Acquiring a business: six points of attention for a smooth transaction
An acquisition is an important step in the growth of a business. With proper preparation, it runs smoothly, from the first discussions through to closing.
At Quorum Law, we assist on more than 70 transactions every year. Our experience shows that the most successful acquisitions are those in which the buyer maps out the legal points of attention from the very start.
In this article, we set out the six most important points of attention. Our starting point is Belgian law.
1. Negotiating is not without commitment
Many buyers assume they are not bound by anything until the agreement is signed. That is not entirely correct. Parties must also act in good faith during the negotiations. Anyone who breaks off the talks unlawfully, for example abruptly at an advanced stage and without serious reason, may be held liable for the damage the other party suffers as a result.
The initial phase usually takes place in two steps:
- The non-disclosure agreement. Before you receive confidential information, you undertake not to disclose it and to use it solely for the intended transaction.
- The letter of intent. In it, the buyer and seller set out the main terms of the transaction: price, structure and timing.
A letter of intent is largely non-binding, but rarely entirely without commitment. Provisions on exclusivity, confidentiality and governing law are generally binding. Moreover, the wording matters: a letter of intent that already reflects an agreement on all essential elements may be qualified as a binding agreement. And a price you accept at this stage is commercially difficult to bring down later.
2. A share deal and an asset deal are two different worlds
In a share deal, you buy the shares. The company continues to exist, with all its contracts, staff and debts. Through the company, you therefore also take over its entire past, including risks that have not yet come to light. You should also check whether the shares are freely transferable: articles of association and shareholders’ agreements often contain pre-emption rights, approval clauses or other transfer restrictions.
In an asset deal, you choose which assets and liabilities you take over. Even so, certain obligations may still affect you without any express arrangement:
- if the transfer qualifies as a transfer of undertaking (Collective Bargaining Agreement no. 32bis), the employees attached to the transferred activity automatically transfer with it, retaining their rights;
- you may become jointly and severally liable for certain tax and social security debts of the seller if you do not request the required certificates in advance.
In addition, the transfer of a contract in principle requires the consent of the counterparty. And where the asset deal includes real estate, registration duties are generally payable on it, which in principle is not the case in a share deal.
Which structure is best depends on the risks, the tax position of both parties and which contracts can actually be transferred.
3. Financing takes more than the bank’s approval
Few acquisitions are paid for entirely with own funds. In most cases, a combination of sources is used:
- Own contribution. Banks and investors expect you to finance a substantial part of the price yourself.
- Bank loan. The bank generally requires security and imposes financial ratios (covenants). If you fail to meet those ratios, it may call in the loan early.
- Vendor loan. The seller leaves part of the price outstanding and thus remains involved in the success of the transfer. Banks often require this loan to be subordinated.
- Earn-out. Part of the price depends on future results. This helps bridge a gap in valuation, but often leads to disputes if the calculation method and the rules after closing have not been laid down in detail.
- External investors. They increase your firepower, but usually also acquire a say and control.
Also pay attention to a point that is often underestimated: the target company may not simply contribute to the financing of its own acquisition. Advances, loans or security provided by the target with a view to the acquisition of its shares are only permitted under strict statutory conditions (the financial assistance rules).
Repayment also requires attention. If you buy through a holding company and want to repay the debt with dividends, you must check whether the target company is actually allowed to distribute those dividends. It is therefore wise to test your financing plan against a less favourable scenario as well.
4. Due diligence is more than a check
The seller knows their business better than you do. Due diligence should narrow that information gap.
Do not start with a list of hundreds of questions, but with one central question: where does the value of this business lie, and what could undermine it? Typical findings include:
- a change-of-control clause allowing your largest customer to terminate the contract as soon as control of the company changes;
- a tax risk that, in a share deal, remains within the company and therefore economically falls entirely on you;
- self-employed contractors who in reality work as employees (bogus self-employment);
- software, trade marks or other intellectual property rights that turn out not to (fully) belong to the company.
Every finding should have a consequence: a price adjustment, a specific indemnity, a condition precedent to closing or an adjusted transaction structure. Sometimes the conclusion is that the risks are too great. That too is a valuable outcome.
5. Without warranties, you are on your own
A buyer of shares can hardly rely on the statutory warranty against latent defects. In principle, it relates to the shares themselves, not to the business behind them. Invoking error or fraud remains possible, but is difficult to prove. Your protection must therefore first and foremost be set out in the purchase agreement.
Pay particular attention to four elements:
- Warranties and indemnities. Their value depends on the wording, the thresholds, the caps and the time limits. What the seller has disclosed in advance (disclosure) also often limits your claims.
- The price mechanism. If the price is set on the basis of a historical balance sheet (locked box), it must be watertight that no value leaks out of the company between that balance sheet date and closing.
- The non-compete clause. It must be reasonable in duration, geographical scope and activity. If it is too broad, you run the risk of it being moderated or declared void.
- The seller’s transition. The value often lies with a few key people, the seller included. A good transition arrangement ensures that customer relationships and know-how actually transfer as well.
6. Not everything is in your hands
Even when the buyer and seller are in full agreement, external factors can delay the acquisition:
- above certain turnover thresholds, the transaction must be notified in advance to the competition authority and may only be implemented after approval;
- investments by investors from outside the European Union in sensitive sectors may be subject to prior screening;
- a works council must be informed in good time and, in certain cases, consulted;
- banks, landlords or key contracting parties sometimes have to give their consent in advance.
Those who only discover this after signing risk the closing being postponed by months. Include these points in your planning from the very start.
Conclusion
Acquisitions usually go wrong because of a series of smaller legal points that nobody raised in time. Those who address them early negotiate from a stronger position and avoid surprises after closing.
Considering acquiring a business? Our corporate and M&A team will be happy to assist you, from the first discussions through to closing.
