This article is the second in a series of publications by J.W. O’Donovan’s Corporate Team on the practical aspects of running a successful mergers and acquisitions transaction. To read the first, click here.
Most people would assume that the starting point for the sale or purchase of a company is the agreement by the seller and buyer of a heads of terms for the transaction. However, there are a number of matters that should be considered at an early stage, even prior to any specific transaction being identified. These include:
- Review of Corporate Structure
A business owner who anticipates a sale of its business in the near to medium term should review its corporate structure to identify the target entity. It may be appropriate for any aspects of the business that would not form part of the sale to be ‘hived-off’ into other structures. Many long-established businesses have complicated group structures due to previous events such as management buy-outs. It may be advisable to simplify these by striking off or winding up dormant companies or merging subsidiaries with their holding companies.
- Tax Planning Considerations
It is critical that a business owner considers the potential tax arising on a sale of the business long before any sale is likely to occur. There are reliefs available but the criteria can be quite technical and specific advices should be obtained to ensure that such reliefs are availed of, to the maximum extent possible. An example might be where the owner’s spouse works in the business – if he or she is appointed as a director they may qualify for entrepreneurial relief or retirement relief on a sale of shares; such shares can be transferred between a husband and wife without any tax arising.
Aside from the personal reliefs that may be available on a sale of a business, many business owners are now choosing to hold a portion of their shares through a personal holding company as that holding company would be able to avail of an exemption from capital gain tax on a sale of such shares.
In order to qualify for some of the available reliefs, it may be necessary for the relevant structure to have been in place for a number of years prior to a sale. It may also be necessary to move any non-trading assets outside of the group (a ‘hive-off’ as described above).
- Vendor Due Diligence
One of the first steps that a buyer will take in a transaction will be to commence a due diligence exercise to examine the financial, operational and legal aspects of the target business. Significant issues identified in due diligence can result in indemnities being sought from the seller or a renegotiation of the commercial terms of the transaction. As a result, it can be advisable for a business owner who anticipates a sale to carry out its own ‘vendor due diligence’ exercise so that any issues in the business can be identified and remedied prior to a transaction commencing.
This exercise would cover matters such as:
- review of internal financial reporting. If adequate management accounts and other financial records are not available it can make it difficult to justify a valuation when negotiating with a buyer,
- review of commercial agreements to identify gaps in documentation, expired contracts in need of renewal and change of control clauses allowing the other party to terminate in the event of a sale of the business,
- review of internal processes such as health and safety and data protection compliance,
- review of employee contracts and policies to ensure all employees have been issued with a contract or memorandum of terms of employment and that each employee has received their legal and contractual entitlements.
Even if an anticipated sale does not materialise, the business will be on a better footing as a result of carrying out this internal review.
- Finance & Target Identification
On the buyer side, before engaging with a seller it is advisable to ensure that the necessary finance to carry out an acquisition is available. In recent years, a number of alternative lenders have entered the Irish market and have provided the finance for acquisitions. However, their requirements can be different from those of the pillar banks and it makes sense to engage with all potential lenders at an early stage in order to establish if they will be a good fit.
A buyer may also want to spend some time identifying potential targets in the relevant market and assessing their suitability for acquisition. Gaining a detailed understanding of the benefits that would result from a proposed acquisition in terms of potential synergies and efficiencies and growth in market share can be very important in ensuring a transaction is approved internally and in obtaining sanction from external lenders, where applicable.
- Identifying advisors
Both the seller and buyer will need to select advisors with the appropriate expertise to ensure their interests are represented and the transaction runs as smoothly as possible. For the seller in particular, firms that previously provided legal and financial services to the business may not have experience in large transactions and it may be necessary to appoint new advisors for the purpose of carrying out the transaction. In such event, it is important to ensure that the existing advisors work closely with those taking the lead on the transaction to pass on their relevant knowledge regarding the business.
Most large accountancy firms will have in-house tax advisory services but, in some instances, a separate tax advisor may be required. Furthermore, in some instances, minority shareholders may choose to take independent legal or tax advice.
In our next article in the series, we will cover the preparation of the heads of terms for a transaction.
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