The Reynolds Report - What is 2 plus 2?

When dealing with business sales I am frequently reminded of the story of the wise business woman who was interviewing accountants to help run her business.


The Reynolds Report - What is 2 plus 2?Three candidates, all with glittering CV’s, lined up outside the door of the interview room. The first candidate came in and sat down in front of the business woman.

“What is 2 plus 2?” the business woman asked.

“That’s easy,” said the first candidate.  “It’s 4.”

“Next candidate,” said the business woman.

The second candidate came into the room and sat down. 

“What is 2 plus 2?” the business woman asked again.

The second candidate hesitated and gave the matter some thought.

“4?” he answered.

“Next candidate,” said the business woman.

The final candidate came into the room and sat down.

“What is 2 plus 2?” the business woman asked again.

“What do you want it to be?” answered the final candidate.

You can guess who got the job.

If a business is being run as a limited company there are, in summary, two ways to sell (or buy) the business:

  1. An asset sale – where the business and assets used to carry on the business are purchased from the company and transferred to the buyer; and
  2. A share sale – where the shares of the company are sold to a new shareholder (ie there is a transfer of the shares and no change in ownership of the assets).

For the seller a share sale may sometimes be preferable for a variety of reasons.  For example it can be tax efficient for the proceeds of the sale to end up directly in the seller’s pocket (rather than in the company).

A seller will however need to exercise extreme caution to ensure that the amount of money with which he (or she) ends up is at least somewhere near the big, bright “headline figure” put forward when he (or she) initially agrees to sell the company.

Share purchase agreements (“SPA’s”), which are almost inevitably drafted by the buyer’s advisers, can contain a whole raft of provisions the net effect of which is likely to be a reduction of the amount actually being received by the seller.  These provisions can include:

  1. An assertion that original price was agreed on a “cash free debt free” basis and a request for a warranty that the company is “cash free debt free”;
  2. A request for a “zero non-cash working capital” warranty (and provision for price adjustment if this is not the case); and
  3. Requirements that, as and when “completion accounts” (ie the accounts prepared by accountants for the buyer and the seller shortly after completion of the sale which are intended to confirm the accuracy of financial information given regarding the company during the sale process) are prepared various items within those accounts (such as depreciation and/or the valuation of assets – particularly intangible assets) be dealt with in a way which is different from that in which they have historically been dealt with in the company’s accounts (and provision for further price adjustment).   

The details of each of these mechanisms (and there are others) is beyond the scope of this report but the overall effect is, almost invariably, a substantial reduction in the amount of money actually received by the seller.  (You might want to go through the exercise yourself using the balance sheet of your own company.  Imagine that you have agreed a sale of the shares at a certain price then make the various “adjustments” referred to above.  The difference can be very significant)   

Of course, “cash free debt free” can, on occasion, accurately reflect what was agreed between the buyer and the seller but it is not invariable and there are, certainly other ways to sell the shares of a business. 

Always remember that the sale (or purchase) of a business is a major decision and you should seek legal advice as early in process as possible – or, at the very least, make it clear that you reserve the right to do so (and to see the details of the SPA) before you commit yourself to a price.  Otherwise you could find yourself at the mercy of the wise business lady referred to above (and her accountant).

The Company and Commercial Department at Barrett and Co would be happy to help you at any stage of this process. 

I have written a book on Ten Common Mistakes Businesses Make with the Law.  To download a free copy of the book go to Martin Reynolds' Book on Business Law.  If you would prefer to meet face to face to discuss your business needs call 0118 958 9711 and speak with my assistant, Ummay Masood, to fix an appointment.

 
Cessation of Business in Reading
If you're planning to exit a business in Reading, we can help you sell it as a going concern, sell shares or business assets and much more. Over many years of experience in Reading we have helped business owners to maximise their gains and minimise their liabilities when selling a business, from Tilehurst to Lower Earley, Calcot to Caversham.

 
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