Buying a business before the Budget – what you need to know

With the new labour government’s first budget looming, the rumour mill has been spinning with predictions that the financial landscape for those looking to sell their businesses may be about to change - to their detriment. Reports suggest that the capital gains tax rate may increase, leaving many with a much higher tax bill to foot once their business has been disposed of. As a result, some are looking to buy or sell a business before the predicted changes come into effect.  The need for urgency may, however come with unwanted consequences.

More haste less speed…

Can the sale/purchase process be shoehorned into what would normally be considered an unreasonably short time frame? Absolutely.

Can be done without additional risk? Probably not.

There is nothing unusual about businesses being sold and purchased under time pressure. However, what is unique about this situation is that so many businesses and individuals will have an urgent sale or purchase on their agenda, courtesy of the budget.  That is likely to ramp up the pressure for all concerned – including professional advisors such as lawyers and accountants involved in the deal. Pushing matters through quickly can result in corners inadvertently being cut, paving the way for future problems.  When the dust settles, days, weeks or months after the budget, those problems may begin to emerge…

Shortcuts make long journeys…

During a commercial acquisition, due diligence is arguably one of the most important stages in the process. Due diligence is the fact-finding process undertaken by the buyer of a business whereby they delve into and review financial, legal and commercial information about the business provided by the seller. The information, made available by the seller, is crucial to permit a buyer to consider matters such as whether the price to be paid is appropriate and whether there are any underlying problems with the business which may cause issues later down the line.

Undertaking due diligence is essential but tedious, calling for hundreds (or thousands) of documents and contracts relating to all aspects of the business to be scrutinised.  Those can range from demonstrating the validity of the business’s title in its properties, to whether its employees are signed-up to proper contracts of employment and even to the functionality of its coffee machines and photocopiers.

Whilst it may be tempting to “take a view” on certain matters which arise during the due-diligence process and implement a less stringent level of scrutiny, due to time pressures, this has the potential to result in serious issues being missed.

The aftermath; when all is not as it should be…

There are any number of claims which may arise due to an expedited (and therefore possibly deficient) level of due diligence being conducted. Just by way of a few examples that we have seen:

• change of control clauses (which determine what will happen in an event where the ownership or control of a company changes) being missed within key contracts – something that upon an acquisition of a business can have huge implications on existing contracts within the business
• there may be structural defects in the business’s premises, which may end up costing hundreds of thousands of pounds to rectify
• it may emerge that the vendor’s business does not actually own the premises
• there may be unusual and commercially unsatisfactory leasehold agreements between the landlord and the business
• the businesses profitability may have been overstated
• incorrect information is provided in respect of the financial health and accounting policies of the business - reflecting a different reality to what is actually going on - and this is information which the buyer relied upon; and
• there may be undisclosed but ongoing court claims against the business which may need to be settled.

With insufficient time to dig into the position, there is plenty of scope for something to slip through the net.  Each of the problems above should have been detected at an early stage but, for various reasons, were not.

Typically, sellers are required to disclose everything that is relevant to the business.  Just in case something is missed, contractual warranties are included in most share purchase agreements and/or other transaction documents.  Their purpose is to protect the buyer from any losses which arise due to a seller’s failure to disclose issues and potential liabilities.

Put simply, a warranty is a contractual assurance given by a seller to a buyer in respect of the state of the business and its affairs, a breach of which may give rise to a claim for damages. Examples of a warranties given by a seller may include that there are no claims against the business from any employees or that the machinery and equipment of the company is in a good state of repair and fit for purpose.

Where the seller is in breach of the warranty and a loss flows from that (for instance the purchase price may have been too high, taking into account the undisclosed issue) it may be possible to make a claim.

Bringing a warranty claim

Making a warranty claim isn’t always straightforward.  The ability of a purchaser to make such a claim can be limited in a number of ways including the following: -

• time – generally, under English contract law, a party has 6 years to bring a claim in respect of a breach of a contract’s terms (including warranties) - 12 years where the contract is executed as a deed. That’s known as the “limitation period,” after which a claim is time barred and will be defeated when met by a defence that the claim is out of time.  However, it is very common for contracts to include a far shorter contractual limitation clause – often as little as 18 months to 2 years. That shortens the time available to bring a claim quite considerably. If you fail to bring a claim within the relevant limitation period, that is likely to be the end of the road, unless some form of fraud is involved
• knowledge – warranties can be expressed not to provide any protection in relation to issues which the buyer would or should have been aware of, had they undertaken reasonable enquiries. If a seller has disclosed information about an issue and the buyer has failed to pick up on this, the seller is unlikely to be liable for a breach of warranty
• amount – transaction documents can contain what is known as “de minimums” provisions, which set out a minimum threshold of the value of claims which can be made. This can prevent low value claims being brought against a seller.

Assuming you are in a position to make a warranty claim, you may be required to put the other side on notice of your intention to do so – and there may also be a time limit for taking that step.  So it’s essential to carefully check the notice provisions contained within the contract, in order to comply with its requirements.  Notice provisions are often very specific and usually set out to whom, where, by when and how (i.e. by post, email etc.) notice is to be served. There may also be requirements to notify the seller of specific details of the potential claim (such as the basis in which you believe you have a claim and the amount), and therefore the requirements should be checked thoroughly beforehand. Failure to comply the notice requirements can render a notice invalid and, with time running to give notice or to make a claim under a contractual limitation period, there may not be a second chance to get this right.

How can we help?

By now it should be clear that, if you discover that the business you have purchased isn’t all that was promised, you need to act quickly and correctly to avoid losing the opportunity to do so.

Weightmans regularly deals with making (and defending) claims of this kind.  We are experienced in making sure that claims are properly advanced, and are equally at home working to undermine unmeritorious claim when they are made against our clients. We will be happy to help you navigate the issues, whether that involves an initial conversation to discuss whether a claim can be brought or making or defending a claim on your behalf.