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One of the common pitfalls business owners can face when looking to sell their company is having to deal with a buyer who for whatever reason is unwilling or unable to pay the full purchase price in cash on the day you complete the sale.
If a buyer says that they want to defer some of the purchase price to a later date (or to pay by way of ‘loan notes’, which amounts to much the same thing), you have to ask yourself why? Why can’t the buyer afford to pay now? Why should you act as the buyer’s bank? Why should you take the risk of the buyer going bust or not paying for any other reason?
Whether you agree to such a deal may depend on what other options you do or don’t have. For example, for various reasons, but usually because they have left it to the last minute, owners sometimes end up agreeing to sell their company to their senior employees, and usually this involves the employees agreeing to pay out of funds generated by the company itself over a period of time. This might be called a ‘seller-funded management buyout’.
Sometimes the buyer says they want an earn-out deal, where much of the ‘goodwill’ element of the price is held back for a few years until various turnover or profit targets have been achieved. This can be a good pretext for the buyer saying they have to hold back payments. But as a seller you should still try to get as much up-front as possible.
If for whatever reason you agree that the buyer does not need to pay the purchase price in full in cash (or bank transfer) on completion, then you have to think about the risks and how you can reduce them and protect yourself. The main risk of course is that the buyer will go bust before it has paid you, leaving you high and dry having sold your company and not having been paid in full for it.
If any of the purchase price is to be deferred, whether on the pretext of an earn-out deal or not, how can you reduce the risks or protect yourself? Methods used include:
- At the risk of repetition, the best way to reduce the risk is… wait for it… to negotiate hard to get the buyer to pay as much of the purchase price as possible in cash on completion.
- Do credit checks and get an idea of how good the buyer or any guarantor is for the risk.
- Where the buyer is a company (which is usually the case), get a guarantee (and possibly additional security) from its controlling shareholder. Go up the line as far as you can to get the richest possible guarantor, whether this be a large holding company or a rich individual.
- Get security, such as a fixed and floating charge (debenture) from a buyer company over its assets.
- Get security from the very company that you are selling, again ideally a debenture over the company’s assets.
- Get the buyer to give a charge to the seller over the buyer’s shares in the company. I very rarely recommend this as it is usually pretty useless protection.
- Put provisions in the share purchase agreement and in any security document preventing things being done which could damage the value of any security which is being given.
- Put other provisions in the share purchase agreement to protect your interests, such as provisions (eg relating to interest) incentivising the buyer to pay earlier rather than later, and provisions discouraging late payments or triggering earlier payment in full in various circumstances.
An experienced corporate lawyer can help you to assess and negotiate the best ways to protect yourself.
If you would like to discuss any of the issues raised in this Guide or any other issues relating to the possible sale of your business please email me at andrew.james@onhandcounsel to arrange a complimentary consultation to talk through what might be involved.
About the author:
I have been a specialist corporate lawyer for 35 years. I have the ‘City quality’ experience and expertise to deal with any deal. But I also offer a level of personal service and value of money that you would struggle to get from most corporate law firms.
My business model and approach are therefore particularly suitable for most deals of any range from £250k to £5m.