December 2022

has any likelihood of being repaid. You cannot
guarantee the future performance of the business
you have just sold (especially under new
ownership) nor the wider performance of the
buyer’s business, so care should be taken to
ensure the buyer has sufficient ‘fat on its back’ to
pay the deferred consideration. This is especially
important where the buyer is a new company with
no trading history.
4. What about security? Where there is a
significant amount of deferred consideration (say,
more than 20-30 per cent of the total), you
should consider pushing for security over (at the
very least) the business and assets you have
sold, but also the assets of the buyer and, if
available, the wider group of the buyer.
How is the consideration calculated?
There are an enormous number of ways a buyer
will seek to price a transaction, which will depend
on the nature of both the target and buyer
businesses, funding arrangements and market
conditions. While there will often be a ‘headline
price’, buyers will often seek to introduce
‘adjustment mechanisms’ that change how much
money is paid. This is also why it is very
important to engage a suitable qualified,
independent advisor to walk you through the
options and how that will affect the ‘bottom line’
in your pocket.
Some of the most common of these are:
1. Cash-free, Debt-free: As the name suggests,
the price is adjusted having regard for how much
free cash (which is added to the price) and debt
(which is deducted from the price) is in the target
business. Buyers will want to keep a ‘normalised’
amount of working capital in the business, which
is not a straightforward exercise and can often
lead to a nasty surprise when final consideration
calculations are circulated if not dealt with early.
2. Net Assets: As a buyer is often basing the offer
on historic accounts, they will want to ensure that
the net asset position at completion is the same
level as the point in time their offer is based on –
the buyer will do a ‘reckoning up’ exercise after
“Tax. No-one likes to pay it, but knowing your
obligations in advance is important to prevent a
shock when the bill arrives”
completion and there will be an adjustment to the
purchase price based on whether the actual net
asset position at completion is above or below a
set target.
3. Earn-out: This is a form of consideration that
is based upon the future performance of the
business after completion. It is typically used if
the business to be sold is on an upward trajectory
in terms of development, so that the seller can
get the benefit of having built it to that position,
but is selling prior to benefiting from the potential.
An earn-out can add significant consideration,
but needs to be carefully negotiated with regard
to how the business is run after completion (for
example, so that profits that would otherwise
come into the business are not diverted to the
buyer, which would mean the seller doesn’t get
credit, or the buyer making major ‘management
charges’ to artificially depress the profits on
which the earn-out payments are calculated).
The wider sales process
Once the headline terms of the sale are agreed,
the technical work begins, which in brief
comprises:
1. A full ‘due diligence’ exercise by the buyer on
the target company, which will involve the seller
(and their advisors) responding to detailed
queries on the legal, financial, tax and
commercial aspects of the business.
2. The drafting of the transaction documents,
which implement the main deal terms, but will
include ‘warranties’ (essentially contractual
promises) to be given by the seller as to the
nature and state of the target company.
3. A ‘disclosure’ exercise in which statements are
made by the seller against the warranties referred
to above so that no claims can be brought against
the seller for breach of those warranties.
If you follow the advice given in part one of this
series, the due diligence and disclosure exercises
should be smooth sailing, so again I urge you to
engage early with your professional advisors
when considering a sale.
Contact Taylors Solicitors
01254 297900
www.taylors.co.uk
@taylorslawfirm
DECEMBER 2022 TC 15