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

In our first two 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. 
  • 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 incurred when negotiating the documents back to a reasonable position.
  • In our experience, it is better (from a seller's perspective) for the seller to prepare the first draft of all transaction documents, but to also be “commercial” when preparing those transaction documents (as documents that are too one-sided will often lead to lengthy negotiations, or even result in a potential buyer walking from the deal).

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 - 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 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 risk associated with the earn-out or other form of deferred consideration - e.g. 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 and requiring accelerated payments if certain events occur (e.g. buyer on-sells the business or key assets, or breaches other restrictions).

Tip 9 - Consider the limitations on potential warranty claims

  • Other than the amount of the purchase price, the warranties and the limitations on warranty claims are the aspects of sale and purchase agreements that are usually most heavily negotiated.
  • Sellers should try to impose:
    • Time limits on warranty claims (i.e. deadlines within which potential warranty claims need to be commenced); 
    • Financial limits on warranty claims (i.e. capping the amount that may need to be paid as part of a warranty claim); and
    • other restrictions (including preventing warranty claims for matters that were disclosed to the buyer as part of due diligence - which reinforces the importance of having a comprehensive data room).
  • Depending on the size of the transaction, warranty and indemnity insurance may also be an option to consider.

Tip 10 - Minimise conditions precedent

  • The conditions precedent in a sale and purchase agreement are the key requirements that need to be satisfied before the parties have an obligation to proceed with completion of the transaction. 
  • Typical conditions include matters such as obtaining necessary regulatory approvals, obtaining third party assignment or change of control consents and the parties also entering into any other required transaction documents.
  • From the seller's perspective, it is important to try to avoid conditions precedent that are entirely in the hands of the buyer to complete and which easily allow the buyer to pull out of the deal (giving the seller limited certainty that the transaction will proceed).  Examples include conditions requiring the buyer to obtain board approval (or shareholder approval - in circumstances where it is not a regulatory requirement) or the buyer obtaining finance. 
  • If these type of conditions are unavoidable, the seller should consider requiring a non-refundable deposit so that the buyer is incentivised to ensure that the conditions are satisfied as quickly as possible.  

To assist sellers in planning for a potential sale of their business, we have prepared a mergers and acquisition planning checklist.  The link to the download page is below:

Download

Look out for our final article in this series, which will be released in the next few weeks.

For more information, please contact:

Craig Sanford, Director, Sierra Legal on M: +61 (0) 416 052 115 or E: csanford@sierralegal.com.au

Mike Jeffery, Director, Sierra Legal on M: +61 (0) 402 745 054 or E: mjeffery@sierralegal.com.au