Ancillary Documents

While the agreement for the sale and purchase of the shares in the company sets out what the buyer and the seller(s) have agreed, this document alone is not enough to give effect to a binding sale and purchase of a company.

Having been running your business for some time, you’ll be aware that you wear two ‘hats’ in this role. One is as ‘director’, and the other is your ‘shareholder’ hat. 

As a company director, you’re responsible for operating and managing the company in line with the law (which applies to all companies) and the company’s Articles of Association (which are specific to your company), and in the best interests of the shareholders.

It’s easy to think, especially if you’re the sole director and the sole shareholder, that you can amalgamate your two hats. From a company law perspective, they are quite distinct. It’s important to document the agreement to sell the company properly, from the point of view of both the shareholders and the directors. This means, for example, having both a board resolution setting out the approval of the sale by the directors, and a shareholder resolution confirming matters required by them (which will vary according to the details of the transaction, but often include approving the adoption of new Articles of Association, for example).

There may also be other documents required, such as resignation letters for directors who are not staying on the board after the sale – and possibly settlement agreements, so that those directors can confirm they’re not going to bring a claim for wrongful dismissal after the event. 

The buyer’s lawyers will often draft these other documents (often referred to as ancillary documents), too, even though some of these will be things that the buyer will not be a party to.

The rationale for this is that the buyer wants to make sure everything’s done properly, and by having their lawyers prepare the documents that are needed, they can be confident that all ‘i’s are dotted, and ‘t’s are crossed.

Good housekeeping to ensure a smooth company handover

Among the other housekeeping tasks you’ll need to arrange pre-completion, you’ll want to check with your bank to see what paperwork they require you to complete in order to hand over control of the company’s bank account(s). The buyers are likely to want up to date bank statements on the day of completion (or the day before), so make sure someone’s organised to do this too.

The buyer will want to receive the share certificates for the shares they are acquiring, to prove the company is theirs. If you’ve been trading for a while, there’s a possibility you have no idea where your share certificate is. If you’ve given or sold shares to others, you need to make sure everyone has looked for their certificates, and (hopefully) got them ready to hand over on the day.

If an individual shareholder is unable to track down their original share certificate, the buyer may agree to accept an ‘indemnity for lost share certificate’, in lieu of the actual certificate.  This is a statement from the shareholder promising that if the lost certificate turns up at some later date, they’ll either destroy it or send it to the buyer. It will also contain a commitment from the shareholder to protect the buyer against the possibility that a third party might materialise and claim to be the rightful holder of the shares. If you’re at all worried that this is a genuine possibility (see our blog post It’s your company, but who owns it?), this is something that you probably want to sort out before handing over an indemnity. Ideally it’s something you’d have identified and fixed beforehand (see our article on pre-due-diligence), so it doesn’t cause delays and problems at the last minute, when you’re getting ready to complete the transaction.

Similarly, you’ll need to hand over your company’s statutory registers (often referred to as the ‘stat books’ or ‘company books’), so make sure they are up to date and ready to go, along with details needed to file online for the company at Companies House (especially if you’re registered for ‘Proof’). 

There may be other practical elements you need to arrange, like access cards for the buyers to get into your office premises – a mental walkthrough of the first few days of the new owners will help flag up any other housekeeping tasks you need to get organised.

How does the money from your company sale get to you?

One thing that many parties neglect to discuss ahead of time is the mechanics of payment. Once upon a time, funds would be exchanged between solicitors, in a similar way to when you buy a house. Before completion, the buyer’s solicitor would issue an ‘undertaking’ to the selles’ solicitor, confirming that they have the buyer’s funds in their client-account, ready to transfer when the sale is complete. 

They would then transfer the money to the sellers’ solicitor upon completion. The sellers’ solicitor would then deduct their own fees, and any other professional fees (such as a company-sale agent, if you’ve used one), and would pay themselves and the other professionals directly from the proceeds of the sale.

Only when everyone else has been paid would the sellers’ solicitors start dividing up the remaining funds between the selling shareholders. 

While this ‘estate agency’ approach has some advantages, modern laws around anti-money-laundering have made holding client funds much more risky for lawyers. Add to that issues arising when the buyer changes their mind about some element of the transaction once the buying solicitor has already given an undertaking on the funds, and you start to appreciate why many city M&A firms are refusing to play the role of banker in company sale transactions. 

Devant’s approach is aligned to this more modern method of managing the proceeds of sale. We specify in the SPA exactly how the funds-flow should occur, and might, for example, require the buyers (or, if they prefer, their solicitors) to pay the relevant sums directly to each selling shareholder, and to the sellers’ advisors (including us!). Alternatively, we will ask for all of the consideration for the sale to be transferred directly to the sellers, and simply manage our fees directly with the sellers as we would with any other work.

Some solicitors (and some company-sale agents) worry that if they take this approach, their clients might ‘take the money and run’, without paying their bills. At Devant, we pride ourselves on building strong, trusting relationships with our clients. If any client had any concern with their legal bill after a company sale transaction, we’d deal with it in exactly the same way as any other issue – collaboratively and openly, ensuring that our clients feel they are getting excellent value for money from their spend with us! 

Whichever way you structure the funds-flow of your transaction, it’s a good to make sure that the banks on both sides of the transaction are warned ahead of time that large sums of money will be entering or leaving a bank account. The last thing you want when you sell your business for £millions is to have the sale proceeds temporarily frozen because your bank thinks the massive influx of cash into your personal bank account is because there’s been some sort of financial crime committed.

We’ve also seen transactions failing to complete on the scheduled date because the buyer discovers their bank has a cap on the maximum cash transfer permitted on a single day, which means they can’t make the whole payment in one go. Planning ahead can prevent this kind of issue from ruining your grand exit.

What happens at completion of your company sale?

Completion is the culmination of your weeks (possibly months) of work selling your company. It can, understandably, be a high-stress event! But if all the preparation has been done, you’ve organised all the housekeeping matters, your SPA, disclosure letter and disclosure bundle and ancillary documents are all ready to go, it should go smoothly.

Electronic completion or in-person?

One discussion to have with your legal team and the buyer in advance of completion day is whether you want to have all parties together in a single physical location to complete the transaction, or whether you’re happy to have completion take place remotely. 

There’s a certain poetry and drama to having a pile of paperwork passed from shareholder to shareholder, board member to board member, until everyone has signed everything they need to. Popping the Champagne, or serving celebratory tea and buns, is definitely much better done in person.

Equally, though, with our more Zoom/Teams-focussed work lives, and greater geographical distribution, getting everyone together on the day might be difficult. Particularly when shareholders live abroad, or at the other end of the country, it can be much more convenient to make use of the various tools available for electronic signature. 

If you do choose remote completion, your legal advisors and the counterparty’s advisors will liaise as to the precise mechanics of the completion. This might involve having physically signed and witnessed pages shared via post, and ‘held to the other party’s instructions’. This means that the lawyers will hold onto signed documents until they are instructed to release them, and enables documents to be completed ahead of time, and only dated and released when all the other completion requirements have been met. 

One advantage of this method is that it provides a mechanism for last-minute changes in documentation to be made, without requiring a massive re-signing exercise. Logistically, regardless of the completion mechanics you’ve agreed, your advisors and those of the buyer will bear responsibility for making sure that all the paperwork is complete, accurate, and signed by the right people at the right time. Completion is a tense time of immense focus and attention to detail for the lawyers. We’ll check, double-check and triple-check that everything is exactly as agreed, before we allow you to sign away your business.

It’s essential to work with a team (like Devant) who are experienced in managing company sale and purchase transactions. Selling your business may be the most complex and high-stakes transaction you’ll ever complete, and having an experienced, knowledgeable and capable partner to help you through the process will make everything smoother, calmer and safer, as well as much more enjoyable!   

How does an earn-out work? And how does it differ from ‘deferred consideration’?

Many company sales are structured so that the sellers receive payment for the business in multiple tranches. For example, if you’re selling your business, you may receive:

1. 60% of the purchase price on completion of the transaction;
2. 20% of the purchase price 12 months after completion; and
3. 20% of the purchase price 24 months after completion.

A payment structure like this, with no conditions attached to the post-completion payment tranches, uses ‘deferred consideration’. So payment 1 would be the ‘initial consideration’, and payments 2 and 3 would both be ‘deferred consideration’.

It’s a useful mechanism where the buyer does not have sufficient cash to pay the full amount of the consideration at completion. In this scenario, it’s common for a buyer to use the profits generated by their newly-acquired business to fund the deferred payments, reducing any requirement for the buyer to borrow funds to finance the full transaction.

A risk for the seller is that if the business doesn’t do as well as expected, the buyer may struggle to fund those deferred consideration payments. While that doesn’t change their obligation to pay the deferred sums, it might make it harder for the seller to actually get their hands on the remainder of the purchase price.

If this is a concern, it may be worth including a remedy in the SPA that says what will happen if the buyer fails to pay the outstanding amounts. This could include, for example, an obligation for them to allow the sellers to buy-back their shares at a discounted price.  

While a ‘deferred payment’ mechanism simply enables the buyer to postpone payment of agreed sums, an ‘earn-out’ adds a further level of complexity. 

Earn-outs transfer risk of poor post-sale performance from buyer to seller

The main difference between a deferred payment and an earn-out is that while with a deferred payment, the sum to be paid is fixed and pre-agreed, with an earn-out, the sum will depend on certain criteria being met. These criteria are often related to the financial performance of the company during the period after the sale. For example, you could have a financial structure where:

1. 60% of the purchase price on completion of the transaction;
2. 20% of the purchase price 12 months after completion IF the company’s gross revenue during that period is more than 105% of its gross revenue during the previous 12 months; and
3. 20% of the purchase price 24 months after completion IF the company’s gross revenue during that period is more than 110% of its gross revenue during the previous 12 months.

Many earn-outs have additional tiers of complexity, such as a ‘rachet’ that enables the seller to earn a higher earn-out payment if the company does better than planned, or to earn a portion of the earn-out payment if it does not hit target, but still turns over more than an agreed threshold sum.

As you can imagine, the possibilities are endless, and it’s important to involve your finance and tax advisors in any discussion of earn-out calculations, as well as your legal advisors.

While agreeing to an earn-out may result in you securing a better sale price for your business, it does mean that you are less likely to actually receive the full price. Many businesses suffer a slump in performance post-acquisition, particularly if the new owner wishes to make significant changes to business operations, marketing, staff incentives and other functions. If the selling shareholders are not continuing to be involved post-sale, there may be no opportunity for them to influence the success of the business, and therefore the amount of the earn-out they achieve.

It’s also possible for a buyer to manipulate the figures or the business structure so that even if the business performs well, it fails to meet the criteria necessary to allow the full earn-out to be paid. This could involve, for example, merging your flagship product with a product sold by the acquirer’s company, so that revenue earned from sales of that product go into their P&L, not the accounts of the company you’ve sold. There are endless ways for buyers to avoid paying earn-outs, so if you do take this approach:

1. Make sure that if you only ever receive the initial consideration, you’ll still feel this has been a fair deal – if you’re relying on the earn-out to make the deal work, you could be very disappointed; and
2. Ensure your legal advisors work closely with your financial advisors to build in as many post-sale operational controls to the SPA as they can, to reduce the opportunities for ‘financial engineering’ that could deprive you of your earn-out; and
3. Be honest in assessing the likely motivators and objectives of your buyer. They will argue that a successful earn-out for you will reflect a successful acquisition for them, and so their objectives are aligned with yours – is that true? Can you see a way for them to benefit from this acquisition without you benefitting too? If so, an earn-out might not be the best way to go.

Earn-outs, deferred payments and tax

As we mentioned in earlier parts of this guide, getting good tax advice early on is an essential component of securing a good deal when selling your business. The UK Government sees tax relief on proceeds of company sales as a political hot-topic, making it vulnerable to change, particularly in challenging times. Recent years have seen us move from Entrepreneurs Relief, where business owners were able to benefit from a tax rate of 10% on the proceeds of the sale of their company (and other qualifying assets) up to £10million, to Business Asset Disposal Relief, which (at the time of writing) limits this 10% tax rate to the first £1million ‘lifetime limit’ of qualifying gains.

When exploring the best commercial structure for your deal, take advice from a tax specialist to help you retain as much value from your sale as you can. This may also impact how you treat any earn-outs and deferred payments – you may find that, if you want to claim the reliefs offered on your company sale, you will have to pay ALL the tax due on the full purchase price on completion (or at your next tax return date), even though you won’t have received all the money by then.

You may choose to adjust the timing of your deal to help you manage the tax liability, for example, by postponing completion from March until April, so that you have an extra year to pay the corresponding capital gains tax. Whatever you decide, it’s important to do it with your eyes wide open, and all the appropriate advice to hand.

Living through the earn-out: when your company is no longer your company

Many owner/directors who sell their business with an earn-out provision, and agree to stay on in the business post-completion to help with the transition and deliver the subsequent growth, are surprised at how different life is when they’re working for someone else. 

When you own your own business, while work may be stressful, you do at least have the freedom of making your own decisions and doing what you think is best in any given circumstance. Being employed in your business but no longer owning it (and having a ‘boss’, possibly for the first time in many years) is a very different experience.

If you’re contemplating an earn-out where you are required to remain in the company for a specified period, it’s important to consider how your post-sale role will change, and what kind of relationship you’re likely to have with your acquirer.

One of our clients agreed to an earn-out and accepted a nice salary within the business so that he could continue supporting the company’s growth and delivering on his vision for it post-sale. In his case, the acquirer changed focus after buying his company, and refused to invest in the product as needed. His time in the business under its new ownership was considerably less enjoyable, and he didn’t achieve his earn-out target. Fortunately, we’d ensured that his initial consideration was enough to make the deal worthwhile. 

It’s also worth remembering that even with strong seller-protections to govern what the buyer does with the company during any earn-out period, actually enforcing those can be tricky. Taking legal action against the company that is now your employer can be stressful and expensive, and many sellers will opt to cut their losses and walk away, rather than attempting to secure some compensation from the acquirer.

By comparison, another of Devant’s clients sold their thriving software business to an American acquirer, and agreed to an earn-out that required them to stay on. They had done a great job of their due-diligence, speaking to other tech companies that this buyer had acquired previously, and were confident that they would enjoy being part of the new, larger business. Some years down the line, they’re still there and having a great time. For these guys, the earn-out was the best decision.

Whatever approaches you’re taking, Devant will be there to help you examine the pros and cons of each deal structure, to maximise your up-side, and to protect you as much as we can from the potential down sides. And if you do need help and support securing your earn-out after the deal’s completed, we’ll be here to hold your hand and give you a practical, pragmatic perspective on your options.