No surprises: preparing for an exit
Exiting a business can be a challenging process. Key to minimising the challenges is preparation. In our experience, inadequate (or late) preparation can lead to a range of issues, such as a difficult or delayed exit, a reduced purchase price (or the requirement for a holdback) and increased seller risk post-completion. To avoid this, it is essential to start preparations well in advance of the anticipated exit. This article summarises some of the steps sellers and the target group can take to ensure they are ready for an exit.
This article assumes any exit will take the form of a share sale. Asset sales will have different considerations and require different preparation.
Critical to any exit is ensuring the sellers maximise the proceeds actually received by them. This article assumes that the sellers have previously taken advice in relation to the structuring of their interests in the target. If not, the sellers should take advice as soon as possible and, in any case, well before any potential exit.
A buyer will expect the registers of members of each entity in the target group to be consistent with the results of an ASIC search. The target group should ensure that all registers of members are complete and up to date.
The target group should ensure all ASIC filings (including in relation to directors and members) are up to date and consistent with the relevant registers.
A buyer will generally prefer to acquire only the companies needed to operate the target group business. Accordingly, the sellers should review the corporate structure of the target group. Any companies (or assets) in the target group which are not required, or not intended to be within the transaction perimeter, should be transferred out of the target group as soon as practicable. Any transfer should be appropriately documented and all relevant taxes paid. A buyer will expect to review any transfer agreement (including to ensure it has been complied with).
To the extent there are any ongoing arrangements between a target group company and any company transferred out of the target group, those arrangements should be on arm’s length terms and appropriately documented. Any shared customer or supply contracts should also be appropriately dealt with.
Depending on the transaction and the identity of the buyer, the sellers may wish to consider winding up or transferring out of the target group any dormant companies. Such transfer should be documented and all relevant taxes paid. Where any companies are to be wound up, all relevant laws should be complied with.
If there are minority interests in any target group company, the sellers should carefully consider the impact those interests will have on the transaction. In many cases, a buyer will prefer to acquire a wholly owned target group. The sellers should consider whether a restructure of the minority interests before completion is required.
A buyer will expect to be provided with copies of any agreements for the purchase by the target group of any other business. A buyer will also expect to be provided with copies of any agreements in relation to the restructure of the target group. The target group should confirm it has correct and complete copies of all such agreements available for review.
A buyer will expect the target group to make available certain key corporate records during due diligence, including company constitutions, company registers and company and shareholder minutes for the last two years (at least). The target group should ensure these are correct and complete.
A buyer will expect the target group to deliver all of the corporate records of the target group on completion (including corporate keys). A buyer will also expect the sellers to warrant the corporate records are correct and complete.
The sellers should ensure that all regulatory and other filings (including ASIC filings) are up to date (and are kept up to date).
A buyer will expect to review all of the material contracts of the business as part of due diligence. Typically, this includes the top 10 customer and supplier contracts, as well as any other agreements which the target group (or the buyer) considers to be material. Material contracts may include joint venture agreements, contracts with competitors, contracts with key-person clauses, contracts with related parties, contracts with government, contracts containing MFN (‘most favoured nation’) clauses and contracts providing for the exclusive licence of intellectual property.
The target group should maintain a list of all contracts by value and spend (as applicable). The target group should also ensure all material contracts are in writing, have been executed and are available for review (including any purchase orders under, or amendments or variations to, such contracts). If any material contracts are not in writing, the target group should prepare a summary of the key terms.
The target group should be aware of any material contracts that are nearing end of term or have expired (but are still being performed).
A buyer may require consent to change of control under any material contracts as a condition to completion. The target should be aware of all material contracts that contain change of control provisions that would be triggered by the exit (note, there can be some complexity surrounding this issue, particularly where the change of control occurs upstream).
A buyer will expect details of all breaches of material contracts. The target group should ensure it keeps records of all such current and past breaches. If possible, any breach should be resolved before engaging with a buyer.
The target group should maintain a list of all plant and equipment owned or used by it in the business. The target group should keep copies of all agreements for the lease of any plant or equipment.
A buyer will expect to be provided with details of all intellectual property owned or used by the target group in the business. A buyer will also expect customary representations and warranties in relation to ownership and non-infringement, etc.
The target group should maintain a list of all intellectual property owned or used by it which is material to the ongoing conduct of the business.
The target group should also ensure that it owns, or has a right to use, all intellectual property material to the ongoing conduct of the business. Depending on the nature of the intellectual property, and its importance, a buyer may require evidence of ownership or right of use. The target group should ensure it has copies of all such agreements available for review.
All intellectual property filings should be made when required and all filing fees paid. Any intellectual property that is required to be registered should be registered.
The target group should maintain a list of all intellectual property licensed by it to a third party. These arrangements should be documented. Any exclusive arrangements should be noted. A buyer will expect to be provided with full details of all such arrangements.
See below.
The sellers should conduct a review of the target group and its business to confirm it complies with all applicable laws and regulations. Any breaches (including the steps taken to remedy the breach) should be documented. A buyer will expect to be provided with full details of any breach.
Where relevant, the target group should have policies and procedures to ensure compliance with all applicable laws. The target group should also have all policies and procedures required by law (eg privacy laws). The sellers should confirm with the target group that all such policies are followed. A buyer will expect all such policies to be made available for review.
The target group should confirm it holds all approvals and registrations required by applicable law. The target group should have copies of all such approvals and registrations available for review.
The target should confirm it has adequate insurance policies in place considering the nature of its business. A buyer will expect to be provided with evidence of such policies (including certificates of currency). A buyer may also require details of the claim history.
A buyer will expect to be provided with high level information in relation to each employee (including position, location, commencement date, modern award coverage and classification (if any), visa status, remuneration, accrued leave entitlements, termination of employment entitlements and other benefits). The provision of this information should be consistent with privacy law obligations, including providing de-identified information where possible. From a legal perspective, areas of interest include remuneration and the amount of accrued entitlements (including annual leave and long service leave). The target group should have such information available for review.
A buyer will also want to know if any industrial instruments, such as modern awards and enterprise agreements, apply to the workforce.
A buyer will typically review the employment agreements of senior management. These are often reviewed for commercial terms, including confidentiality, IP, restraints of trade and notice of termination (particularly when new offers of employment are proposed to be made by the buyer). The target group should ensure that copies are available for review.
Depending on the target group industry and workforce composition, a buyer may also want to review template employment agreements for each class of employee. Again, these will be reviewed for commercial terms and for the purposes of alignment and integration with a buyer’s business. The target group should ensure copies are available for review.
The target group should ensure all employee policies are complete and up to date. They should be available for review (if required).
A buyer will expect to be provided with details of all commissions, bonuses (including transaction bonuses) and other benefits payable to employees. The target group should have details of all such arrangements available for review.
A buyer will expect details of all independent contractors engaged in the business. A buyer may also want to review the agreements for each contractor. This is likely to be the case where contractors have been used to provide key services, eg software development and coding (and in such cases, the target should confirm all intellectual property in such works vests with the relevant target group company).
The target group should ensure that all contractors engaged by it are properly classified as such (as opposed to employees). Classifying employees can be a complex area of law so specialist legal advice should be sought if there are any concerns.
The target group should ensure all records of current and former employment-related disputes or investigations are accurate and up to date. A buyer will require details of any such disputes or investigations. If possible, the target group should try to resolve these in advance of engaging with any buyer.
All rights to occupy, lease, licence or otherwise use any real property should be documented. A buyer will expect to review such documents for term, rent, rent review, change of control requirements and make good provisions.
In relation to any personal guarantees that may be in place for real property, see below.
A buyer will typically expect the target group to repay all of its debt on completion (ie the transaction will be debt free). A buyer will also expect all security interests in respect of such debt to be released. Accordingly, a buyer will want to review the debt agreements to ensure any pay-off letter and release adequately describes the debt and security to be repaid and released (as applicable). The target group should ensure that all debt documents (including all security documents) are available for review.
In some cases, debt will not be required to be repaid on completion (ie permitted debt). This is typically the case with hire purchase and similar arrangements. Again, a buyer will want to review copies of such agreements. The target group should all ensure that all permitted debt documents are available for review.
A buyer will require any loans made by the target group to a seller or its associate, to be repaid on completion. The target group should ensure the loans are documented and are available for review.
In some cases, the liabilities of the target group will have been guaranteed by the sellers or their associates. In that case, it is customary to expect the buyer to arrange for replacement guarantees following completion. A buyer will want to understand the liabilities these guarantees secure. The target group should have a list of all guarantees and copies of the agreements for which guarantees have been provided.
Preparing a business for exit can be a complex, expensive and time-consuming process. However, the cost of failing to adequately prepare can often be greater. To avoid this, it is crucial that preparations begin early (and well before the proposed exit). The sellers and target group should also consider engaging professional advisers (including lawyers) to assist.
