There comes a point for a business when organic growth just isn’t enough or when owners of a business decide that they have had enough – and mean it. This seismic shift for the business also brings major challenges for its advisers. A client’s first step is often to turn to their accountant for advice on the process and the value of their business, perhaps forgetting that the process is largely legal and that advising a business on its day to day accounting needs is not the same as advising in relation to a sale or purchase.
First things first – challenge your client’s motivation! There is no point proceeding down this arduous and time-consuming route to then find that the client has changed his mind or that you have misinterpreted an expression of frustration for something more substantial. It will inevitably be quite a demanding process which most clients do not enjoy, coming as it does on top of the existing pressures of running a business. Also, if acting for the buyer, it is worth making enquiries of potential funders as the lending criteria of banks have been subject to the vagaries of the economic climate.
Next, make sure that your client’s aspirations are realistic. People tend to know what their houses and cars are worth but even astute and experienced business owners can get a potential business valuation horribly wrong. Business valuation is a specialised area, accountants who dabble need to be very careful that they have access to relevant and recent comparators. The old adage of “your business is worth what someone is prepared to pay for it” holds true, but there are useful rules of thumb.
The next area to consider is the transaction structure and tax planning. A seller will, if it operates via a limited company, want to sell the shares in that company. But a buyer, wary of inheriting any skeletons in the company’s cupboard, will prefer a purchase of assets. However, in practice the tax disadvantages are usually such that if a company is involved then shares will be sold.
Marketing a business for sale is also a task that can be more involved than anticipated. At a basic level it is a case of producing the latest accounts and management accounts and letting the buyer make up their own mind. It is more likely that you will be asked to produce a summary of the key headline figures which can be circulated in sale particulars. There will be pressure to “sex up” the particulars. That pressure needs to be resisted, although that does not mean that the figures cannot be presented in the best possible light. For an accountant who is used to working on numbers without worrying about presentation this can be an interesting new challenge.
Sometimes, usual client confidentiality about releasing business details can be relaxed, but as the buyer is often an actual or potential competitor it is important to get lawyers involved to ensure that confidentiality agreements (non-disclosure agreements or NDA’s as our American cousins call them) are signed before information is released.
At this point if the parties have decided that there is a price at which a deal can be agreed, then the lawyers will get involved. The first document that they will produce is the heads of agreement (or heads of terms or sometimes Memorandum of Understanding). This short document will seek to set out, usually in no more than half a dozen pages, the key aspects of the transaction.
Price is of course the key factor but not surprisingly the lawyers often find room for manoeuvre even in this aspect. A seller will want cash at completion, a buyer will want to protect their cashflow by payment in instalments and this will also allow it to ensure that everything is as it should be in the acquired business. The buyer may want to hold onto some of the purchase price for a period of time to see if any issues emerge from the woodwork, but more likely he will want formal post-completion checks on the acquired business. These can include a stock take or a full blown accounting exercise which will lead to production of a set of completion accounts.
Completion accounts can be a real minefield for accountants, because unlike normal year end accounts they are produced as part of an adversarial process and are subject to a specific timetable. Having to produce first draft accounts within a tight timescale from completion (typically 45 days) and then having them reviewed and commented on can be daunting. Any dispute will be subject to further discussion and possibly escalation to an independent accountant for resolution. Accountants need to ensure that they review the process which the lawyers intend to subject them to critically, to ensure a pressurised situation is not made worse by an unrealistic time frame or influences.
More recently, instead of completion accounts some transactions have favoured a “lock box” arrangement which involves production of a balance sheet prior to completion with undertakings from the seller to prevent leakage from the company between the balance sheet date and completion. Although much favoured by venture capitalists (and in many ways easier and less confrontational for the accountants) this approach is not becoming widespread.
Earn-out’s; where part of the price is linked to the future performance of the business are less common in recent, more uncertain, times than they used to be. If an earn-out is proposed the accountants will again find themselves centre-stage reporting; reviewing and agreeing the final figures.
The Heads of Terms will also often include provision for an exclusivity period to allow the buyer to pursue its investigations of the target business with the comfort that, for a limited period, the seller will not talk to other potential buyers. Once this exclusivity period is agreed the buyer will be more willing to instruct its professional advisers to roll up their sleeves and get stuck into the due diligence process.
For larger transactions a vendor due diligence report may be required. This involves the seller’s accountants producing a report covering the key aspects of the business, trends, areas for growth, risks and threats etc. Alternatively the potential buyer may ask their accountant to investigate and report on the target business. Accountants can find these reports immensely enjoyable but the temptation to go into unnecessary detail or to focus on areas that are not of direct concern to the potential buyer needs to be resisted. Burying bad news in the detail is commonly attempted, but rarely works !
For the investigating accountant this is a real opportunity to demonstrate their understanding of the client’s business and to go beyond the basic numbers and look at potential opportunities. This can be very rewarding intellectually and practically as integration plans for the target business (and an ongoing role for the accountants) can be developed.
However the cautious accountant must ensure that, in the rush to get the deal done, access to key confidential information is restricted until the likelihood of the transaction proceeding becomes more certain. A confidentiality agreement might be great in theory, but in practice it is best to keep some cards close to your chest.
After the due diligence process has been completed (or more usually in parallel with it), the lawyers will produce a share purchase agreement or asset purchase agreement as necessary. This document will inevitably land with a thud, typically involving fifty to one hundred pages of legal drafting.
In relation to a share purchase the accountants will need to focus on the financial and tax warranties and also the tax covenant. The drafting is usually opaque but accounting input early on in the process can prevent lawyers spending lots of time on points that are not relevant. In relation to an asset purchase agreement the role of the accountant is more limited, but agreeing the allocation of the consideration between different classes of assets is an area that should be tackled to prevent disputes (in front of HMRC) further down the road.
The other main legal document that is worth mentioning is the disclosure letter. The purchase agreement will contain various statements e.g. that the latest accounts have been prepared on a consistent basis with the accounts for the previous three years. The seller must detail in a document known as the disclosure letter if any of these statements are untrue. Accounting input may well be required to ensure that all appropriate disclosures are made.
Thinking beyond the formal role of the accountant there is also the personal angle to bear in mind. The process of buying or selling a business can be quite traumatic. A buyer can find the ups and downs quite challenging but the biggest issues can arise for the seller. Letting go of a business that you have started and developed can be an emotional rollercoaster. Counselling might be a new skill that needs to be added to the accountant’s toolbox in his role as trusted adviser.
Merging accountancy practices is a subject in its own right, the points raised above all apply but then there are additional issues too.
Professional services firms are usually owned by a collection of partners who do not necessarily share the same motivations and concerns. Some partners will be more concerned about their role in the practice going forward. Sometimes it is the oldest partners for whom this is the biggest concern as they may not relish the prospect of moving elsewhere late in their career. Partners who have become used to functioning autonomously may struggle to fit into a larger practice.
Paying out the capital and current accounts of exiting partners can also impose quite a financial burden on the buyer, so some partners may end up tied in whilst others are paid out.
Unlike other industries, there are rarely long term commitments in place from customers. For this reason, retiring accountants tend not to command the sort of goodwill payments that are commonplace in other sectors – much to their disappointment.
The acquiring practice will need to consider the impact on its on-going professional indemnity insurance – different practices have different histories and premiums can vary widely. Run off professional indemnity insurance for any practice areas that are being discontinued, can be expensive and may therefore also need to be considered.
Jas Singh is a corporate partner with Ansons Solicitors LLP and specialises in mergers and acquisitions. He can be contacted at email@example.com.
First published in AAT Magazine [Oct 2012]