Selling your business - preparing for due diligence

The legal due diligence process is nobody’s favourite part of a business transaction. However, sellers who engage with their buyer’s due diligence requests quickly, and offer plenty of detail, will reap the benefits during the other transaction stages – right up to completion and beyond.

Let’s imagine that a seller provides clear answers and supporting documentation in response to the buyer’s information requests. If the buyer is happy that there are no (or limited) information gaps, they’re more likely to take a reasonable approach to the sale warranties.

There will also be reduced scope for the buyer to seek specific sale warranties or indemnities to cover information gaps. This is because there should not be many business matters that the buyer can’t get a clear picture of from their due diligence.

To make selling your business a smoother process, you should start to prepare for due diligence well before the transaction actually begins. It’s wise to do this when you start to discuss taking your business to market with your corporate finance advisers. This will also help you:

• save time and costs – during both the buyer’s due diligence process and during the disclosure exercise later in the transaction. Usually, a number of the disclosures will flow out of the due diligence; and
• experience a smoother transaction, giving you more time to continue running your business during the transaction.

Although every business sale is different, we regularly come across common issues during due diligence. These can lead to delays in the transaction, the buyer seeking additional protections from the seller or the buyer re-evaluating what they’re willing to pay. In the worst cases, the buyer may even walk away. These issues can typically be avoided if a seller prepares for the transaction early.

Below, we’ve set out the key things to consider for typical areas of legal due diligence. It’s tricky to explain how to resolve or reduce your exposure to these often complex issues in just one article. but our key takeaway is this:

Consider any issues as early as possible to give you time to investigate and potentially resolve them, or at least reduce their impact before any buyer discovers them.

Share capital structure and records (where you’re selling a company or a group of companies)

Do you have up-to-date statutory registers for your company/group companies? They’re not the same as your company’s online file at Companies House. Instead, they’re internal registers maintained by a company to show information like details of its past and present:

• share capital;
• shareholders;
• directors; and
• persons with significant control.

Have you carried out any historic share capital events like:

• share buybacks;
• capital reductions; or
• share exchanges.

They may have been standalone events, or taken place as part of wider restructuring. If so, did you receive professional advice on how to document and implement such events? Is the relevant documentation available within your records?

Do any directors, employees or third parties hold options for shares in your company? If so, you should gather the share option documents, including any correspondence with HMRC if the share options were issued as part of an Enterprise Management Incentive scheme. This will help all parties have a clear understanding of the impact of the share options on the transaction structure – and save time. For example, will those who hold share options get to exercise them once the company is sold? If so, how will they receive their share sale proceeds?

Finance and banking

You should identify your current loan/funding facilities and outstanding security. Also, make sure that any historic facilities and security are genuinely historic – meaning they’re fully repaid, with any associated security released and the release(s) registered at Companies House and HM Land Registry.

Can you speak to your bank(s) or other lender/funder(s) at an early stage so they’re informed and involved from the outset – even if it’s a generic conversation? This will help speed up any input required from them later in the transaction, like consent or assurance that security in their favour will be released.

Contracts and trading

Do you have up-to-date written contracts with your key customers, suppliers, agents and distributors? Are these available within your records?

Do you have (or are you able to prepare) key financial statistics relating to your top customers and suppliers from the most recent full financial year and current year to date? Helpful information includes the revenue received from your top 10 customers, and the costs paid to your top 10 suppliers. Your buyer will be able to carry out focused due diligence around these contracts and relationships, saving them and you time.

Intellectual property rights (IPR)

Can you specify the IPR used in your business and how it is held? Is it owned by you personally, your company or one of your group companies, or formally licenced from a third party? You should specify any “word marks”, like your business name and any other trading names, and any “figurative marks” such as logos. It’s particularly important if you, or a connected company that isn’t being sold, own IPR because you’ll need to set out how you’re going to transfer certain IPR to either (i) the company/group being sold (on a company/group sale) or (ii) the buyer (on an asset sale).

Do your employment contracts vest any IPR developed by employees “on the job” in their employer?

Would your business be able to operate without being negatively impacted if even some of your IPR could not be used? If not, is that essential IPR protected by being registered with the Intellectual Property Office (or overseas equivalent)?

Consents

Will you need the consent of any third parties to sell your business? This could include:

• key customers;
• suppliers;
• particular stakeholders or investors; and
• governmental/regulatory bodies.

If so, you should make a plan to tell them about the transaction at the right time – even if the initial conversation needs to be generic.

Do your or your customer’s business activities fall within any of the specified sensitive areas of the economy set out in BEIS Guidance, and within the scope of the National Security and Investment Act 2021 (NSIA)? If so, or if it’s even a possibility, you should get professional advice about the extent to which the NSIA may apply to the transaction.

This needs to be considered early on, as the buyer is likely to explore this in their due diligence. NSIA may also impact the transaction structure. For example, the buyer may need to apply for the consent of the UK Government’s Investment Security Unit before they can go ahead with the purchase.

Data protection

Does your business hold, use or process personal data about employees, consultants, workers, contractors, customers, suppliers or members of the public? Personal data is a broad category. It includes employee information like employment contracts, payroll details, pension and other retirement benefits information. health and safety records (e.g. entries in accident books), insurance claims, customer lists, B2C contracts and statutory registers.

If so, you should:

• make sure your Information Commissioner’s Office registration is up-to-date;
• gather copies of your internal data protection policies, records, security and training information;
• check and summarise examples of how you get consent from customers and other individuals for marketing; and
• gather the information a buyer is likely to be interested in during their due diligence (e.g. a list of your employees, including their details, and key terms and conditions of employment). Before sharing this with the buyer and their advisers, you should seek professional advice on the extent to which, and how, any personal data should be anonymised.

Employment and pensions

Are all your employment contracts and any contracts with consultants, workers or contractors available within your records?

Do you have up-to-date details of your employees’ key terms and conditions of employment? Do they reflect any changes that have happened since their original employment contracts were entered into?

Have all right to work checks been carried out and is the relevant evidence/documentation available within your records?

Is your pensions information available within your records? This should include:

• scheme details;
• employer and employee contribution rates;
• scheme documentation/correspondence from the pension provider; and
• employee opt-outs.

Real estate

Do you have summary details of the properties used by your business – including whether they’re owned outright, leased and/or occupied under licence?

If you’re selling a company that’s part of an international group, or are selling your assets through a ‘vehicle’ that’s an overseas entity, there are a few more things to think about (based on the scope of the transaction).

• Company sale – Do any overseas entities within the group own any of your company’s property in the UK?
• Asset sale – Does the selling “vehicle” own any of your property in the UK?

If yes to either, is this overseas ownership registered at Companies House? This is required for HM Land Registry to allow dealings with the relevant property.

Are the leases and/or licences to occupy still within their express term? Or is there a formal hold over for the lease (under the Landlord and Tenant Act 1954) or a rolling licence period for licences to occupy? If not, you should consider putting in place new leases/licences for your business before completion to reassure your buyer.

For leased properties, do you have recent surveys/dilapidations reports?

For properties that are leased or occupied under licence, do you have landlord/landowner consent for any historic alterations and do you require their consent to the transaction?

Can you speak to the landlord/landowner at an early stage, even if just a generic conversation, so they’re prepared to answer any requests? This could be their retrospective consent to historic alterations or their consent to the transaction. They will need time to consider the context to any requests and the associated documentation. For example, this could be the identity and the ability of the buyer to comply with the covenants of their lease.

Environmental and health and safety

Do you have environmental or health and safety reports, property surveys (e.g. asbestos), investigations, sanctions or correspondence? If so, are these available within your records and have you taken action to address remedial requirements or recommendations?

Do you have records of any past accidents and have you implemented procedures to reduce future risks? This could be making changes to the locations where the accidents have occurred and carrying out internal training.