When acquiring an SME, buyers are typically focused on growth, opportunity, and building on an established business. However, without careful legal and commercial planning, transactions can give rise to a number of common pitfalls.
This article highlights key issues to consider when buying a UK SME.
Buying the whole company or just the business?
Many buyers assume that acquiring a business means taking over its customer base, assets and goodwill. In reality, there is more to consider. The buyer may have the option of acquiring selected assets of the target business without purchasing the shares in the company itself. While acquiring the shares in the company as a whole can appear to be the more straightforward option, it may also mean inheriting its existing obligations and liabilities. These include outstanding debts, ongoing contractual commitments, employee-related obligations, unresolved disputes and, in some cases, potential legal or insurance claims.
Understanding exactly what is being acquired is therefore an important first step in assessing the risks associated with the transaction.
Pitfall: Concentrating on what the business has to offer without fully considering how the structure of the deal may affect the risks assumed by the buyer.
Why understanding the business before you buy is essential
Due diligence is the process of reviewing legal, financial and commercial information relating to the target company or business.
Whilst due diligence can assist a buyer, to assess value for money, its purpose goes beyond justifying the purchase price. It is a critical stage in identifying issues which may not be immediately apparent at the outset of a transaction, and which could impact the level of risk the buyer is willing to accept.
Without a full independent due diligence process to gain an understanding of the target business, a buyer may find itself relying on the disclosure given by the seller to identify key issues.
Pitfall: Assuming that due diligence is about confirming value, when it’s really about uncovering unpriceable risk.
How buyers protect themselves if problems emerge after completion
One of the key protections available to a buyer in an acquisition is the inclusion of contractual statements made by the seller in the purchase agreement. These are known as warranties.
Warranties are intended to provide assurance to the buyer that certain information about the business is accurate at the point of completion. If a warranty later proves to be untrue and the buyer suffers a loss as a result, the buyer may be able to bring a claim against the seller for breach of warranty.
However, the existence of warranties does not automatically mean that any loss suffered by the buyer will be recoverable. In practice, a buyer’s ability to rely on warranties is often limited by a number of factors, including disclosures made by the seller, contractual time limits for bringing claims, and strict notice and evidential requirements which may impact the buyer’s ability to recover losses.
Recovery is not guaranteed and will depend on both the drafting of the agreement and the specific circumstances of the claim.
Pitfall: Overestimating the extent of legal protection under the warranty provisions.
What happens to contracts when the business changes hands?
When acquiring a business, buyers often assume that existing customer and supplier contracts will continue automatically after completion, particularly where the business continues to operate through the same company and remains the contracting party. This assumption can be misleading.
Many commercial contracts contain change of control provisions which require the other party to be notified of, or consent to, a change in ownership of the company. Non-compliance with these requirements may allow the counterparty to terminate, suspend or vary the contract.
In transactions where the business is being transferred rather than the company itself, buyers should consider whether key contracts include provisions allowing for their transfer. If this is not permitted, the buyer may be required to renegotiate or enter into new contracts entirely, potentially losing the benefit of existing favourable terms which may not be reinstated.
Pitfall: Risk losing key contracts in the target company.
Why moving too quickly in a deal can cause costly mistakes
Once a buyer has identified a suitable acquisition target, there can be significant pressure to agree commercial terms to secure the opportunity rapidly.
Standard heads of terms, email correspondence and informal understandings can often be progressed at pace to maintain deal momentum and move the transaction forward. As a result, the buyer may become committed to key commercial terms before fully understanding the legal and commercial implications of the deal they are agreeing to.
Taking early legal advice can significantly reduce exposure and improve deal outcomes. It allows potential issues to be identified before positions become entrenched and it helps ensure that the proposed structure, pricing and payment mechanisms align with the buyer’s objectives and appetite for risk.
Pitfall: Agreeing the deal before understanding the deal.
An acquisition is only as strong as the planning behind it. Early advice helps ensure the deal reflects the buyer’s objectives and helps avoid unnecessary risk and unwelcome surprises.
If you would like advice on acquisitions or SME transactions, please get in touch with our Corporate Team here.