Thinking about selling? Do your DD, before doing DD

Posted on: July 25th, 2017

The sale of a business can live or die at the due diligence stage. Too often this early but important stage of the sale cycle is underestimated.

This article is aimed at giving you a brief introduction into the common problems that arise during due diligence and why it is a good idea to go through your own checks internally before beginning the sale process.

Common problems

While each transaction is unique, there are certain issues that, without fail, repeatedly come up.

Who has the Company registers and are they up-to-date? Most likely the company registers were stored in a cupboard, and are now gathering dust, or were left with the company accountant. They will be needed for the sale and it is best to get this sorted in advance to avoid rushing once the deal is under way. The introduction of PSC registers has meant many companies hold statutory books that are not compliant with UK law and there is often confusion as to whether an update at Companies House is all that has to be done. More importantly, companies often store their more important share ownership documents, such as stock transfer forms and share certificates, with the registers. Have you checked that these have been completed correctly? Have the stock transfer forms, where necessary, been stamped by HMRC? 

Are you registered with the Information Commissioners Office (“ICO”)? With the General Data Protection Regulations soon to come in to force, more than ever it is vital that your company is compliant with the law on data protection. Time and time again we find that companies have no policies in place relating to data protection and often they will not have registered with the ICO when they should have. This can be fixed quickly, during due diligence, but as data protection becomes more of a national concern, buyers will become more twitchy about taking on a company which has no procedures in place. Even if your company does not deal specifically with data, you may sell washing machines, it doesn’t mean you are exempt from the regulations.

Who owns your intellectual property (“IP”)? This is not just an issue for companies working in the tech sector. Simple things, such as whose name the company website is registered in, are often overlooked and it causes unnecessary stress and hassle trying to get it fixed once an offer is on the table. Has your trading name and logo been protected? If you have had a website made for you, has the IP in that website been handed over? The value of a company is often based in its recognisability. There is nothing worse than getting to the due diligence stage of your sale to find that the company name, that John Smith should have registered two years ago, was never protected or that no-one has renewed the protection and it has since expired.

What is your product built upon? If your business is based on the sale of your own product, where do the components for that product come from? This relates to both IT products and those more physical. If it is IT, is your product based on open source software? Do you have the correct licences for any code that is not your own? A buyer of any company is always going to be eager to know what your product is based on and ensuring that there are going to be no disputes over ownership after they buy the company.

Is anyone going to object to the sale? Change of control clauses are a common thing to find in contracts; you will inevitably find them in any agreements you have with utility providers. While these can often be easily overcome, as long as the company continues to pay its phone bill the provider is unlikely to object to a new company owner, what about clauses in your contracts with customers and other suppliers? If there are customers that the company relies on, the last thing you want is for them to be able to terminate upon the sale of the business and any buyer will be rightfully wary of anything that allows customers to do so. Regularly reviewing contracts you have in place is an important thing to do. You may have signed contracts that were heavily one sided when the company first started but, now that you have grown, you are in a stronger position to negotiate something fairer and so should take advantage of that.

Where are your key contracts? Keeping track of contracts you have in place with customers, suppliers, and employees may seem like an obvious thing but it rarely seems to be done. Any buyer is going to want to see agreements you have in place before committing to any deal and there is nothing worse than rushing around to find them all, or parts of them, when you are also trying to keep your business running. 

Is your workforce in order? Have you made sure that your employees have the right to work in the UK? It’s important to ensure that all the necessary paperwork is in place. No prospective buyer wants to find out that employees of the company are not allowed to work there. Are you keeping track of the terms of employment for each member of staff? If an employee pay rise is agreed via email, save it. Even if you do not have the time to update the contract immediately, make sure you keep a running log of the changes so there is no dispute down the line. Then, every once in a while, do a full review with legal help, to make sure your contracts are up-to-date and in line with current legislation. With a sale it is especially important to make sure that key staff are sufficiently tied to the company. A prospective buyer is going to want reassurance that employees who add value to the business are not going to walk away at completion of the deal, that they have adequate notice periods and that their contracts contain strong and enforceable restrictive covenants.   

Do you want to keep anything? It may seem a weird question but it is not uncommon for there to be company assets you, as the seller, may want to purchase from the company. These may be laptops and cars but could also be art work and tractors! It is important to check whose name these assets are registered in and to make sure that you deal with the process of transferring them to the right place early on. A buyer may not protest about you taking such items away but it is better to have clarity from the outset rather than uncertainty and awkwardness later on.
It is also important that any transaction between director shareholders and the company is properly documented and careful consideration given to the proper price to be paid to the company for those assets.

Protecting yourself in case the deal doesn’t go through

There is another important side to doing preliminary due diligence, making sure you are not going to be giving away anything that could help a competitor. There is a large amount of trust that goes into any due diligence process. Confidentiality agreements will be signed but you will still be giving the potential buyer access to huge amounts of financial and legal information, which cannot be unseen. You do not want to be in a position where the deal falls through but a competitor now knows everything about how your company operates and potentially how to get hold of the value of your company, be it customers, employees, or a specific product you sell, without having to buy you out.

By doing a pre due diligence stage, you can figure out what needs keeping back and what can be shared. By leaving it to the formal due diligence process of the sale, the pressure to provide answers and to keep the buyer happy can overcome rational thought and you can end up giving away more information than intended. Anonymising client and employee records is also a time consuming process (but something that is important to do from both a secrecy and a data protection perspective), and so it is better to get this done before any deal process begins.

Setting up for a smoother ride

An effective due diligence round can make the rest of the sales process a lot smoother. It can provide a strong basis for preparing your disclosures to any warranties and can help avoid price chipping and further negotiations by making sure all gremlins are laid bare from the start. By making sure that your house is in order before you get to the more formal process, you are giving the sale a greater chance of success. There is nothing worse, nor more frustrating, than a deal collapsing, and early retirement plans slipping away, because of something small that could have been dealt with through a little preplanning.  

If you are thinking about selling or you just want to make sure that your company is in order, we offer a range of business services and will be able to pair you up with the right person for whatever help you need.