Legal considerations on the purchase or sale of a business
This is a high level overview of what you should consider if you are selling or buying a business.
Are you selling business assets or the shares in a company?
The first consideration is to clarify what is being sold.
If the business is not incorporated (is not held through a company structure), then what is on the table are the assets (such as stock), and possibly some corresponding liabilities (such as loans to buy the stock).
If the business is operated through a company structure, then what are for sale again might be the assets, or it might be the shares in the company.
The difference may seem academic but in legal terms it is a chasm.
When a company is sold, the buyer purchases everything that the company owns. These include liabilities, both those that can be identified at the time of sale, plus future ones that may be harder to identify (such as obligations to fix faulty goods sold to customers before the sale).
When the business assets are sold, the issue for the buyer becomes one of identifying the scope of the asset. A buyer of the shares in a company does not have to worry about scope because the company owns everything. By contrast, if only assets are being sold, then the seller may still retain ownership of some part of the asset that the buyer thinks he is purchasing. For example, if a website is being bought, are the intellectual property rights to the photographs used on the site also being bought, or could the seller use them on another of his websites.
Buying all the shares in a company, however, requires alternative work. The corporate structure will need to be investigated. For example, someone may hold an option agreement that enables him or her to force the future owner to sell at a certain price.
The process of assessing the value of what is for sale, and whether there are any restrictions that might prevent the buyer from purchasing, or reduce the value of assets after purchase is called due diligence (DD). It is effectively, careful consideration of what is on the table.
Depending on the complexity of the business, the buyer may need to appoint an accountant (to provide a valuation of the business), a lawyer (to check existing contracts) and expert valuers (to value individual assets).
It is the buyer who carries out the DD process and who pays for it. However, in practice, the buyer often asks the seller for information, and the seller who does the work in providing it. Sale agreements usually contain terms (warranties) that if the seller hasn’t fully disclosed information, the buyer can seek damages or cancel the sale. Read more on warranties here.
Transfer (assignment) of contracts
If shares in a company are being sold, then the contracts that the company has with third parties will not need to be changed. However, if assets are being sold, then contracts will need to be assigned or novated (different types of transfer) to the buyer.
Often a business changes hands because the new owners hope to operate it more efficiently than the existing owners. One way a new owner might choose to save money is by employing fewer staff. Contracts of employment are safeguarded against this possibility by Transfer of Undertakings (Protection of Employment) Regulation 2006.
The Regulations provide for continuity of employment on the same terms as existed before the change of ownership. It is still possible to reduce the workforce for usual reasons, but you should take professional advice before approaching staff with a view to terminating their employment.
In any business there are ongoing contracts. These will be for supply of the goods or services of that business and for the purchase of goods and services of every kind. A business seller might assume that all such contracts will be transferred with the business assets. This is not so. The contract is with the owner of the business, whether a company or individual.
The other party to a contract may be in a position to cancel or rescind a contract if you sell the business. It is therefore most important that you prepare the ground on all contracts, so that the buyer can obtain the benefit of them. Some contracts will be transferable without notice, some only with notice or consent. You should make sure the consent is in writing in the case of all contracts which go to the heart of the business. It may be necessary to novate some contracts after discussion with the third party concerned.
Where the business operates from leasehold premises, the assignment of the lease is essential to the ongoing business. Unfortunately, few landlords share the buyer's enthusiasm to take the business over, or the seller's to bank his cash. The best way to persuade a landlord to act fast is to negotiate with him directly. Net Lawman provides a free lease assignment template with many business purchase agreements. It is primarily the seller’s job to obtain consent to the assignment, but the buyer may be able to deal faster.
A frequent cause of delay in obtaining landlord's consent is that the buyer is not ready with good references. Landlords' requirements vary, but none is likely to require more than a reference from a bank, one from a previous landlord (if any), and two others.
If there is provision in the lease for a guarantor it may be difficult to resist a demand by the landlord that the buyer also provides a guarantor. Even if there is none now, the lease may provide either expressly for a guarantor, or some other term which enables the landlord to refuse an assignment to a person without financial "substance". Where the tenant is a limited company, the personal guarantee of one or more directors is invariably required.
It is likely to be provided in the lease that the legal costs of the landlord in connection with the consent are payable by the tenant. This bill is usually picked up by the buyer. The work is simple. It consists in: drawing the consent document, obtaining the approvals of all three parties, taking up references and completing the agreement by exchanging parts.
The buyer wants his money back!
Under certain conditions, the buyer may be able to rescind his contract. He may choose instead to claim damages. When a contract is rescinded, the result is that everything goes back to the position before the contract was made so far as possible. In this case the buyer gets his money back and the seller gets his business. Of course, this would be a "disaster scenario" for the seller in most cases.
Because this is such a powerful weapon, it is most important that the seller considers carefully (and negotiates) the circumstances when it might apply. The remedy of rescission should be available to a buyer only when the seller has failed to comply with the terms of the contract in the most serious way.
The best option for the seller is to provide full information in advance of the sale and to cover all "sticking points" before the formal agreement is signed. It should be within the power and control of the seller to eliminate situations where disaster might strike. If he does that, then he has nothing to fear from a provision for the contract to be rescinded in specific circumstances.
VAT on the sale of the business
Briefly, the position is that when a business is sold as a going concern, the sale of the assets does not normally constitute a taxable supply provided:
the assets sold are to be used by the purchaser in carrying on the same kind of business as that carried on by the vendor; and
where the sale comprises only part of the vendor's business, the part sold is capable of separate operation.
You may need to look also at the VAT provisions on sale of property. Owners of buildings and land, the supply of which would otherwise be exempt from VAT, have been able to make elections to waive exemption from VAT in respect of some or all of the buildings and land in which they have an interest. Once made, an election to waive exemption from VAT cannot be revoked whilst the buildings and land remain in the same ownership.
When properties, for which an election to waive exemption has been made, or new properties, are transferred as part of a sale of business as a going concern, the transfer of the properties will be standard rated for VAT unless the transferee has made an election to waive exemption in respect of the properties and has notified HM Revenue and Customs of that election on or before the date and sale is completed. For VAT purposes a freehold building remains new for three years after completion.
Once a sale has been agreed it is usually in the interest of both parties to complete as soon as possible. The seller will have lost interest in day to day operations while the buyer is not only bursting with enthusiasm and also fears the seller will neglect vital matters.
The problem with immediate completion is that certain matters, such as obtaining landlord's consent to an assignment of a lease, may necessarily be deferred.
If a delay is necessary, make it as short as possible.
The documents you need
Additionally, you may need assignment and novation agreements to transfer contracts between the seller and the buyer.
If company shares are being sold, then you will need directors service agreements, board minutes to document approvals to changes, and possibly, a new shareholders agreement and new articles of association.
We can help you find exactly what you need for your circumstances if you contact us and ask.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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