Legal Advice on Selling a Business – “Caveat Vendor”

I’ve acted for various clients recently who have sold their businesses and companies, some for many millions of pounds, and I have been astounded by the extremely high levels of risk, often personal risk, that some sellers seem quite content to take on board when they sell. The terms that some sellers are currently prepared to accept are nothing short of suicidal in some cases.

As @London_Law_Firm (our Twitter name), I recently posted the following ‘tweet’ on Twitter and was gratified by an immediate response from Ian McAllister, a very savvy entrepreneur in recruitment. It seems to sum up the current malaise.

Some sellers are indeed rushing to sell their businesses like lemmings and are seemingly quite prepared to do so on terms that, quite frankly, verge on the lunatic. 

This is little point in selling a business if the terms of the sale leave the seller much more personally exposed to the buyer than they previously were, in the normal course of business, to the bank and to suppliers - especially if the price and terms are heavily stacked in favour of the buyer. Sellers are often unduly eager to take on huge personal liability to a buyer in circumstances where, up until the moment of completion, they have the benefit of limited liability and virtually no personal liability at all, or at least a limited personal exposure that is under their control to a large degree.

Buyers, of course, are traditionally cautious and very risk averse. The maxim ‘caveat emptor’ or ‘buyer beware’ is well-known and applies equally when buying a business. In contrast, eager sellers of businesses seem to have virtually no perception of risk at all and it is often very difficult to reason with them.

Buyers will do their ‘due diligence’; they employ accountants and lawyers to audit the target business; they ‘kick the tyres’ of the target; they look under every stone; they identify, limit, ring-fence and avoid the legal and financial risks inherent in the business acquisition. Sellers, on the other hand, are quite often totally (and sometimes often deliberately) blind to the risks of selling on the terms first offered to them and ridiculously shy of saying ‘no’ or trying to negotiate a better deal.

The due diligence that it is open to a seller to do is usually limited to asking around in the trade as to whether the buyer is trustworthy, whether they are solvent and whether they have ‘stitched up’ any sellers in the past. It is often almost exclusively a question of whether the seller likes, and is prepared to ‘trust’, the buyer.

In my experience, and, particularly, in my recent experience, sellers are far too trusting of buyers who are promising a fat cheque for the business, especially when that fat cheque is not paid in cash on completion but is deferred and, even perhaps, conditional on future profits or other uncertain conditions, conditions which are not usually within the control of the seller at all.

In short, sellers are likely to accept far too much risk if they form the view that they like and trust the buyer and, when the sweet scent of money and possible retirement is in the air, they are far too quick to form such a view.

Sellers are also very reluctant to believe that any loss or circumstances that could give rise to a warranty claim against them will arise. I suppose familiarity with their own business breeds a cavalier bravado as to the likelihood of future claims.

All this is, of course, totally naïve, especially where the sellers have personally underwritten the risk.

It is invariably impossible to spot circumstances that will give rise to a claim against the seller until the claim actually arises. No-one has a crystal ball. There could be claims for unpaid tax, genuine accounting errors, TUPE claims from employees, or disputed ownership of business assets such as software, trade marks and other intellectual property.

Also, buyers are notoriously good at contriving a claim against the seller, even on the flimsiest of pretexts, especially when there are deferred payments still due to the seller and the ‘claim’ is just a cynical attempt to avoid payment or negotiate a heavy ‘ex post facto’ discount on the price.

I acted on a deal recently where my client, against express advice, insisted on accepting a provision that allowed the buyer to set-off claims against deferred payments simply by asserting a claim. The buyer wasn’t even obliged to issue proceedings, let alone obtain judgment, in respect of the amounts claimed before knocking the value of the claim off the deferred purchase price. The client knows where he stands and was adamantly prepared to take the risk. I wouldn’t have done so in his shoes. I hope the client gets away with it and the deferred payments will be met, but I suspect we may well be opening another file on this when the buyer uses this contractual power to avoid payment later.

When it comes to giving legal advice on selling a business, I believe very strongly that the seller’s position should not be ‘over-lawyered’; in other words, there naturally has to be some give and take in order that the transaction proceeds on terms that are acceptable to both parties rather than does not proceed at all. Not every point has to be won. However, sellers should always dig their heels in on the ‘big points’ such as the extent of personal liability that it is reasonable for them to accept going forward, and should not enter into any transaction that affords a buyer too great a scope for prevarication over future payments. A seller, especially a seller of mature years who may be near retirement, is entitled to expect a high degree of certainty in such matters.

The lawyer’s maxim that you should trust no-one is borne of bitter experience. Buyers may appear genuine but, in reality, may be charlatans and sharks. They may be smiling villains. I can usually spot such types at 100 yards now because I have met so many, but an eager seller is easily blinded to the truth.

Even if the seller is prepared to trust those with whom he is currently negotiating, the buyer may, after the sale goes through, quickly undergo a re-organisation or change of control, or perhaps a change of staff, so that the trusted and liked executives with whom the seller negotiated the deal move on, or get sacked, and the seller is left confronting an altogether different set of personalities, hostile to the seller and with a completely different business agenda. The new guard will exploit every possible way to recover the cost of the deal or avoid payment of any deferred consideration payments.

Call me a cynic, but I think it is almost axiomatic that deferred payments are either never paid, or are heavily negotiated (downwards) by the buyer. My strong advice to sellers is to make absolutely sure that the cash paid on completion is regarded as reasonable compensation for having sold the business, with any deferred consideration being ‘bunce’ - because there is a high likelihood in this topsy-turvy financial climate that deferred payments will never be paid.

The legal risks for sellers when selling a business are very real and potentially devastating if they come home to roost. 

So here are a few basic DOs and DON’Ts by way of some impromptu legal advice on selling a business that will hopefully minimise these risks or at least establish a fair balance of risk between buyer and seller.

	DON’T be too eager to swap the benefits of limited liability for unlimited personal liability under personal warranties and indemnities to the buyer following a sale of the business.
	DON’T give personal warranties in respect of matters that are clearly impossible to predict, such as warranting the forward profit of the business after completion, or warranting the accuracy of cash-flow forecasts or business plans.
	DON’T accept a paper-only deal if at all possible (for example, shares or options in the buyer, but no cash).
	DON’T accept personal cash liability for future claims in excess of the cash you have actually received from the buyer for the business at the time the claim arises.
	DON’T automatically expect deferred payments to be met.
	DON’T accept an ‘earn-out’ based on future profits without retaining close involvement in the business going forward.
	DON’T allow the price payable for the business to be based on post-completion accounts prepared by the buyer using different accounting principles or treatment that have been applied to the business prior to the sale.
	DON’T accept ‘joint and several’ liability amongst several sellers for the full price when the price is being split between those sellers. Ensure that liability is several, not joint, and is limited in each case to the amount of cash actually received.
	DON’T allow buyers to set-off potential or threatened claims against deferred payments.

	DO insist on as much of the price as possible being paid in hard cash upfront on completion and not in options, shares, deferred loan stock or other instruments, even if this means accepting a lower price. Certainty bears a premium and deferred payments are often not met if the buyer has cash-flow problems or simply goes bust.
	DO insist on as much cash being paid on completion, even if a proportion of this is paid into a retention account for a short period of time whilst completion accounts are drawn up.
	DO ensure certainty in the calculation of the price and, if there is some uncertainty, insist on a minimum price.
	DO avoid giving extensive personal warranties, personal indemnities and personal guarantees to the buyer.
	DO negotiate limits (in time and amount) to any warranty liabilities and personal guarantees that you cannot avoid having to give.
	DO insist that these limits apply to all future claims against you and not just to claims for breach of warranty.
	DO insist on security for deferred payments by way of charge over property, assets, shares or bank bonds.
	DO request a personal guarantee for future payments from the buyer’s directors, shareholders or some other third party.
	DO insist that the buyer’s obligations are guaranteed by the holding company of the buyer’s group, particularly future price payments or salary obligations under any continuing service contract.
	DO build in a commercial penalty for non-payment of deferred payments by the buyer, such as an option to repurchase on favourable terms.
	DO negotiate payment of deferred payments into a neutral escrow account pending settlement of any future claims.
	DO insist that you can meet any future claims that the buyer may bring by surrendering shares in the buyer at the value attributed to them on completion (they may go down to zero after the deal, so this latter point is crucial).
	DO impose restrictions on the buyer’s ability to deal with the assets after completion when you are depending on an ‘earn-out’.

So if you are looking for some legal advice on selling a business, we hope the above pointers will be of some assistance.

It requires quite a lot of nerve to sell a business and a considerable amount of patience. We always tell clients that selling a business is a process rather than just a matter of pitching up and signing an agreement. And good legal advice on selling a business is difficult to find so, if after read this, you would like a ‘no obligation’ chat about any aspect of selling your business, just call us or ping us an email and we will be very pleased to spend an hour with you to talk through the issues.  It will only cost you your time and it will probably save you a lot of anxiety and ultimately even a lot of money.
 
Thanks for reading…and good luck!

Chris Sherliker

07989 445179 (mobile)
020 7749 2715 (desk)

cjs@silvermansherliker.co.uk