Buying Assets - What You Need To Know
Thursday, March 02, 2006
There are two ways to buy a business. One is to buy shares of the company that owns the business, the other is to buy the assets which make up the business, in some cases together with certain liabilities of the business.
These are fundamentally different. If you buy the shares in a company all its assets, liabilities and obligations are acquired (even those you don’t know about). If you buy assets, only the assets (and liabilities) which you agree to buy and which are clearly identified are acquired.
Buying assets is often more complicated than buying shares due to the need to transfer each separate asset required to operate the business. More consents and approvals are likely to be required than on a share purchase; for example, the consent of landlords to assignment of a lease. There is, however, a greater amount of flexibility on an asset purchase. If, for example, a target company has liabilities which cannot be easily ascertained, or if only part of the business of the target company is to be acquired, then an asset purchase may be the better route.
As well as the commercial considerations, there are important tax considerations to be taken into account when structuring an acquisition. There are differing tax consequences for both routes and advice should be sought to see which route will be more tax effective.
Step 1 – Discussions
Once a target has been identified and parties want to enter into detailed discussions the following documents may be required:
- Confidentiality agreement. Most deals will require that you have access to significant information about the target business, some of which may be confidential. It is therefore standard practice for a seller to ask any prospective buyer to enter into a confidentiality agreement before making any information available.
- Exclusivity agreement. Embarking on a prospective purchase will usually involve a substantial investment of time, effort and money. Where possible it is prudent to seek exclusivity by requiring the seller to agree not to negotiate with other parties for a given period.
- Heads of terms. Often reaching agreement in principle on the key terms of the acquisition before beginning the process of due diligence, disclosure and drafting the asset purchase agreement is useful. It is common practice to record these terms in writing as heads of terms (also known as “heads of agreement”, “memorandum of understanding” or “letter of intent”).
The basic rule is that heads of terms should cover key commercial only points. Heads of terms are usually not intended to create any binding legal obligation on the parties, although they may contain individually binding provisions, such as confidentiality and exclusivity clauses, if these are not set out in separate agreements.
Although heads of terms may not be legally binding, most company executives consider them to be morally binding, at least in the absence of a significant new development. They should therefore be approached with caution and preferably with the involvement of professional advisers.
Step 2 – Diligence
Purpose
You can now commence the due diligence exercise - gathering information about the target business.
The purpose of this exercise is to build as complete a picture as possible of the business you are buying and the issues which will be relevant to the acquisition, such as the nature and condition of, and title to assets, transfer issues and details such as timing and regulatory consents. The business may consist of a number and variety of different assets including tangible assets such as land, machinery, vehicles, fixtures and fittings, raw materials, stock, work-in-progress and office equipment and intangible assets such as the benefit of contracts, goodwill and intellectual property rights.
In particular, you should focus on the key asset or assets which you wish to acquire early in the due diligence process and ensure that title can be effectively passed. Different businesses may be based on one or a combination of key assets such as:-
- Property : for example, a hotel where the key asset is the building itself.
- Employees : for example, a consultancy business.
- Intellectual Property : for example, a software company.
- Customers : for example, a manufacturer for a large retail outlet.
- Licence from an authority : for example, nursing homes.
The information-gathering process will aim to find out information on a number of “specialist” areas which may impact on the negotiation process and, in particular, on the price you are prepared to pay and the protection you will seek from the seller in the form of warranties and indemnities.
Although the seller will usually give warranties which will give some comfort if a problem arises after completion, most buyers would prefer to find out about serious problems before the purchase and be able to negotiate an appropriate reduction in purchase price or, in extreme cases, pull out of the acquisition. However, the extent to which a due diligence investigation is possible may depend on the nature of the purchase. In certain circumstances, the seller may be reluctant to make sensitive commercial information, such as customer lists, available until a later stage in the negotiation process.
Sources
The diligence exercise will rely on a variety of information sources.
Information Memorandum
Often there is an information pack on the target business put together by the seller and its advisers. Information memoranda are often used when the seller is actively marketing a business.
Format and content of the information memoranda vary. However, it is a selling document and is likely therefore to summarise for a prospective buyer all of the key investment considerations. It may also have appended to it recent financial information, sales analyses, details of key personnel and descriptions of property.
Buyer’s Enquiries
Your own enquiries will focus on material made available by the seller, together with searches of publicly-available material (for example, company searches, land registry searches and searches of intellectual property registers). The cornerstone of the exercise will be a memorandum of information requirements, which your solicitors will submit to the seller. This may seek to elicit much more information about the business than a seller may have included in its own information memorandum.
Data Room
In some circumstances information may be made available to you in a data room. These are commonly used in auction sales and in particular where the sale is of shares rather than assets. The idea of a data room is that the seller retains physical control of all of the information and can ensure that, where there are a number of prospective buyers, they all have access to exactly the same information. Access to a data room is usually strictly controlled, for example, copying documents is usually prohibited and the use of dictating machines may also be forbidden. You may also be given a limited time in which to carry out your review so careful planning is needed to ensure this is not wasted.
Specialist Reports
Part of the due diligence process may involve instructing accountants or other specialists to prepare reports on the target business.
Step 3 – Approvals
A variety of consents and approvals are likely to be required for an asset purchase. These will broadly fall into two categories: contractual consents relating to the assets themselves and approvals required by statute and other regulations:
Board approval. As a matter of good corporate governance, acquisitions should be considered and approved by the boards of both parties.
Regulatory authorities. Once the buyer has established which assets it is to acquire, it will need to give early consideration to the question of whether the acquisition will trigger the need for the involvement of any regulatory authorities.
Landlord’s consent. If the target’s business property includes leasehold premises, it is likely that the landlord’s consent will be required to the assignment.
Lenders. The consent of lenders may be required if the transaction breaches borrowing covenants or the terms of security taken over the assets of the parties. Any charged assets will need to be released from any fixed charge and a non-crystallisation certificate obtained for those assets which are subject to a floating charge.
Contracts. The parties should review major contracts with customers and suppliers. Some contracts (for example, licences of intellectual property) may require the approval of the other party to assignment.
The nature and extent of the approvals required will obviously have an important bearing on the timing of the transaction, as will the level of due diligence required. There is no standard timescale for an acquisition, which can take from a few days (usually the case on the purchase of assets of an insolvent company) to many months. Subject to commercial considerations, it is clearly advisable to approach landlords, key suppliers, customers and so on as early as possible so that their consent does not delay the transaction.
Step 4 – Documentation
Asset Purchase Agreement
The key document for transferring the assets or business to the buyer is the asset purchase agreement. This is usually drafted by the buyer’s solicitors and is often fairly lengthy.
Key provisions of the asset purchase agreement include:-
Parties. If the buyer is a group, it should decide which company within the group should make the acquisition. This will be determined by commercial and tax considerations.
Details of Assets. As the only assets (and liabilities) transferred are those that are agreed to be transferred, particular care must be taken to identify and define those assets and liabilities in the asset purchase agreement. This will be done in the definitions section and by reference to specific schedules listing assets within certain categories.
Agreement to sell. A clause under which the seller agrees to sell and the buyer agrees to purchase the business on completion. Title to some assets will pass on completion pursuant to this clause. Further formalities and documents will be required to transfer legal title to other assets.
Consideration. The parties should consider the nature (for example, cash, shares or loan notes) and timing of payment of the consideration. It is common on asset sales for part of the consideration to be withheld pending the production of completion accounts or a completion statement valuing the assets at the completion date.
The consideration should be apportioned between the various assets. This has important tax implications.
The transfer of a business as a going concern is outside the scope of value added tax, although various formalities may need to be followed on the transfer of heritable property.
Conditions precedent to completion. These will be determined largely by the consents and approvals referred to above. They may, for example, include the removal of fixed charges over assets being purchased or regulatory clearances.
Mechanics. The agreement will set out how the various assets are to be transferred (for example, by formal assignment, delivery, and so on) and the obligations of the parties before and after completion to perfect transfers and ensure the smooth transfer of the business.
Warranties and indemnities. Most transactions will include full warranties relating to the assets being acquired. But limited warranties may be given in some circumstances (for example, on a sale to management or where the seller is a receiver). You may require indemnities to cover some potential liabilities (such as ongoing litigation).
Restrictive covenants. These fall into three basic categories: non-solicitation of customers, non-solicitation of employees and non-compete.
Disclosure letter
The disclosure letter qualifies warranties given in the asset purchase agreement. It will normally be divided into two sections: general disclosures (relating to matters on public record and information to which the buyer has had access) and specific (relating to specific issues).
Other documents
Many ancillary documents are required to perfect the transfer of assets; for example, property transfers and/or lease assignments, assignments and/or novations of contracts, assignments of intellectual property and so on. Other documents include board minutes, releases from charges and letters from HM Revenue & Customs.
Step 5 – Completion
Completion is not the end of the process rather the beginning. You should ensure that developments in the new business are monitored with an eye on warranty deadlines and restrictive covenants. There will also be various post-completion matters to attend to including:-
- Announcements to customers/trade press/staff etc.
- Stamp duty.
- Assignments and novations of contracts with customers and suppliers.
- Administrative matters such as insurance, payroll, PAYE, VAT and pensions.
An asset purchase can be a complicated process and having the right advisers can make it a great deal easier. If you have any questions on a proposed acquisition please contact Catherine Feechan, Corporate Finance Partner on 0141 228 8000.
The information contained in this article is given for general information only and does not constitute legal advice on any specific matter.