Buying or selling a business is different from buying or selling a house.
In a house purchase, a buyer has the opportunity to undertake searches of the public registers and commission a survey, but the acquisition is at the buyer's risk (the caveat emptor - or buyer beware - principle).
The acquisition of a business is more complicated, because the asset being bought is a fully functioning business, and the risk borne by buyer and seller is open to negotiation. And nursery businesses also have their own nuances.
What are you buying or selling?
The first decision that a buyer or seller needs to make is whether the sale should be structured as 'a share sale' or 'an asset sale'.
What are the main differences between a 'share' and 'asset' sale?
With a share acquisition, ownership of the company transfers to the buyer, along with all the assets and liabilities previously assumed by the company - which may also include liabilities that the buyer was unaware of.
With an asset purchase:
* each individual asset used in the business has to be transferred separately to the buyer
* any ongoing contracts (including a lease) have to be assigned to the buyer
* as the 'person' running the business will change, so the buyer may have to organise various consents and approvals, including Ofsted registration
* any employees have to be transferred to the buyer on their existing terms and conditions and with their continuity of service intact, and the 'TUPE'
employment regulations (the Transfer of Undertakings (Protection of Employment) Regulations 1981) apply, requiring both the buyer and the seller to inform and consult with representatives of any employees affected by the transfer.
Who decides whether to sell shares or assets?
It is usually the seller who decides whether to sell shares or assets.
Various factors will influence this decision, including commercial issues and tax reasons, and sellers should seek expert advice about the better option for them.
It will also depend on whether or not the business is incorporated - that is, formed into a business with its own separate legal identity.
Take the example of Mary Smith who operates a nursery business as a limited liability company, Teletubbies Tots Limited, trading as 'Teletubbies Tots'.
Mary took advice at the outset and decided that there were advantages to 'incorporating' the business, particularly the extent to which it would limit her liabilities were the business to fail.
Mary is the only shareholder of Teletubbies Tots Limited and also a director, but as an incorporated company, Teletubbies Tots Limited has its own 'legal personality'. All the business contracts, such as those with utility companies, are with Teletubbies Tots Limited rather than with Mary herself, and Teletubbies Tots Limited is the leaseholder on the nursery's rented premises.
If Mary decides to sell the Teletubbies Tots business, she could sell the shares that she owns in the company. In this instance, the owner of the business will remain Teletubbies Tots Limited.
However, Mary also has the option of allowing the company itself to sell the assets used in the business. In this instance, the company would assign the lease and sell the tables, chairs, computers and so on, and the ownership of the business would pass to the buyer.
If Mary had not incorporated the business, and so was trading as a sole trader, then it would only be possible for her to structure the sale as an asset sale.
What happens next?
Once the seller has found a buyer and a price has been agreed, several important steps need to be taken to complete the deal (see below). The process is likely to take longer than a house purchase and a turnaround time of three to four months from agreeing the terms of the sale to completion is not uncommon. Solicitors will also expect hands-on input from their clients to complete the sale within that timescale.
Stage 1 Agreeing and signing pre-contract agreements
Once a deal has been reached, seller and prospective buyer will be advised to enter into certain pre-contract agreements with each other. These include:
* an exclusivity agreement - this protects the interests of the buyer by preventing the seller from negotiating with other interested parties
* a confidentiality agreement - this aims to protect sensitive commercial information for both parties, but particularly the seller
* heads of terms - this sets out the key terms agreed between the parties (such as, price) and is not usually legally binding. However, it has the useful effect of drawing a line under the negotiation stage of the transaction and acts as a reference document when the full transaction documents are drafted.
Stage 2 Due diligence
The due diligence process is essentially an investigation into all aspects of the business by the buyer, including commercial, financial and legal aspects of the business.
Buyers may instruct accountants to undertake commercial and financial due diligence, or may undertake it themselves.
Legal due diligence is usually undertaken by the buyer's solicitor who will ask the seller to supply supporting documents and provide answers to a list of queries dealing with all aspects of the business. This process will cover, for example:
* the nature and condition of the assets used in the business
* whether there are any disputes with clients or employees
* whether there have been any adverse findings by Ofsted
* whether there have been any recent accidents
* whether there are any planning constraints on the use of the relevant premises.
A buyer who undertakes the due diligence exercise at an early stage can take timely action to address any problems revealed during the process:
* For a minor problem, the transaction documentation can be amended to reflect the additional risk that may arise
* With a significant problem, there may be scope for the price to be adjusted
* If the problem is more serious, the buyer can withdraw altogether from the transaction.
Stage 3 Transaction documents
Once the due diligence process has been concluded satisfactorily (or even while it is being undertaken, if timing is tight), the buyer's solicitor will prepare the transaction documents. These will usually include the following:
* Sale and purchase agreement - this is the main transaction document, which will set out the key provisions:
* who the parties are
* what is being acquired
* the price to be paid (sometimes referred to as the consideration) and when it is to be paid (some of the consideration may be deferred, for example)
* whether the sale is conditional on anything else (for example, requiring any relevant consents), meaning that there is a time-lag between exchange and completion
* any practical mechanism required to transfer the ownership of the business to the buyer.
The sale and purchase agreement will also contain various 'warranties'
given to the buyer by the seller. These are contractual promises about the condition of the business being bought. Subject to the 'disclosure letter'
(see below), if those promises are incorrect, the buyer may be able to claim compensation from the seller.
* Disclosure letter - this qualifies the warranties given by the seller. It will normally be divided into two sections:
* general disclosures (relating to information to which the buyer has access, such as matters on public records)
* specific disclosures (relating to specific issues such as, for example, bad debts or disputes with employees).
The disclosure letter is likely to have a bundle of disclosed documents annexed to it, which will be 'deemed' to have been disclosed to the buyer.
* Tax covenant - this may be required for a share acquisition and apportions the tax liabilities of the target company between the buyer and the seller.
* Ancillary documents - depending on the circumstances of the business, other documents may be required, including leases and property transfer documents and new employment contracts with key staff.
Stage 4 Completion
Once the documents have been agreed by the parties, often following keen negotiations, meetings and numerous rewrites, the matter can proceed to completion and the agreed price can be paid to the seller.
A successful conclusion
As with any business transaction, success is not guaranteed. There are clearly many issues to consider for somebody who wants to buy or sell a nursery business. Nevertheless, the process should not be daunting, if you have suitable professional advice and plan the sale or acquisition in advance.
Further information
* Veale Wasbrough Lawyers, Orchard Court, Orchard Lane, Bristol BS1 5WS.
Tel: 0117 925 2020, fax: 0117 925 2025. E-mail: cbetts@vwl.co.uk; website: www.vwl.co.uk.
Please note
* The advice given in this article is for guidance only. Nursery World readers should not place reliance upon it or take action without obtaining further advice relating to their specific and individual circumstances.
Robert Collier is a solicitor with Veale Wasbrough Lawyers, specialising in sales and purchases of schools and nurseries, undertaking mergers, corporate structuring, banking and general finance work
A PROBLEM OF VALUATION
Q. I am a nursery owner and have twice started enquiries into buying another nursery. Each time I have found that the valuation is based on the number of Ofsted registered places rather than the number of places approved by the planning department. Is this a valid basis for valuation?
A. Valuation of a nursery business is often based on the number of Ofsted registered places. This sounds reasonable unless you find that planning permission was granted for a lower number. While Ofsted may be satisfied that the premises and staffing are suitable for caring for 30 children, the planners look at different criteria. They may decide that noise and parking considerations mean that only 20 places are appropriate.
A nursery may, in fact, have operated for some time on the basis of 30 places despite 20 being the number specified in the planning permission. If this has gone on for at least 10 years with no challenge from the planning department, the planners cannot bring enforcement action.
If there is a significant amount of time to run before 10 years is achieved, or if the buyer wishes to increase numbers further, there is a risk that the planning department may take enforcement action which could, in a worst case scenario, result in closure of the business.
It would, therefore, be wise to regularise the position with an application to amend the planning consent. How and when this is done and by whom will be a matter for negotiation between the parties. A buyer may decide to take the risk of making the application after acquisition but can use the situation to seek a reduction in the purchase price. A prudent seller might make the application as part of the pre-sale preparation.
HOT TIPS FOR BUYERS
* Consider well in advance how you are going to fund the purchase.
* If the purchase is to be funded by a bank loan, your professional advisers will need to review the loan documents and security documents provided by the bank. In addition, the bank may want its solicitors to review the transaction documentation and due diligence process, and will want you to meet the additional costs. The bank is likely to require security for any finance provided. There are further complications if you are acquiring shares and offering assets owned by the target company as security to the bank, but these can normally be overcome with professional advice.
* Consider whether you should try to impose restrictive covenants on the seller to prevent them from setting up in competition with the acquired business within a certain period of time or poaching clients or employees.
* Note that with an asset acquisition, stamp duty is payable in relation to certain assets, particularly property. With a share acquisition, stamp duty at a rate of 0.5 per cent will be due.
* Remember that even if you are already running a nursery business, Ofsted requires you to register under the Children Act 1989 in order to provide daycare at different premises. With a share acquisition, you will need to notify Ofsted that although the registered person (the limited company) has not changed, there has been a change of director or directors.
HOT TIPS FOR SELLERS
* Whatever your reason for selling, forward planning is always beneficial.
Consider preparing for the sale even as much as three years in advance.
* Consider undertaking your own pre-sale due diligence exercise to ensure that the business is legally as 'clean' as possible - any issue that is unearthed during the transaction may be used by a buyer to negotiate a lower price.
* Valuation is a crucial factor on which you may need expert advice.
Although ultimately a business is only worth as much as somebody is prepared to pay, a formal valuation based on factors such as cash flow, dividend yield and/or net assets or market multiples (that is, appropriate multiples of estimated future earnings) is a good professional starting point.
* Tax advice should be taken at an early stage to ensure that the proposed sale is structured in as beneficial a manner as possible in terms of the tax implications .