It’s not hard to find examples of corporate transactions in the sector – Factor Sales Ltd being acquired by Pearson Ham Group in March, Express Factors Sevenoaks being bought by AAG in April, and Alliance Automotive acquiring CAAR Group in May.
But for others new to the process, what does it involve?
In overview, mergers and acquisitions (M&A) refers to transactions between two companies that combine in some form. Although mergers and acquisitions are used interchangeably, they come with different legal meanings. In a merger, two companies of similar size combine to form a new single entity. On the other hand, an acquisition is when a larger company acquires a smaller company, thereby absorbing the business of the smaller firm.
M&A deals can be friendly or hostile, depending on the approval of the target company’s board.
Activity in this area hit a high in 2021 but slowed in 2022 – according to report from pwc, Ready to move: Gearing up for the deal rebound in 2023. It noted that “in total, the UK saw 4,232 deals across 2022, compared to 5,033 for the previous year, a 16% decline.” It added that “there was a total of £93.5bn worth of UK deals in H1 of 2022 compared to £51.4bn in H2 bringing the total deal value for the year to £144.9bn. However, total deal value for the year was down 56% compared to the record £332.1bn in 2021.”
Nevertheless, the figures involve some large numbers and activity in this area is still worthy of consideration.
Paul Taylor, a partner in the corporate department of Fox Williams, is of the view that success depends on understanding what an M&A seeks to achieve. For many he says that “the goal is to achieve a clean exit from a business. But some may wish to stay on and become a part-owner of a bigger business that makes the acquisition.”
Deciding on the goals at the outset and communicating these to a potential buyer upfront makes it more likely that the desired outcome will be achieved.
Many sales take the form of a share sale rather than an asset sale. In essence, the former transfers ownership interests in the company, whereas the latter means the sale of assets and business to another company.
Taylor says that there are benefits and drawbacks to each, but a key driver is tax: “A share sale may give rise to capital gains tax on the profits made. An asset sale will result in corporation tax on the proceeds of the sale made by the company. Once the company has paid the corporation tax, the proceeds of the sale can then be distributed, but if the owners are individuals, they will be charged income tax on the proceeds.” In effect, there can be double taxation on an asset sale which is why share sales are preferred.
An issue for private limited companies is that they have no open market for their shares, making it difficult to determine a valuation – at least not without external advisers. Here Taylor recommends that “a valuation is obtained from a reputable corporate finance adviser early on in the process.” He continues by explaining that there are options for sellers: “With a ‘locked box’, the price is locked on a particular date and any leakage out of the company to the sellers and connected persons from then is owed to the buyer. But with completion accounts, the price is subject to adjustment once accounts have been prepared and finalised following the completion date to reflect the true position at the date that the buyer acquired the company.” Understandably Taylor sees locked box being more preferable for sellers.
Regardless of the route, key terms that are important to the seller should, says Taylor, be “documented by way of a letter of intent or heads of terms.” He says that “while such a document generally won’t be legally binding (save for certain specified provisions such as confidentiality), it will record that the parties agreed to proceed with the deal on the basis of the terms.” In other words, the document makes it much harder for the buyer or its lawyers to argue about the basis of the sale when the official documentation is drafted.
Naturally, centre-stage of any transaction is the payment.
Those looking to make a clean exit will likely be looking for the buyer to make a single cash payment upon completion. However, as Taylor has seen, those intending or are required to remain with the business following completion, may see the buyer suggest a different consideration structure such as an earn-out.
In fact, he’s often seen “provisions that link a target – say profit or revenue – to the price that is payable at a future date… there are myriad other potential consideration structures that may be proposed, depending on the motivations and finances of the buyer.” One example he comes across in private equity transactions is where the buyer expects sellers to stay on with the business and must reinvest a portion of their proceeds into shares or loan notes within the buyer’s group.
Often there are obstacles to be overcome that buyers will need resolved ahead of completion. For example, the firm may have material customers with contracts that contain change of control provisions whose consent the buyer will need to obtain prior to completion. There might be other significant issues that will be uncovered by, or revealed to, the buyer via the diligence and/or disclosure processes
Even so, Taylor advises that “in all cases, you should communicate potential issues to your advisers at the outset of the process. Consider together at what stage to make these known to the buyer and how best to handle them at that time.”
Managing the process
The M&A process takes time because buyers want to conduct a due diligence and as Taylor highlights, “the timing of this exercise will depend on the buyer’s level of urgency, the amount of information to review and the materiality thresholds the buyer might have set for such review.”
Another consideration for Taylor is the high likelihood of the need to give warranties in the sale documentation relating to the company and its business operations, “against which you can disclose any untrue or misleading information to limit your liability.”
It should be said that due diligence does open up a company’s innermost secrets. It also risks the public, customers or suppliers learning of the deal itself before it completes. On top of this are worries if the potential buyer is a competitor and/or within the same industry.
It’s because of these risks that Taylor recommends that sellers enter into a confidentiality or non-disclosure agreement at the outset to “provide some comfort that potential buyers will keep the information they learn during the deal process, and the existence of the potential deal itself, confidential.” That said, there are other ways to protect sensitive information that is disclosed during the transaction; two options that Taylor mentions are to “only upload data once it has been established that the buyer is sufficiently serious about the deal and to apply permissions to documents so that they cannot be printed or downloaded.”
Personal tax implications
Lastly, while proceeds from a share sale should be taxed as capital gains, with the rate depending on whether the individual is a basic rate, higher or an additional rate taxpayer and whether they have made any other capital gains within the same tax year, there is also the business asset disposal relief (BADR), formerly known as entrepreneurs’ relief, to consider.
Taylor puts great store in BADR since it “currently entitles you to a 10% tax rate rather than the otherwise applicable capital gains tax rate.” He adds that, broadly speaking, “this relief should also be available on asset sales and share sales but there are various qualifying conditions and you should definitely take advice from your tax advisor before structuring the sale transaction.”
Those seriously considering a sale of their business, should instruct lawyers and any other advisers as early as possible. They will need corporate finance advisers, accountants as well as lawyers and their early involvement will maximise the chances that the desired outcome with be achieved.