it is common for the buyer to pay by cash, there are many variations, for example the consideration may be shares in the buyer company. Regarding cash payments, though the buyer could pay the purchase price in full on completion, it is common for the purchase price to be split so that the remainder is paid at later dates. Known as deferred consideration, this usually guarantees fixed payments in the future. The buyer could also pay earn-outs, which are also paid at a later date subject to the Target reaching certain performance criteria.

Conditions: Some transactions may require the seller to comply with certain conditions before completion takes place. Common examples include obtaining regulatory consent for the change of control or change in scope of business, the prior repayment of indebtedness, and, where required, the buyer obtaining third party funding.

Warranties and Indemnities: Whilst the purpose of the due diligence process is for the buyer to uncover all material information of concern, it is customary for the buyer to seek additional protection by obtaining warranties from the seller as part of risk management – especially where it is not possible to ascertain any facts by reviewing any due diligence materials. Warranties are contractual statements of facts about a particular state of affairs in the Target. The purpose of giving warranties is to give the buyer the right to claim damages for breach of contract if the warranties turn out to be false and to encourage the seller to disclose information about the Target. The seller will usually give warranties in respect of any issues having a bearing on the value or viability of the business. At the least these will cover title to the shares, the Target’s business, financial records and tax matters.

Warranties will not protect the buyer, however, if the seller gives the buyer any information which should make the buyer aware that the relevant warranty cannot be true (see ‘Disclosure Letter’). The buyer will then most likely seek to negotiate a lower price to reflect this risk arising from the lack of warranty. However, if there is uncertainty about whether the risk will actually occur or, if it does occur, what the actual cost would be to the buyer, the buyer will usually seek an indemnity from the seller, which is a promise by the seller to reimburse the buyer an amount equivalent to the eventual loss suffered as a result of such risk or issue.

Other key provisions in the agreement may include:

  • Directorships and management – usually the existing directors of the Target will resign on completion and be replaced;
  • Post-Completion Restrictions: To preserve the value of the Target, the buyer typically imposes restrictions on the seller and its directors or significant employees, such as agreeing not to poach clients and employees or compete with the Target for a set period following completion;
  • Limitations of seller’s Liability: The seller will not wish to be liable indefinitely under the warranties and will require a limited period in which warranty claims may be brought and will limit the total amount of the claims as well as stipulating a minimum size of claim to avoid small nuisance claims; and
  • All the practicalities of how completion will occur.

Disclosure Letter

As explained above, warranties create potential liability for a seller. If the disclosure meets the requirement for fair disclosure i.e. sufficient detail to identify the nature and scope of the matter disclosed, the seller may avoid liability for breach of warranty. It is therefore critical for the parties to review the disclosures in detail as a poorly drafted disclosure would result in a claim for breach of warranty by the buyer.

Signing and completion

Once the agreement, the disclosure letter and any other relevant documents are agreed, the parties sign the documents in readiness for completion. Completion takes place when the transaction completes, which is when title to the relevant shares pass to the buyer and the buyer pays the purchase price.

Post-completion

After completion, there is still a lot of work to do on the legal aspects to formalise the transfer in ownership. The buyer’s advisers will usually take post-completion actions, such as updating the Target’s registers to reflect the change in ownership, making appropriate filings at Companies House and paying stamp duty on share transfer where it concerns a share sale.