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Growing Business

Businessmen who want their business to grow have two options in hand. First, the business can be expanded by reinvesting profit and adding on new things to the existing business. Second, merge or acquire some other business. Those who are not fortunate enough to expand their business with their own investment, have to get finance from some other source. This guide provides information about the legal process of acquiring a business and getting the purchase financed. While acquiring a business, one needs to go through three basic steps to get the legal work done. First of all, the businessman needs to lay the groundwork by doing negotiations on the initial terms of the purchase. Next, the contract document for the purchase needs to be drafted. Finally, the deal needs to be financed.

How to lay the groundwork?
Once you find a business that you want to buy and the present owner is willing to sell, the first thing that you need to do is lay the groundwork so that you can sail through the deal smoothly. In the pre-contract stage itself, you should try and agree on the deal as much as possible and also get all the important information about the business. The initial steps that have to be taken are:

Getting the Heads of Agreement drafted – The Heads of Agreement is a non-binding document which outlines the major issues regarding a tentative agreement. Even though this is a non binding document, getting it drafted helps to focus the minds right from an early stage and at the same time ensure that the major aspects of the transaction are all set out, as well as, agreed in principle. Important issues, along with their possible solutions, can be included in the Heads of Agreement which can help the business to save time as well as money in the future.

Agreement of confidentiality and exclusivity – Until the process of sale and purchase is completed formally, every seller will want the buyer to maintain confidentiality of all the information about the business that is made available to him. On the other hand, the buyer too can negotiate for an exclusivity period that can last for a few months, during which the seller cannot consider any other offer from a potential buyer. The exclusivity period offers the required time and space to the buyer, so that he can wrap up the acquisition process properly. One can also get the suitable terms covering these aspects drafted and included as a legally binding part in the Heads of Agreement.

Due diligence – It is a process of investigating a business before signing a contract. At times it can be a legal obligation for a business, but most often it is done voluntarily. The investigation is either carried out by the financial or the legal advisors of a business. At times, the businessman might also need the help of other experts like the environmental consultants and surveyors to carry out the investigation properly. The main motive behind this investigation is to gather important information related to the assets, liabilities, staff, ongoing contracts, properties, tax affairs etc of the business being sold, so that the buyer becomes aware of any existing issue and can also find the most appropriate solutions to deal with them before proceeding further. This information gathered during this investigation also helps in getting the sale contract drafted. In case a formal due diligence report is required, it can also be prepared. Lenders and other investors, who are financing the purchase, will also be interested in reviewing the findings of the investigation.

The Documents of Acquisition
By the time the buyer reaches this stage, he would have already agreed with the seller whether he is buying the shares (if the business is owned through a limited company) or any other asset associated with the business being sold. Every decision taken is according to the circumstances of both the parties, along with their power to negotiate and also relevant findings of due diligence. Usually, if the business being sold is held through a company, the seller will also want to sell the company shares, as it will provide the seller more favourable tax benefits. Although there may be exceptions, usually the buyer also accepts it, unless the company’s underlying liabilities are of an unacceptable nature or scale, as revealed in the due diligence reports.
To complete the purchase, the following documents will be required:

The Acquisition Agreement – The agreement is initially drafted by the buyer’s lawyers. It undergoes negotiation and amendments, before a mutually acceptable final document is prepared. In case of complex deals, the contracts are also lengthy. This happens generally in cases which involve purchase of shares and the buyer agrees to take on the responsibility of the liabilities of the purchased company.
Some of the key aspects of the Acquisition Agreement include:

  • Calculation of the price to be paid along with the payment method – These are some of the key factors to be considered and can be very detailed. Often the price of a business being sold is determined by the completed balance sheet or by referring to the future potential earnings. The situation can also be complex when a part of the purchase price is delayed or paid in instalments or some amount is held back by the buyer for retaining a future event, like a possible warranty claim.
  • Considering Warranties/Tax indemnity – The Warranties and Tax indemnity reflect the truth about all the relevant aspects of the business being sold and hence provide protection to the buyer. If these statements prove to be false, the buyer can claim compensation from the seller to cover the losses incurred.
  • Restrictions that can be levied on future activities – The seller may provide a binding agreement where he agrees not to get involved in any competing business or will not entertain offers from potential customers, employees or suppliers for a certain period of time after the completion of sale. The main purpose of these agreements is to provide protection to the goodwill attained by the purchaser.

Disclosure Letter – The disclosure letter is prepared by the solicitors hired by the seller. It qualifies the warranties so that at the time when they are read along with the Disclosure Letter, they can provide the complete and actual picture of the issue in question.

Other documents required for completion – The other documents that are required varies from case to case. However, in most of the cases the other documents that are needed include new service contracts for directors or other important employees, a new lease for the premises to be used for operating the business etc.

The Available Options for Finance
Most of the time, the buyers of a new business have to go in for some type of a loan finance. It can be anything like a bank overdraft, invoice discounting, term loan, asset finance etc. The buyer can either go for a single form of financing or for a combination of more than one form. Those in need of huge transactions can also go for equity finance. However, the choice of the buyer will also depend on the current market condition and which option is affordable and available at that point of time.

Loan finance
While most of the documentation from the big clearing banks comes with the standard terms of “take it or leave it”, the bigger deals with customised documents come with the prospect of negotiations on the terms.
The loan seeker should consider the terms of any periodic financial tests or covenants asked by the lender with outmost care and ensure that the business will be able to meet those criteria very easily. In case the business fails to meet those criteria it can lead to a default generated in the loan agreement. The loan seeker must be ready to fulfil a number of security requirements from the end of the lender, which can also include personal guarantees which are backed by security over personal assets. The loan seekers usually do not have any choice in the matter. However, if circumstances are fortunate enough to allow negotiations, one must try and resist giving any kind of guarantee or should at least try and get a monetary limit placed on the liability.

Equity finance            
Getting loans from institutions that provide finance against equity stake in the business is indeed a complex and time consuming process. However, it can prove to be one of the best options available for those who are in need of a large funding and at the same time the business too has the capacity to make payments for the interests and dividends.
In this case the investor, before making any investment, carries out a thorough due diligence on the business in which he is going to invest.
The documentation needs are usually complex and bespoke. The complexity keeps on increasing along with the transaction size. The subscription agreement is one of the main documents that is required. In certain cases it acts similar to a sale agreement on which the applicant and the management team will need to give a number of warranties associated to the business. They also have to enter a restricted agreement on the terms mentioned earlier. The subscription agreement will also imply restrictions on how the business can be run, along with a long list of matters, on which action cannot be taken without a prior consent from the investor. A very important thing that one should keep in mind while dealing with private equity finance providers is that most of the time they have an exit strategy ready in their minds from the very beginning. Therefore, it should not be taken for granted that they are long-term investors. Most often, the investors tend to realise their investment within a maximum timescale of three to six years at a considerable profit, which can either be through a trade sale or a public listing, which will depend on the market conditions. The decision of acquiring a business or merging with some other business partner is a time consuming process and at times can be very demanding. In order to have a successful deal, the business owner needs to understand the new business in question thoroughly and at the same time pay attention towards every detail in the process of getting a formal contract prepared, so that the desired outcome can be achieved.




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