A large part of my practice over the nearly 30 years has comprised what us lawyers refer to as “transactional work” or “M&A”. Fancy sounding words and acronyms for what is essentially assisting clients in “buying and selling businesses”. I guess part of the fun of being involved in this line of work has been learning impressive sounding acronyms which one can throw around at dinner parties!
Seriously though, it has been interesting and rewarding to develop an expertise in this type of work. Businesses that are the subject matter of the transactions are almost always different from one another and so are the transactions, with each bringing its challenges and complications, all of which need creative solutions to get the deal across the line.
Lately, I seem to have spent a lot of time on the sellers’ side of the negotiating table. But whichever side you are on, there are some key aspects that need to be considered. Let’s look at some of these.
Probably the key overriding principle in any negotiation on a transaction is the question of “risk”. Who bears the risk in whatever is agreed, and what are the probabilities of the risk coming about?
As most businesses are housed in a company or legal entity, the first question that usually arises is whether the sale of the “business” will comprise a sale of the entity in which the business is housed, or whether it will be a sale of the business out of the entity – often referred to by foreign lawyers as an “asset sale”. The main issues here are typically (1) whether the purchaser is willing to buy the legal entity and thereby take the risk that it may take on of historical liabilities that have not been disclosed or are unknown, as opposed to buying the assets out of the entity and leaving the disclosed and undisclosed liabilities behind in the entity, (2) the tax consequences for the seller and purchaser in doing the transaction one way or the other, and (3) the ease with which the transaction can be done in the one manner as against the other. Often it can be far more difficult to implement an asset, as regulatory approvals, licenses and contracts cannot automatically be transferred from the seller to the purchaser without going through laborious approval or new application processes, whereas it may be possible to transfer the ownership of the entity in which they are housed, without needing such approvals.
Whether the transaction will lessen competition is another consideration that should be assessed at an early stage, especially where the transaction involves competitors or parties that conduct business in overlapping markets. In terms of our Competition Act, approval from the Competition Authorities may be required before the transaction can be implemented. An application for approval can take up to 3 months or more, depending on the classification of the merger. Apart from anything, this will have a bearing on the transaction timeline and process.
Employees are another important consideration. Under current legislation, regardless of the form of the transaction, the employees must be transferred to the purchaser, unless the employees agree to remain behind.
The warranties to be given by the seller are generally the most negotiated part of any disposal agreement. When one talks of warranties, there is often an initial misunderstanding of what is contemplated. A seller will start off by telling me they want a clean deal with no warranties. What they really mean is that they do not want to warrant the future profit of the business, once it is in the hands of the purchaser. And rightly so. I have not been involved in a transaction for a long time where the seller gives a long-dated profit warranty. But what will be expected, are warranties in relation to the assets, liabilities and obligations of the business that is being transferred, prior to and at the time it is sold. This will apply whatever form the sale takes. Potential tax liabilities are always an issue in any entity sale, as are potential environmental liabilities where the transaction involves an environmentally sensitive business.
As a seller, how does one protect oneself against potential liability for the warranties given? Common methods include a well-controlled and documented due diligence and data room, on the basis that decent disclosure by the seller and an ability to later prove the disclosures is best protection. Also, contractually agreed limitations on the time within which claims may be made, as well as hurdles and caps to the level of liability to which the seller may be exposed. On the other side of the table, a buyer will look to obtain various types of security for the warranties – to make sure there is money available to meet any claims, if and when the need arises. Warranty and indemnity insurance is also a means of mitigating risk for both the seller and purchaser. This is becoming more popular, and one of my easiest negotiations on warranties was when we used that form of insurance.
Every transaction has its own dynamic, issues and psychology. The emotions are always interesting, especially where the sale involves a family built and owned business. No two transactions are the same. So, it’s an interesting space to practice law.