Whether you have engaged a corporate finance adviser to market your business for a sale or received an unsolicited offer, the Heads of Terms (“HoT”) sets out the fundamentals of their offer to you. They outline the consideration payable for the shares (or trade and assets), any expectations for key staff or seller to remain in the business, payment terms for deferred consideration and any exclusivity period for the offer, amongst other things.

While the HoTs are not legally binding, they do indicate a commitment from both sides. From this point onwards, both buyer and seller are acting in good faith, will start to incur significant professional fees, so getting the fundamentals right early is crucial. Once agreed, it can be difficult to deviate from key terms established in the HoTs, and therefore it is always worth considering taking professional advice on these to protect your position and minimise renegotiation through the process. 

Once the Heads of Terms are signed, the Due Diligence (“DD”) process begins. This is the buyer’s opportunity to have a detailed look at the business, reviewing everything from financial and tax position to employees, contracts, and customers. Think of it as looking under the hood of the business, how it works and any potential issues that could arise. 

It is also an opportunity for the seller to disclose information that may be relevant to the buyer and that might not be obvious from the documents provided. Doing this early can prevent issues later on in the process or after the sale.

The DD process can be an intense period for both the sellers and the business, especially if not prepared for it. It can require significant time and effort from key staff of the business such as your accountant or HR manager who may not directly benefit from the transaction. It will require them to be discreet to avoid disrupting the business or the deal.

It is important that key staff are brought into the transaction early, to help this process go smoothly, and it is not uncommon for these individuals to be rewarded for their efforts through bonuses or other incentives.

Professional advisers play a critical role in the process, answering complex questions, managing outsourced areas of DD with accuracy, speed and aligned with your requirements.

Typically, a transaction is based on two common approaches either completion accounts or locked box mechanism. Both approaches deal with the business’ financial position and therefore can impact the final consideration at completion. These will consider areas such as target working capital on a cash-free, debt-free basis.

Completion accounts are prepared after the completion date and reflect the actual financial position at completion. Adjustments are made for items such as working capital, cash, and debt to ensure the agreed cash-free, debt-free basis. This method provides accuracy but can lead to post-completion negotiations and delays while the accounts are agreed.

Locked box accounts fixes the price based on a set of accounts at an agreed locked box date prior to completion. From that point, the seller undertakes that no value will leak from the business other than permitted items. This gives the buyer price certainty and avoids lengthy post-completion adjustments, but it places more risk on the buyer for changes between the locked box date and completion.

For both methods, specific accounting policies and provisions will be agreed between the parties even if statutory accounts are used. It is important to understand the business and any specific accounting policies that are applied and relevant, to ensure they are properly reflected in this mechanism – typically the accounts are prepared on a normal basis e.g. under UK GAAP under FRS102 or IFRS for larger, international focused businesses.

The Share Purchase Agreement (“SPA”) is the main transaction document and often runs to hundreds of pages, depending on the complexity of the deal and the buyer’s jurisdiction. It brings most of the elements of the transaction together, such as the structure, warranties and covenants, schedules of key information, definitions, completion accounts mechanism and templates. 

This document is typically drafted by the buyer’s solicitors but will have input from all parties such as lawyers, accountants, corporate finance and tax advisers on both sides. It is where the detail matters most.

The Warranties and Covenants (“W&C”) primarily protect the buyer. They cover all aspects of the business from employees and customer contracts to accounting and tax provisions. These should be reviewed in detail alongside the due diligence findings to ensure they are not overly onerous and that your position is also reasonably safeguarded.

The W&Cs should be considered in detail by your legal and tax advisers. Often, these start as generic clauses that may not reflect the transaction or your business. These are often heavily negotiated parts of the documentation and link directly to the disclosure documents such as the disclosure letter.

During the due diligence process, issues may be identified by the buyer or seller that will require disclosure against specific or general warranties within the SPA. The disclosure letter plays several different roles in a transaction, it:

1. Qualifies the warranties given by the seller in the SPA and discloses exceptions to the warranties that would otherwise constitute a breach.
2. Allocates risk to the buyer by disclosing known issues, preventing warranty claims where the seller has already disclosed these. It is not uncommon however for known issues to be resolved pre- or as part of the transaction by agreement between the buyer and seller.
3. Protects the seller’s liability where items are fair and sufficiently detailed.
4. Provides transparency to the buyer and supports the due diligence findings.

Other ancillary documents for a transaction may include Loan Notes for part of the consideration, or Service Agreements for directors and/or sellers remaining in the business post-sale. Service agreements can be particularly important if any sellers are remaining in the business as employees, and part of the consideration includes an earn-out.