Tips and traps for selling your business (Part 3 of 4) – Transaction documents

In our first two blog articles in this series (“Proper preparation prevents poor performance”) and (“Get your backyard in order”) we gave 6 initial tips for potential sellers to consider before embarking on the process of selling their business.  Our next 4 tips relate to the transaction documents:

Tip 7 - Try to get drafting control for transaction documents

Transaction documents typically include sale and purchase agreements, new employment contracts, transitional services agreements, contract assignment or novation agreements, new leases or assignments of existing leases, shareholders agreements, property conveyance agreements, etc.  It is worth considering at the start of the transaction all potential documents that may be required.

Sellers often fall into the trap of thinking that they will save costs by getting the buyer to prepare the first draft of all transaction documents.  There are 2 main risks with this approach:

• The seller may end up in a far worse position because the buyer is likely to produce buyer friendly transaction documents; and
• Substantial costs can be involved in negotiating the documents back to a reasonable position.

In our experience, it is better to be “commercial” when preparing transaction documents (as documents that are too one-sided will often lead to lengthy negotiations).

Tip 8 - Try to avoid earn-outs (and other forms of deferred consideration) as a seller

An earn-out is a deferral of part of the purchase price pending certain events occurring.  Typically, this is usually linked to performance of the business after it has been sold.  From the seller’s perspective, it is best to avoid earn-outs and other forms of deferred consideration, as they create risk and often lead to disputes.

If you must have an earn-out or other form of deferred consideration, try to reduce the proportion that is deferred compared to the consideration that you will receive upfront at completion.  Think about whether you would still do the deal if the deferred amount was never ultimately paid.

Consider appropriate protection mechanisms to reduce the risks associated with the earn-out or other form of deferred consideration.  For example, negotiating security over the business or other assets of the buyer, becoming a director of the buyer until all deferred payments have been made, imposing restrictions on the conduct of the business during the earn-out period, accelerated payments if certain events occur (e.g. if the buyer on-sells the business or key assets, or breaches other restrictions).

Tip 9 - Consider warranty protections in sale and purchase agreements

Other than the amount of the purchase price, warranties are probably the biggest part of any negotiations in a business sale transaction.

It is important to consider warranty caps, collars, and other restrictions.

A seller should try and have all documents disclosed as part of due diligence apply as a carve out to any warranty claim.  This reinforces the importance of a comprehensive data room.

Be careful with any request by the buyer for security for warranty breaches (e.g. personal guarantees or deferred purchase price).

Depending on the size of the transaction, consider whether either buy-side or sell-side warranty and indemnity insurance is required.

Tip 10 - Minimise conditions precedent

Especially avoid broad conditions precedent that make it easy for buyer to back out of the deal (e.g. conditions that make the overall transaction subject to finance or subject to satisfactory due diligence).

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For more information, please contact any member of the Sierra Legal team, whose contact details can be found here - LINK.