Burgis & Bullock - Guide to Mergers and Acquisitions in the UK

A Guide to Mergers and Acquisitions in the UK September 2015

Simon Chapman

Burgis & Bullock Corporate Finance

2 Chapel Court

Holly Walk

Leamington Spa

CV32 4YS

United Kingdom

www.burgisbullock.com

A GUIDE TO MERGERS AND ACQUISITIONS IN THE UK

Burgis & Bullock Corporate Finance 1

About the author

Simon Chapman is a corporate finance partner with Burgis & Bullock, specialising in M&A

transactions and valuations. A graduate of the University of Oxford, he qualified as a

chartered accountant with Coopers & Lybrand and subsequently spent seven years in the

corporate finance department of Ernst & Young. Simon was a partner at Baker Tilly

where he headed the firm’s Birmingham M&A team before joining Burgis & Bullock in

2010.

Simon has advised on many international transactions, including a £46m buy-out jointly

funded by a UK private equity house and French industrial group, the acquisition of a UK

building products company by a US acquirer, and the management buy-out of an

industrial services group with subsidiaries in six countries from a US listed parent.

He holds the Corporate Finance Qualification of the Institute of Chartered Accountants in

England & Wales and is a member of the Institute’s panel of valuation experts.

About Burgis & Bullock Corporate Finance

Burgis & Bullock Corporate Finance is an award winning M&A firm specialising in the

provision of the highest levels of expertise, hands-on transaction support, and leading

edge corporate finance solutions to owner-managed businesses.

We provide strategic advice and practical support for:

Company sales

Acquisitions

Management buy-outs and buy-ins

Equity and debt finance raising

Valuations

The firm is part of the Burgis & Bullock Group, a member firm of the TAG Alliances, which

is ranked as one of the top three independent professional services associations in the

world. Through TAG we have a global footprint of 592 offices in 101 countries which

enables us to provide a seamless infrastructure for cross-border deals.

A GUIDE TO MERGERS AND ACQUISITIONS IN THE UK


Contents

Page

1. Introduction ................................................................................................................. 2

2. Deal activity in the UK ................................................................................................. 4

3. Legal and regulatory framework ................................................................................. 7

4. Finding and researching targets ............................................................................... 10

5. Public M&A ............................................................................................................... 14

6. Private M&A .............................................................................................................. 25

7. Financing the acquisition .......................................................................................... 42

8. Common deal issues in the UK ................................................................................ 46

9. Tax considerations for overseas buyers ................................................................... 51

10. Advisers .................................................................................................................... 55

Appendix A: Companies legislation .................................................................................. 58

Appendix B: EU merger regulation thresholds ................................................................. 60

Glossary ............................................................................................................................ 61

INTRODUCTION


1. Introduction

INTRODUCTION


The UK is a highly attractive place to do business as evidenced by the large levels of

inward investment into the country seen over the last few years. For overseas

companies wishing to set up operations and trade there are a number of highly useful

guides to doing business in the UK produced by the accounting and law firm members of

the TAG Alliances (www.tiagnet.com and www.taglaw.com).

However, one of the most common methods for international companies to seek a

presence in the UK is through acquisition. Having advised and supported overseas

businesses to acquire UK companies we have observed there are many subtle, and not

so subtle, variations in how different countries conduct M&A activity. This includes not

just the obvious legal differences, but also variances in style, custom, market practice, the

role of advisers, and the process undertaken.

This guide does not cover the strategic and commercial aspects of an effective

acquisition strategy that would be common across the globe, such as defining your

acquisition criteria, target analysis, valuations, negotiations, and post-acquisition

integration. The document is designed to provide non-UK acquirers with an overview of

the legal and regulatory regime governing M&A activity in the UK together with an

understanding of the processes and transaction issues that are most commonly

encountered in this country. It is no substitute for good quality professional advice, but

should help buyers to plan their M&A strategy for maximum effectiveness.

http://www.tiagnet.com/

http://www.taglaw.com/

DEAL ACTIVITY IN THE UK


2. Deal activity in the UK



In 2014/15, there were 190 deals involving a UK target company and an overseas

acquirer (“Inward Investment Report 2014/15” by UK Trade & Investment). Purely

domestic deals represent a minority of UK transaction activity by both volume and value,

and cross-border M&A now accounts for nearly 80% of the value of all UK deal activity.

The UK is the leading target jurisdiction in Europe for cross-border M&A activity, and for

foreign direct investment in general. In particular, the UK is a key market for US buyers

who make up nearly 40% of the overseas acquirers of UK companies (source: Office for

National Statistics).

While there are a wide range of factors that drive individual deals and buyers, a number

of common themes emerge when asking why overseas companies choose to make

acquisitions in the UK:

Stable political regime.

Well established rule of law, contract, and property rights.

Favourable business regulatory environment with few restrictions on foreign

ownership.

Low levels of corporate taxation.

Flexible labour market.

Advanced economy and educated workforce.

Domestic22%

Inbound34%

Outbound44%

M&A deal mix by value

Domestic44%

Inbound26%

Outbound30%

M&A deal mix by volume

USA37%

Other Americas

8%

European Union28%

Other European

14%

Rest of World13%

Origin of overseas acquirers



Strength in key industries such as financial and professional services, creative

industries, aerospace, automotive, information technology, life sciences, and

energy.

Large and diverse range of owner-managed businesses, many of which trade

internationally.

Access to the wider European Union (“EU”) market, but outside the Eurozone.

Specifically, the UK is an open market in terms of overseas companies wishing to acquire

trading businesses. Other than for protecting competition and certain strategic

companies or industries, there are no restrictions on overseas companies making

acquisitions in the UK. In the listed company arena there is a well-established and

effective mechanism for ensuring the orderly conduct of takeover bids and in the private

sphere parties are largely free to contract on whatever terms they wish. Supporting the

M&A market is a diverse range of funders and advisers. These factors make the UK an

attractive destination for global corporate acquirers.

LEGAL AND REGULATORY FRAMEWORK


3. Legal and regulatory framework



3.1. Overview

The “Doing Business in the UK” guides produced by UK TIAG and TAGLaw members

provide a good overview of the general legal and regulatory regime covering the

establishment and operation of businesses in the UK. In this section we specifically focus

on the regulations affecting the purchase and sale of businesses.

It should be noted that each of England and Wales, Scotland, and Northern Ireland is a

separate jurisdiction for legal purposes in the UK. While in many respects covered in this

section the relevant laws and regulations are the same for all territories, in some areas

(such as property and litigation) the relevant laws can vary significantly. This guide

focuses on the laws of England and Wales. If you are considering an acquisition in

Scotland or Northern Ireland we would be happy to refer you to an appropriate adviser.

3.2. Companies legislation

English law is often favoured by buyers and sellers even for deals with limited connection

to the UK. While there are some legislative provisions and principles of case law that

affect what can be included in contracts, essentially under English law the parties are free

to contract on whatever terms they choose. There are very limited areas where English

law principles will override the terms expressed in a contract, and terms are rarely implied

into a contract by law or the courts.

The four main statutes that affect acquisitions in the UK are the Companies Act 2006, the

Financial Services and Markets Act 2000, the Financial Services Act 2012, and the

Criminal Justice Act 1993. In addition, the Companies (Cross-Border) Mergers

Regulations 2007 implements the EU Merger Directive 2006/56/EG in UK law. The main

legal provisions relating to M&A transactions are summarised in Appendix A.

3.3. Regulatory bodies

Acquisitions in the UK are regulated by a number of different authorities deriving power

from several sources.

3.3.1. The Panel on Takeovers and Mergers

The Panel on Takeovers and Mergers (“the Panel”) regulates takeovers of companies

that are subject to the City Code on Takeovers and Mergers (“the Code”), which

principally covers companies that have shares listed on a stock exchange or that are

traded publicly (see section 5).

3.3.2. Competition and Markets Authority

This body investigates mergers that may restrict competition and possible breaches of

UK or European competition regulations.

In certain cases, the European Commission has exclusive jurisdiction to review

competition issues resulting from proposed takeovers.

3.3.3. Financial Conduct Authority and Prudential Regulation Authority

For transactions involving financial services firms, the UK’s statutory financial regulators

may become involved. These are the Financial Conduct Authority (“FCA”) which is

responsible for regulating financial services firms and parts of the companies’ legislation,

and the Prudential Regulation Authority (“PRA”) which is specifically responsible for the

supervision of banks and insurers.



3.3.4. Other regulatory consents

There are certain industries in the UK where specific regulatory consents (including from

Government departments) may be required, for example, newspapers, television, radio,

utilities, and financial services.

Certain other regulatory and government bodies may become involved in a transaction

depending upon its specific characteristics, such as The Pensions Regulator and HM

Revenue & Customs (“HMRC”).

3.4. Competition legislation

UK competition laws are set out in the Competition Act 1998, the Enterprise Act 2002 and

the Enterprise and Regulatory Reform Act 2013.

The Competition and Markets Authority (“CMA”) is the relevant regulatory body for

competition matters in the UK. The CMA may initiate an investigation (phase 1

investigation) if a proposed takeover creates a qualifying situation for investigation, other

than where the European Commission has exclusive jurisdiction. The CMA is under a

duty to refer a takeover for a detailed phase 2 investigation if there is a relevant merger

which has or may result in a lessening of competition.

A takeover qualifies for investigation if there is a coming together of two previously

distinct enterprises and either:

the UK turnover of the target exceeds £70 million per annum; or

as a result of the merger a 25% share of the supply of goods or services in a

particular market is created or enhanced in the UK.

There is no statutory obligation to notify the CMA of an acquisition that qualifies for

reference, but in practice most such takeovers are referred to the CMA by the

participants. Where the merger is notified, the CMA has 40 days to decide whether to

clear the takeover or refer it for a detailed investigation.

If a merger is not notified to the CMA, then this body has a period of four months from the

date of closing (or the date the transaction becomes public knowledge if later) in which to

initiate an investigation.

In order to secure clearance from the CMA, the parties to a transaction may provide

certain undertakings, such as the divestment of parts of the enlarged business. For

mergers that have been subject to a detailed investigation, the CMA may:

clear the takeover;

prohibit it and force the parties to unwind any completed arrangements; or

approve the transaction subject to certain remedies, such as divestment of parts

of the enlarged business.

The European Commission has exclusive jurisdiction to review competition issues arising

from takeovers that are “concentrations with a Community dimension”. Whether this test

is met depends on the takeover reaching certain turnover thresholds, which are set out in

diagrammatic form in Appendix B. Overseas buyers should note that for transactions

where EU merger regulation applies, closing before clearance is secured is prohibited.

FINDING AND RESEARCHING TARGETS


4. Finding and researching targets



4.1. Acquisition strategy

The decision to make an acquisition may be strategic or tactical and driven by one or

more factors, such as:

Acquiring new products and services to take into wider markets.

Gaining new technologies, processes, know-how, and skilled personnel.

Securing access to new customers, markets, and industry sectors.

Geographical expansion, notably into the EU.

Securing manufacturing or distribution facilities closer to end markets.

Gaining control of supply sources or forward integration into higher added value

products.

Deploying surplus funds.

Where the prospective acquirer has not already identified a target company it is

necessary to research the population of possible UK businesses in order to identify a

company matching the relevant acquisition criteria. Fortunately for acquirers, there is a

large volume of publicly available information on many UK businesses which can be used

to quickly screen potential targets.

4.2. UK Government

The UK Government actively encourages investment in the country, particularly in the

development of greenfield sites that will create new jobs. The principal body that

supports inward investment into the UK is UK Trade and Investment and further

information can be found on their website: www.gov.uk/ukti

The Government primarily encourages investment by creating a favourable business

regime through de-regulation and low corporate taxes and by providing advice and

contacts to investors. Direct subsidies to secure investment from overseas companies

are rare but do happen in certain strategic industries.

4.3. Companies House

All companies, whether listed or privately owned, are required to file information at the

UK’s company registry which can then be freely accessed. This information includes the

following:

Annual accounts, which for all but very small companies will include full profit and

loss accounts, balance sheets, and cash flows and comprehensive notes.

Annual return containing details of directors, shareholders, and the share capital

structure.

Articles of Association, which is the company’s constitution and sets out directors’

powers and responsibilities, the rights of each class of shares including

dividends, the mechanism for dealing with share transfers, and procedures for

shareholder meetings.

Details of all legal charges such as mortgages.

Information on certain share transactions, including company share buy-backs.

Your financial or legal adviser should have registered access to Companies House and

will be able to provide filed documents on target companies. However, information can

http://www.gov.uk/ukti



also be obtained directly via the Companies House website:

https://www.gov.uk/government/organisations/companies-house

4.4. Company databases

There are a number of subscription databases that obtain information from Companies

House and other sources, including FAME operated by Bureau van Dijk and Experian’s

MarketIQ. Owing to the high level of disclosure required from all UK companies these

databases generally provide good levels of functionality for carrying out searches by

industry, region, size of business, type of owner etc. A good M&A adviser or accountant

should have access to one or more of these databases to assist you in your UK

acquisition search.

4.5. M&A advisers and professional networks

A good M&A adviser can assist an overseas acquirer in undertaking a large amount of

the research work by identifying and analysing potential targets and locating non-public

information about companies that may be of interest. The adviser may have a particular

knowledge about an industry sector or will almost certainly be able to identify a person or

firm with insights into the market sector that is of interest to an acquirer. In addition, the

M&A adviser may know and be able to speak informally with the target company’s

financial or legal adviser to get an indication for whether an approach might be welcomed

by the target company and how best it should be made.

After an acquirer’s own in-house team, M&A advisers and accountancy firms are

considered the most important source of intelligence on potential cross-border M&A

targets (“Cross Border M&A: Perspectives on a changing world”, Clifford Chance).

4.6. Trade bodies and directories

Many UK companies are members of an industry or trade body that seeks to promote

that industry, lobby government, and provide information to its members. Their websites

usually contain a large amount of valuable information, including membership directories,

research reports, and industry news.

The UK has several major international conference venues including Olympia in London

and the National Exhibition Centre in Birmingham. These locations are frequently used

for national and international industry fairs and exhibitions, which provides an excellent

opportunity for gathering market intelligence.

4.7. Private equity portfolios

The one certain thing about private equity backed companies is that they are all for sale.

While opening a dialogue with the owner of a private company can sometimes be

challenging, private equity executives are generally much more open to discuss M&A

opportunities. As deal values are often publicised, or can be calculated from publicly filed

information, it is also possible to estimate the likely price range that will give the private

equity its target return.

Approaching private equity firms through a UK adviser is often more productive than a

direct formal approach by the buyer to either the house or investee company. The

adviser may well know the investment executives personally and should be able to

extract useful information through an “informal” dialogue.

https://www.gov.uk/government/organisations/companies-house



Banks may be a similar source of information, but generally they are not as close to their

clients as private equity firms are generally reluctant to engage too openly with third

parties.

4.8. Business for sale listings

There are a number of online and hard copy business for sale listings that advertise

companies for sale. However, these are most frequently small businesses being sold by

brokers and transfer agents and so relying on such sources is unlikely to support an

effective acquisition strategy.

PUBLIC M&A


5. Public M&A

PUBLIC M&A


5.1. Regulatory overview

The acquisition of certain companies in the UK is governed by the City Code on

Takeovers and Mergers (“the Code”) and overseen by The Panel on Takeovers and

Mergers (“the Panel”). The Code is most commonly applied in the acquisition of

companies whose shares are quoted on a stock exchange, such as the London Stock

Exchange and the Alternative Investment Market (“AiM”), or on a trading facility.

However, the Code also applies to other companies, notably:

All public limited companies (whether quoted or not).

Companies whose shares have been publicly traded or prices quoted within the

last 10 years (even if the company is not currently listed on a stock exchange)

Companies that have filed a prospectus for the offer, admission to trading, or

issue of securities.

For small companies and low value transactions, compliance with the Code may result in

a disproportionate level of transaction fees. In certain limited circumstances it may be

possible for the target company to obtain a waiver from the requirement to comply with

the Code.

5.2. Transaction structure

In the UK, an acquisition of a listed company is normally undertaken in one of two ways –

an offer or scheme of arrangement. Which method is selected will depend on the

particular circumstances of the bid, for example, whether it is hostile or the likelihood of a

significant dissenting minority.

A contractual offer is similar to a US tender offer under which the bidder makes an offer

to the target company’s shareholders who choose whether or not to accept. The offer will

be subject to a number of conditions, notably an “acceptance condition”. If the bidder

secures 50% of the shares they can secure control and complete the transaction.

However, typically the acceptance condition will be set at 90% because at this level the

bidder can then compulsorily acquire the remaining shares.

A scheme of arrangement is a court approved process which is under the control of the

target company’s board and is governed by sections 895 to 901 of the Companies Act

2006. Accordingly, it is unlikely to be appropriate for hostile bids. The scheme must be

approved by 75% in value of the target company’s shareholders who vote and then

sanctioned by the court. Once sanctioned and registered at Companies House the

scheme binds all shareholders and the bidder secures 100% ownership of the target

company. Therefore, this method may be appropriate if a bidder is not certain of

achieving the 90% acceptance level of an offer but can secure the support of 75% of the

target company’s shareholders.

The principal differences between an offer and scheme of arrangement are set out in the

table on the following page.

PUBLIC M&A


Aspect Offer Scheme of arrangement

Acceptance Minimum acceptance condition

of 50%. Shareholders wishing to

block need 50%.

Requires 75% by value of voting

shareholders plus court sanction.

Lower threshold needed by

dissenting shareholders to block

the scheme compared with an

offer.

Achieving 100% Require 90% acceptances to

compulsorily acquire remaining

shares.

Once passed, the scheme binds

all shareholders; no minority

shareholders remain.

Timetable Code timetable applies. Code timetable subject to court

hearing dates. Can be quicker

than an offer to achieve 100% with

greater certainty on timetable.

Hostile bids/ competing

situations

Bidder controls process and

greater flexibility in competitive

situation.

Target board controls process;

less flexible in competing situation;

bidder cannot proceed unilaterally.

Overseas jurisdictions May be necessary to publish

locally compliant offer

documents in multiple

jurisdictions.

Possible exemption from overseas

takeover offer rules and securities

law implications.

5.3. The Panel

The Panel’s role is to ensure that the Code is adhered to on transactions to which it

applies. The Panel is not interested in the financial or commercial advantages or

disadvantages of a transaction and wider public interest issues, such as competition

policy, are the responsibility of other regulatory bodies. It has an active, hands-on role in

regulating bids to ensure fair treatment for shareholders and that takeovers are

conducted within an orderly framework. As a result, there is very little court intervention

or tactical litigation in public M&A in the UK.

The Panel should be consulted at an early stage in relation to any transactions which

might be subject to the Code.

5.4. The Code

The Code is based on a set of six General Principles underpinned by 38 detailed rules.

Equivalent treatment of target shareholders of the same class; and protection of

other shareholders when a person acquires control of a company.

Sufficient time and information for target shareholders to decide on a bid.

The target company’s board of directors must act in the interests of the company

as a whole and must not deny shareholders the opportunity to decide on the

merits of a bid.

A false market in the target company’s shares must not be created.

Bidder must announce an offer only after ensuring it can fulfil in full any cash

consideration and after taking all reasonable measures to secure implementation

of any other consideration.

The target company must not be subject to a prolonged siege.

PUBLIC M&A


The detailed rules cover a range of topics, including secrecy and announcements,

conduct of boards and independent advice, dealing in shares, the content of offer

documents, provision of information, the use of profit forecasts, and the offer timetable. A

brief review of some of the main rules that are relevant to acquirers is set out below.

5.4.1. Secrecy and announcements

Secrecy must be maintained before any offer is launched, which would normally include a

restriction on the number of parties involved, maintenance of an “insider list”, and use of

code names. Any leak may force an early announcement which would then trigger an

obligation on the bidder to make an offer within a prescribed timescale or withdraw.

A bidder is obliged to make an announcement regarding their bid intentions in the

following circumstances:

Rumour, speculation, or untoward movement in the target’s share price and there

are reasonable grounds for concluding the bidder’s conduct led to the situation.

If knowledge about a possible offer is about to extend beyond those who need to

know in the parties and their advisers.

When a firm intention to make an offer is notified to the target.

On the acquisition of an interest in the target company (30% shareholding) which

triggers an obligation to make a mandatory offer.

The target company must make an announcement in the following instances:

If, after an approach by a bidder, target is the subject of rumour or an untoward

movement in its share price.

If target is seeking one or more potential bidders and is the subject of rumour or

an untoward movement in its share price, or the number of potential bidders is

about to exceed a very restricted number.

Target and bidder may choose to make an announcement about an offer at any time.

Generally, before the board of the target company is approached the potential offeror is

responsible for making any announcement and following any approach it is the

responsibility of the target company.

The announcement of an offer signals the formal commencement of the offer process

under the Code. An offeror must notify a firm intention to make an offer to the board of a

target company or its advisers before making a public announcement.

5.4.2. Put up or shut up

A potential bidder has 28 days after it is first publicly identified in a possible offer

announcement to make a formal offer. If it fails to make a firm offer it will be unable to

launch another bid for the target for six months unless:

the Panel agrees to an extension at the request of the target;

a competing bidder announces a firm intention to make an offer; or

if the potential bidder is participating in a formal sale process started by the

target.

PUBLIC M&A


5.4.3. Financing

Committed funding must be in place at the time a firm intention to make an offer is

announced. Financing conditions are generally not permitted in offers under the Code.

The bidder’s financial adviser must publicly confirm that the bidder has the cash

resources to acquire all the target company’s shares where a cash offer is made.

5.4.4. Due diligence

All due diligence must be undertaken before a firm offer announcement and there can be

no due diligence condition in the offer.

There is no obligation on the target company to provide information to the bidder for the

purposes of due diligence. However, any information that is provided to one bidder must

be provided to all competing bidders. Given this Code requirement, the level of due

diligence that a target permits is usually much more restricted than for a private company

sale.

5.4.5. Deal protection

There is only very limited deal protection available to a bidder in public M&A in the UK.

There is a general ban on offer-related arrangements between parties, which would

include a prohibition on the following:

Most break fees payable by target.

Implementation agreements.

Exclusivity and non-solicitation agreements.

However, the restrictions on deal protection do not prohibit the following:

Irrevocable undertakings and letters of intent from shareholders.

Standard confidentiality undertakings.

Reverse break fee.

Subject to Panel approval, break fee payable to a successful bidder within a

formal sales process initiated by the target.

Stake building (subject to the other rules of the Code).

Other arrangements imposing obligations on the bidder only.

5.4.6. Special deals

There is a general ban on a bidder entering into special deals with select shareholders

which applies when an offer is reasonably in contemplation and during the offer period.

This would cover a wide range of deals, for example, a promise to make good to a seller

of a target company’s shares the difference between the sale price and the price of a

subsequent successful offer.

Where the bidder plans to put in place incentivisation arrangements for target

management these may need to be disclosed and a fairness opinion obtained from the

target’s financial adviser. Where the management arrangements are unusual or

significant the Panel should be consulted and it may require additional conditions to be

met, such as approval from the target company’s shareholders.

PUBLIC M&A


5.4.7. Stake building

Care must be taken by a bidder when acquiring shares in a target company prior

launching a formal bid because the price paid for those shares will affect the pricing of

any subsequent offer.

When a bidder or connected group (“concert party”) acquires interests in shares carrying

30% or more of the voting rights of the target company they must make a cash offer

(“mandatory offer”) to all other shareholders at the highest price paid in the 12 months

before the offer was announced.

When interests in shares carrying 10% or more of the voting rights of a class have been

acquired by a bidder in the offer period and the previous 12 months, the offer must

include a cash alternative for all shareholders of that class at the highest price paid by the

bidder in that period.

If the bidder acquires shares in the target company at a price higher than the value of the

offer, the offer to all shareholders must be increased accordingly.

Bidders should also have consideration to other laws and regulations when stake

building, notably:

insider dealing and market abuse; and

requirement to publicly disclose significant shareholdings in listed companies and

dealings during an offer period.

5.4.8. Irrevocable undertakings

Before a bid is announced an offeror will usually seek irrevocable undertakings from key

shareholders (primarily institutions but in some cases major individual shareholders) and

target management that they will accept the offer. Irrevocable undertakings can be

legally binding in all circumstances or may cease to apply in the event of a higher offer

from another party.

5.4.9. Conditions and pre-conditions

The Code permits an offeror to include conditions or pre-conditions that need to be

satisfied in order for the offer to proceed. A pre-condition is a condition that must be

satisfied or waived before an offer is formally made by sending the offer document. Pre-

conditions are usually restricted to competition or other regulatory clearances. A

condition applies when the offer has been formally made and relates to the closing of the

offer.

Conditions and pre-conditions should not usually depend solely on the subjective

judgements of the directors of the offeror or target.

The Code restricts the ability of an offeror to invoke non-compliance with conditions to

those matters that are of material significance. In particular, for an offeror to invoke a “no

material adverse change” condition and withdraw its offer it must demonstrate

circumstances that are entirely exceptional in nature that could not have been reasonably

foreseen.

PUBLIC M&A


5.4.10. Offer Document

The offer document must normally be sent to the shareholders of the target company

within 28 days of the announcement of a firm intention to make an offer. Where a

scheme of arrangement is used, the scheme circular takes the place of the offer

document.

The offer document will normally include a letter from the offeror setting out the offer and,

where the offer is recommended, a letter from the chairman of the target company. The

offer must set out the following:

Details of the offeror and any parties acting in concert.

Terms of the offer for each class of security including the consideration and how

this is to be discharged.

All conditions to which the offer is subject and break fees payable.

Procedures for accepting the offer (or voting under a scheme of arrangement).

Details of the share price history of the offeree.

Details of all irrevocable undertakings.

Details of any securities offered as consideration, including arrangements for any

trading facility.

Disclosure of relevant share dealings and shareholdings in the target company.

How the offer is to be financed and cash confirmation from the offeror’s adviser.

Fees and expenses to be incurred by the offeror in connection with the offer.

In addition, the Code sets out certain information relating to the offeror’s intentions

regarding the target company that must be included in the document as follows:

Long-term commercial justification of the offer and intentions regarding the future

of the target business.

Intentions regarding employees and the management of the target company and

its subsidiaries, conditions of employment, and any existing pension schemes.

Strategic plans for the target business and likely impact on employment and

location of business.

Plans for the redeployment of fixed assets.

Maintenance of any trading facility for the securities of the target company.

Details of any post-offer undertakings given by the offeror.

Where the offeror is a UK company that is listed on a regulated market, AiM or ISDX, the

following information must be disclosed:

Names of directors.

Nature of its business and its financial and trading prospects, including trading

since the last published results where there is a securities offer.

Website address where relevant financial information can be obtained.

A statement of the effect of the full acceptance of the offer on the offeror’s

earnings and assets and liabilities.

Summary of material contracts entered into otherwise than in the normal course

of business during the previous two years.

PUBLIC M&A


Non-UK listed offerors should disclose the same level of information as for a UK listed

company to the extent possible. In addition, information relating to shareholders owning

more than 5% of the share capital of the offeror and parties who will acquire or increase

their shareholding in the offeror must be disclosed.

The offer document should also contain details of public ratings accorded to offeror and

offeree and details of any changes to those ratings and outlooks during the offer period.

Where a profit forecast is included, the offeror must state the bases of the forecast and

include statements from its reporting accountants and financial adviser confirming the

forecasts have been carefully and properly compiled.

Within 14 days of the publication of the offer document the target company board must

publish its response to the offer, including the advice of its independent advisers. In the

case of a recommended offer this is usually incorporated in the offer document.

Otherwise, such views will be published in the defence document.

5.4.11. Restraints on frustrating action

The Code places restrictions on the actions of a target company that might frustrate a bid

or prevent its shareholders from deciding on the merits of a bid. During the course of a

bid the target company must not:

Sell or issue shares or grant options in respect of unissued shares.

Create or issue convertible securities.

Acquire or sell assets of a material amount (typically 10% of assets).

Enter into contracts other than in the ordinary course of business.

In addition, the target cannot withhold information from an unwelcome bidder that has

already been provided to other parties.

The effect of the above provisions is to prevent target boards using “poison pill” defences,

which would be breach of both the Code and directors’ fiduciary duties.

Legitimate means that target companies can adopt to resist a bid considered to be

damaging to the offeree or at an undervalue would include appealing to a regulatory

authority, preparation of a profit forecast, undertaking to pay a special dividend or

repurchase shares, and commenting on the value of shares in the offeror that are offered

in exchange for shares in target.

PUBLIC M&A


5.4.12. Offer timetable

The timetable for a public M&A transaction will depend on whether the acquisition is

structured as a contractual offer or scheme of arrangement.

Contractual offer

Day Key events

Day - 28 Offeror announces offer.

Day 0 Publish offer document (and prospectus if applicable).

Day 14 Target’s defence document to be published (hostile bids only).

Day 21 Earliest permitted first closing date of offer.

Day 39 Last date (unless Panel agrees otherwise) when target may announce

material new information.

Day 42 Acceptances by shareholders may be withdrawn after the date which is

21 days after the first closing date if the offer is not unconditional as to

acceptances.

Day 46 Latest date for offeror to send revised offer document.

Day 60 No acceptances or purchases made after this date may be taken into

account for the purpose of the acceptance condition. Withdrawals

cease to be permitted. Latest date by which offer may be declared

unconditional as to acceptances.

Day 74 Earliest date on which offer can close.

Day 81 Assuming offer declared unconditional as to acceptances on Day 60,

all other conditions must be fulfilled by this date unless the Panel

agrees otherwise.

Day 95 Latest date for despatch of consideration if offer wholly unconditional at

Day 81.

Scheme of arrangement

Day Key events

Day - 28 Offeror and target announce offer.

Day - 10 File court documents.

Day - 2 First court hearing for leave to convene shareholder meetings.

Day 0 Publish scheme document (and prospectus if applicable).

Day 7 Latest date for revision to the terms of the scheme.

Day 21 Shareholder meeting: Court meeting and general meeting of

shareholders.

Day 40 Court hearing to grant order sanctioning the scheme and confirm any

capital reduction.

Day 41 Court order filed with Companies House; scheme becomes effective.

Day 55 Latest date for despatch of consideration if scheme becomes effective

at Day 41.

PUBLIC M&A


5.4.13. Information

The Code sets out certain standards for the quality of information provided to

shareholders in an offer, which must be presented adequately and fairly and should not

be misleading or create uncertainty. The directors of the bidder (and the directors of

target in the case of non-hostile offers) are required to take formal responsibility for

information contained in offer related documents and advertisements.

Particular care needs to be exercised by parties when making public statements about

employees, pension schemes, and strategic plans for the target company or its place of

business. The Panel has the power to monitor post-offer compliance with any

undertakings given by the offeror during a bid.

5.5. The Listing Rules and prospectus legislation

If the consideration offered by the bidder is in the form of shares, or a mix of cash and

shares, a prospectus is likely to be required. A prospectus, or equivalent document,

approved by the Financial Conduct Authority is necessary for any offer of transferable

shares to the public or for admission of such shares on a regulated market, including the

Official List of the London Stock Exchange.

In the case of a cash offer with a loan note alternative, consideration would need to be

given as to whether the loan notes would be treated as transferable securities that require

production of a prospectus or equivalent document.

5.6. Other regulatory considerations

In addition to compliance with the Code, acquirers must comply with other laws and

regulations applicable to dealing in listed company shares and M&A in the UK, notably:

Insider dealing rules.

Rules on market abuse, financial promotions, and misleading

statements/impressions.

Major shareholder notification rules.

Company law requirements, such as directors’ duties.

Competition regulations and special rules for regulated sectors.

PUBLIC M&A


5.7. Difference between public and private M&A

As noted in the following section, in the private arena buyer and seller and largely free to

engage on whatever terms this wish in an M&A transaction. The table below highlights

the principal differences.

Public M&A Private M&A

Deal structure

Company purchase effected by contractual

offer or scheme of arrangement.

Can be share purchase or acquisition of

business and assets.

Negotiations

Bidder negotiates with target company Board.

Buyer negotiates directly with shareholders.

Bid/offer

Can be recommended or hostile.

Normally must be agreed by all shareholders.

Structure

Price and form of consideration determined by

bidder (with target board if recommended);

other terms determined by the Code.

Parties free to negotiate all terms.

Due diligence

Restricted due diligence which must be

completed before an offer is made.

Extensive due diligence after Heads of Terms

agreed; closing usually subject to satisfactory

diligence reviews.

Warranties and indemnities

Generally no warranties.

Extensive warranties (and indemnities) from

target company shareholders.

Securing control

Risk that takeover does not succeed if

acceptance level not reached.

Full ownership usually assured if conditions

are met.

Post-closing adjustments

Not applicable.

Common practice.

Timetable

Governed by the Code; offer period can be up

to three months.

No defined timetable – could be four to six

weeks after Heads of Terms agreed, or

several months.

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6. Private M&A

PRIVATE M&A


6.1. Overview

Unlike public M&A, participants in transactions not subject to the Code have wide

freedom to decide how they contract and on what terms. The purchase process will be

affected by a range of factors including the nature of the sellers and whether or not there

is an auction process. Therefore, this section only contains a high level summary of the

main elements in a private company M&A transaction.

6.2. Assets or shares?

If the target business is run by a sole trader or a partnership then the acquisition will take

the form of the purchase of the trade and assets, including contracts and goodwill. If the

business is owned by a company there is a choice of buying the trade and assets from

the company or buying the whole company itself by acquiring its shares from the

shareholders. The table below sets out the main differences between the two methods.

Share purchase Asset purchase

Method of transfer

The minimum requirement is a stock transfer

form to effect the transmission of shares from

seller to buyer. However, in practice, for most

deals a long-form sale and purchase contract

will be used.

Business transfer agreement together with

several other documents to effect the transfer

of individual assets, such as property, patents,

leases and contracts.

What’s included?

All assets and liabilities of the company, known

and unknown, including potential/contingent

liabilities.

The purchaser can select which assets to

acquire and what liabilities to accept. Any

liabilities not assumed by the buyer remain the

responsibility of the seller. However, some

liabilities transfer by operation of law, notably

in relation to employees (see section 8).

Employees

There is no change of employer and

employees remain employed by the target

company on their existing terms and

conditions.

Employees automatically transfer to the buyer

on their existing terms and conditions. Buyer

and seller are obliged to inform employees

about their plans and consult with them prior

to closing.

Warranties and indemnities

Given the risk of past liabilities, the purchaser

will usually require extensive warranty

protection and indemnities against specific risk

areas, including tax. The disclosure exercise

by the sellers will be correspondingly more

detailed and exhaustive.

As only known liabilities are accepted by the

purchaser, the level of warranties tends to be

lower. Given the lower level of warranties, the

disclosure process is also likely to be much

more limited.

Due diligence

Given the risk of past liabilities the due

diligence process will be comprehensive,

typically covering historical accounts, tax, legal

contracts and the constitution of the company,

litigation, employee and pension matters,

property, environmental, and insurance.

Likely to be more limited and restricted to

commercial and key financial matters.

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Share purchase Asset purchase

Relationships with customers and suppliers

Trading relationships are unchanged and so

there should be no impact on the operations of

the business unless key contracts contain

change of control clauses.

Contracts will need to be novated or assigned

to the purchaser. This will require the consent

of the other party and while this is usually

obtained, unfavourable changes to terms of

trade may be requested.

Taxation for the sellers

Individual shareholders will be subject to

Capital Gains Tax on the profit on sale at a rate

of 18% or 28%, falling to 10% if they qualify for

Entrepreneurs’ Relief. Corporate vendors may

be able to obtain Substantial Shareholdings

Exemption, meaning they pay no tax on any

profit on the sale of a subsidiary.

Individual shareholders may be subject to a

double tax charge. Firstly, the profit on the

sale of the business and assets is taxed in the

company, and secondly, the proceeds are

taxed when transferred to the shareholders.

Corporate vendors pay Corporation Tax on

any gains made on disposal.

Taxation for buyers

No tax deduction in the UK for the cost of

investment or goodwill arising on consolidation.

Certain funding costs may be tax deductible as

they are amortised.

A Corporation Tax deduction may be available

for the amortisation of certain acquired

intangible assets. There is no Corporation

Tax deduction available for the amortisation of

purchased goodwill arising on the acquisition

of business and assets after 8 July 2015 (tax

deductions are available for deals closed

before this date). Purchase costs will be

allowed against any future disposal of the

purchased goodwill. Certain deal and funding

fees may be tax deductible as they are

amortised.

Stamp Duty

Duty is paid at 0.5% on the total consideration

(including deferred and contingent amounts).

Stamp Duty Land Tax is charged on property

at rates between 1% and 4% depending on

the consideration allocated to non-residential

land. There is no other stamp duty payable

on any other assets.

It follows from the above that individual and corporate shareholders will generally prefer a

share sale rather than an asset sale because it is more tax efficient and provides a clean

break. Conversely, a purchaser may prefer an asset purchase as it reduces the risk of

inheriting unknown past liabilities. Historically, it was more financially advantageous for

an acquirer to undertake an asset purchase deal because they would receive a

Corporation Tax deduction for the amortisation of any purchased goodwill. This tax

deduction was ended for new deals from 8 July 2015 and so for a buyer there is little

difference in financial terms between a share or asset purchase structure.

As vendors usually drive the decision whether to sell, most transactions are structured as

share sales in the UK. The main exceptions would be in the following circumstances:

A sale of business and assets of a company that is in administration or liquidation

that is overseen by an Insolvency Practitioner.

Carve-out of a division from a company, although typically the seller would want

to transfer the division into a new company prior to sale for tax planning reasons.

PRIVATE M&A


Sale of a business at a loss to the vendor where the seller has the ability to make

use of that tax loss.

Very small transactions where the costs of due diligence and preparing

comprehensive legal documentation is disproportionate to the deal value.

Where the target company has a large and/or unquantifiable liability which the

purchaser is not willing to take on.

There are circumstances in which a buyer would prefer a share purchase transaction, for

example:

Where the target company has important contracts, licences, and consents that

are non-transferable.

The target company has tax losses that can be utilised against future trading

profits.

The buyer may not wish to alert customers and suppliers to a change of

ownership.

6.3. Sales process

While there is no prescribed procedure for conducting private M&A in the UK, sale

processes generally fall into one of the following categories:

Bilateral transaction involving the seller and one buyer, typically where the buyer

has made a direct approach to the sellers, which may include a management

buy-out situation.

Auction process, where a seller or their advisers markets the business to a broad

range of potential buyers.

Accelerated sales process, where a business in financial difficulty is marketed to

a small number of buyers on the basis that a swift closing is sought to protect the

target business.

Insolvency sale, in which the trade and assets of a business in a formal

administration or liquidation process is sold by an Insolvency Practitioner.

In certain cases, business owners may follow a “twin track” process, for example, running

an auction process to trade buyers alongside preparation for an Initial Public Offering

(“IPO”).

6.3.1. Bilateral v auction sales

Clearly for a buyer, entering into sole discussions with a seller is more advantageous

than an auction process. It gives the buyer more time and greater access to the

company in order to make a proper assessment for valuation and due diligence and

enables the buyer to build rapport with management. By avoiding a competitive

environment the buyer should be able to strike a better financial deal and maintain

confidentiality within the market. Conversely, the seller is less likely to be prepared for

the transaction than if an experienced financial adviser was running a sales process and

so the information flow may be slow and haphazard and the process for actually

negotiating the deal may prove difficult.

Waiting for companies to come up for sale is a poor strategy for securing the right

acquisition targets at the best price. However, securing a sole discussion with the

owners of a business involves some upfront time and cost in developing an acquisition

strategy and identifying and approaching suitable targets. This is an area where an

PRIVATE M&A


experienced financial adviser can add significant value by helping to identify target

companies that are not yet up for sale and opening up a dialogue with the owners.

The strategy for handling an auction process is different from that for a bilateral deal. If

you are not to win the deal solely by being the highest bidder then the overriding objective

is to break the auction process being run by the seller’s adviser. Again, an experienced

financial adviser with knowledge of how various M&A advisers operate can support you

with the best tactics to adopt in different situations. For example, many brokers and

transfer agents in the UK simply advertise their clients’ businesses for sale but have little

involvement in the sale thereafter, and often do not turn up to any meetings. This

provides a buyer with a great opportunity to build a relationship with the sellers and/or

management at an early stage and learn the non-price issues which matter. Conversely,

a tightly controlled auction run by one of the larger corporate finance boutiques may

necessitate a strategy of simply bidding through at a high enough level to secure access

to management at a later stage in the process or of focusing on your own ability to

complete quickly with cash compared to rival bidders who may need to raise funding.

Unlike public company M&A, in private company transactions there is no obligation on the

seller or their advisers to treat all parties equally or provide the same information to all

bidders.

PRIVATE M&A


6.3.2. Auction sale process

While each sale process is different, in broad terms most private company auction sale

transactions in the UK follow a similar pattern as set out below.

Where the seller’s adviser expects a strong level of interest in the business from a range

of buyers a more tightly controlled version of the auction might be run. This would involve

Vendor and advisers

develop sale strategy

Prepare information

memorandum

Research buyers

Approach buyers

Initial meetings/

presentations

Non-binding offers/

valuation proposals

Site visits and management

meetings

Submission of offers

Negotiations

Heads of Terms

Due diligence

Legal documents

Completion

Stage Comments

Buyers are asked to sign a confidentiality agreement

In formal controlled auctions, indicative offers may be requested

before management meetings

Seller may provide access to a data room and/or vendor due diligence

Structure paper

Working capital paper where “locked box” mechanism used

Exclusivity period granted to buyer

Cost undertakings

Generally non-binding other than for the above terms

Purchaser due diligence/confirmatory review

Clearances and approvals

Sale and purchase agreement or asset purchase agreement

Service/consultancy agreements

Ancillary agreements

Public announcements

Post-closing price adjustments

Prepared by the seller’s financial adviser

There are no specific regulations in the UK regarding the content

of marketing documents for private company sale transactions

Offers are subject to contract

PRIVATE M&A


provision of a timetable to bidders and a requirement to provide initial offers based on the

information memorandum alone. Short-listed buyers will then be given the opportunity to

meet management and be provided with access to a data room and/or a vendor due

diligence report. Purchasers will then submit offers together with a mark-up of the draft

sale and purchase agreement provided by the seller’s lawyers.

6.3.3. Accelerated sales process

A typical private company sales process may take six to nine months from start to finish.

In certain circumstances a deal needs to be concluded more quickly, for example:

The business is under pressure from creditors, including its bank.

Loss, or imminent loss of funding lines.

Loss of a key customer or dramatic decline in demand for the company’s

products or services.

The company is incurring losses but cannot afford to re-structure the business in

order to reduce its overhead base.

Death of a key shareholder-director.

In such circumstances the company’s financial adviser may run a fast-track sales process

aimed at securing the sale of the company on a going concern basis. The key

differences from a normal sale process are:

The company’s principal lender(s) are usually engaged in the process early on to

ensure their continued support while the transaction proceeds.

Focusing on a smaller number of potential purchasers, including key trade buyers

and turnaround funds.

There may be a requirement for interim management to provide stability for the

business.

Restricted period for purchaser’s due diligence.

The marketing of a business under an accelerated M&A process is often the prelude for

placing the company into a formal administration process. This potentially enables a

purchaser to acquire the trade and assets of the business without all the liabilities that

would be assumed under a share purchase.

6.3.4. Acquisition out of administration

The management of companies in financial distress is governed by the Insolvency Act

1986 and the Enterprise Act 2002. The Insolvency Act provides a mechanism for

potentially viable businesses to be rescued and rehabilitated as an alternative to

termination of the trade and liquidation of the company’s assets.

A company can be placed into administration by the court, its directors, or by the holder

of a qualifying floating charge. Typically, this event will be crystallised when the directors

conclude that the company is unable to pay its debts as they fall due.

The purpose of the administration, in the order of priority, is as follows:

to rescue the company as a going concern; or

to achieve a better result for the company’s creditors as a whole than would be

achieved through a winding-up; or

realising the company’s property to make a distribution to one or more secured or

preferential creditors.

PRIVATE M&A


The administration will be managed by a licensed Insolvency Practitioner (“IP”) who is

usually an accountant.

Following appointment, the IP will decide whether it is viable to continue to trade the

business until a sale can be achieved and in so doing may make certain employees

redundant. If this is the case, a brief information pack will be prepared and the business

is publicly marketed for sale. Owing to the short timescales involved in a sale out of

administration and the possible lack of co-operation from management and staff, the

quality of information provided to purchasers can be highly variable. Companies seeking

to acquire businesses out of administration should bear in mind the following key points:

The IP only has the power to sell unencumbered assets. If the purchaser wishes

to acquire or use assets that are subject to financing arrangements they must

contact those third parties separately to negotiate an arrangement.

Where the company operates from leased premises it will be necessary either to

re-locate the business or secure a new lease with the landlord. In the short-term,

the buyer should request that the IP assists in securing a “licence to occupy” from

the landlord. Rather than lose a source of income, landlords are often quite

flexible in these situations.

Customers will frequently order large amounts of inventory during an

administration which can give the misleading impression of an improving trading

profile (which the IP will not seek to dispel). In reality, customers are building

buffer inventory which may result in a significant drop in orders post-closing or

the permanent loss of trade if customers re-source.

The purchaser of a business out of administration does not inherit any past

liabilities (other than in relation to employees). Most UK suppliers will accept this

situation as a normal business risk and will continue to supply the acquired

business under new ownership, but key suppliers could demand payment of past

debts before continuing to supply and this should be assessed before closing any

deal.

The IP will always rank an immediate cash deal ahead of structures involving

large amounts of deferred consideration, however, an IP will consider some

deferred or contingent payment options.

As with any other sale of a business and assets, all existing employees transfer

automatically to the purchaser on their current terms and conditions.

The IP will provide no warranties to the buyer on sale.

In order to avoid disruption to the business and the loss of goodwill that might be

generated from a long administration process, it is common practice to conduct a pre-

packaged deal (“pre-pack”) for a business in distress. This involves the company’s

directors and the proposed IP (before his appointment) negotiating an outline deal with a

purchaser before the company is formally placed into administration. Once this is

secured the company is placed in administration and the IP completes the sale of the

business and assets. This has the advantage to the buyer of limiting customer loss and

internal disruption to the business. However, unlike a normal administration process

there is no opportunity for the IP to reduce the overhead base through redundancies, so

the purchaser must take on the existing workforce in full.

PRIVATE M&A


6.4. Confidentiality agreements

Regardless of the type of sales process adopted by the seller, there is normally a

requirement for interested parties to enter into a non-disclosure agreement with the seller.

This will impose several obligations on the buyer, including:

a duty not to disclose confidential information to any third party;

not to use any confidential information for any purpose other than evaluating the

transaction;

not to disclose the fact that the target company is for sale;

not to approach the target company’s customers, suppliers, or lenders.

where the vendor is a listed company there may be restrictions imposed on

dealing in the seller company’s shares.

Buyers should be alert for the inclusion of onerous terms in confidentiality agreements,

such as indemnification clauses or provisions that make the purchaser liable to pay the

fees of the seller’s broker.

6.5. Information memorandum and other marketing material

Where you are participating in an auction process it is likely that you will receive an

information memorandum prepared by the seller’s financial adviser. For share

transactions that are classified as regulated activities, which broadly encompasses all

offers of shares to the general public, there are very strict rules about what information

can be included in a prospectus, which must be issued by an authorised person or firm.

However, most sales of private companies fall outside these rules and there is very little

regulation covering what can be included in an information memorandum. The document

does not need to be approved by any qualified individual and will not form the basis of

any subsequent contract. Therefore, care must be exercised when relying on any

information in such documents and all key matters should be confirmed through due

diligence. As noted later in this section, representations are not usually given by the

sellers in M&A transactions, so reliance should not be placed on any seller produced

marketing material.

The content, length, and quality of information memorandums vary considerably,

depending upon the size of transaction, the financial adviser, and the structure of the

sales process. The larger corporate finance boutiques and accountancy firms generally

produce comprehensive and informative documents. The information memorandums

from brokers and transfer agents are often either hyped up marketing material or little

more than a short business summary accompanied by a set of accounts.

6.6. Offer letters

Offer letters are usually non-binding, but it is important to state in the document that the

proposal is “subject to contract” to ensure you are not unexpectedly making an offer that

is capable of acceptance and enforcement by the vendor.

There is no prescribed format for an offer letter. In an auction process the seller’s adviser

will normally specify the matters to be covered in any proposal. In other situations, or

where the vendor’s adviser does not prescribe an offer format, the proposal letter might

include the following:

Identity of the acquirer.

Price/valuation.

PRIVATE M&A


Structure of the consideration (cash, shares, loans etc.) and when it is to be paid.

Main valuation assumptions.

Principal conditions.

Due diligence requirements.

Funding requirements, if any.

Identity of advisers.

Main reasons why the offer is attractive to the vendors.

Next steps and timetable.

6.7. Heads of Terms

Also called “Heads of Agreement”, “Term Sheet”, “Letter of Intent”, or “Memorandum of

Understanding”, this document summarises the main commercial and legal points of the

deal between buyer and seller. It will be used by the lawyers to prepare the first draft of

the sale and purchase agreement.

There is no prescribed format for this document. The memorandum usually states that

the terms are not legally binding or are “subject to contract” other than in certain specified

areas where the parties wish to be legally bound. Typically, the document would include

the following:

Details of the parties.

Description of the shares or assets to be acquired and sold.

Consideration and how this is to be discharged, including any deferred or

contingent consideration.

Valuation assumptions, for example, that there is no debt in the target company

or that historical trading is maintained at a certain level.

Principal conditions, normally restricted to matters such as financing, shareholder

approvals, due diligence, and any regulatory approvals.

Price adjustment mechanisms.

How relevant assets that are held outside the business will be treated, for

example, property or intellectual property rights.

Future involvement of the sellers in the business (if any).

The main commercial principles to be adopted for the warranties and indemnities.

Relevant law and jurisdiction.

Grant of exclusivity to the buyer, if not contained in a separate document.

Responsibility for costs and cost underwriting/break fees payable.

Confidentiality undertaking or re-confirmation of existing confidentiality

agreement.

The items in italics would normally be made legally binding on buyer and seller.

PRIVATE M&A


6.8. Consideration structure

In private company sales the buyer and sellers have wide freedom to determine both the

purchase price and how this will be paid. While cash at closing is clearly the preferred

consideration structure for all sellers, most will accept some form of alternative

arrangement, which may include one or more of the following:

Deferred payments: can be used to either preserve the buyer’s cash by

spreading payment for the acquired business over a period of time, or to protect

the purchaser’s position should there be a claim under the warranties or

indemnities.

Loan notes: part of the consideration is satisfied by the buyer issuing a formal

loan note (promise to pay) to the seller. These have certain attractions to a seller

over deferred payments, notably, the loan notes can be secured or guaranteed,

giving the seller greater assurance they will be paid, and secondly it may be

possible for the seller to defer paying their Capital Gains Tax until the loan notes

are redeemed.

Earn-out: this is a variable amount payable to the sellers after closing based on

certain agreed performance measures of the business. Normally, the earn-out

will be calculated by reference to future sales or profits of the acquired business,

but any payment trigger can be used, such as the renewal of a key contract.

These arrangements are most effective when the sellers continue to work in the

business after closing and the acquired business is maintained as a stand-alone

entity. The tax treatment of earn-outs is complex in the UK and specialist advice

should be obtained.

Shares: the purchaser, whether listed or not, may issue shares to the sellers of

the target business. This raises a number of financial and tax issues for the

sellers, including when and how the shares can be sold and for what value. In

addition, certain tax reliefs that the owner of a UK company may enjoy may not

be available for a minority holding of shares in a non-UK company. As with earn-

outs, specialist tax advice should be obtained before the Heads of Terms stage.

6.9. Price adjustment

Historically, the usual method to adjust the purchase price was through a set of

completion accounts to verify net asset, working capital, and/or cash balances at

completion. To the extent that one or more of these balances was above or below target

there would be a corresponding increase or decrease in the purchase price.

In a number of transactions, particularly in auction sales, the “locked box” mechanism can

replace completion accounts. This method provides greater certainty on the final price for

the seller and speeds up finalisation of the deal. Under this method the purchase

consideration is fixed by reference to a historical balance sheet that has been audited or

subject to due diligence review by the purchaser. The deal structure is confirmed by

reference to that balance sheet position and economic risk and benefit then pass to the

purchaser from the locked box date. This is backed up by indemnities from the seller in

relation to any value leakage to the sellers, such as payment of unauthorised dividends or

salaries.

The choice of completion accounts or locked box will depend primarily on the bargaining

power of the buyer and seller, the reliability of the target company’s accounts, and any

third party conditions and consents, such as from a funding bank.

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6.10. Due diligence

As mentioned in section 3, English law rarely implies terms into contracts freely entered

into between parties and so for company or business purchases the principle of “caveat

emptor” or “buyer beware” applies. Therefore a buyer should gather as much information

about the target business as possible to understand what he is acquiring and whether the

right price is being paid.

A thorough due diligence exercise will help the buyer to:

evaluate what is being purchased;

decide whether to proceed to closing;

determine the right price;

identify relevant risks and liabilities that may affect the deal;

identify areas where protection may be required in the contract through

warranties and indemnities;

identify any third party consents that may be required; and

identify and asses areas that may need action after closing.

6.10.1. Financial due diligence

Most M&A transactions will involve some form of financial due diligence, ranging from a

review of the books and records by the buyer on a small deal through to the preparation

of a comprehensive long-form due diligence report by an accountancy firm on a larger

transaction. The success of an acquisition to an acquirer can be significantly enhanced

by a focused and rigorous due diligence exercise. It provides assurance to both

corporate and financial buyers by analysing and validating the financial assumptions that

underpin the deal. The due diligence review enhances the purchaser’s understanding of

the target business and so increases the likelihood of the deal achieving its objectives.

The scope of a due diligence review will typically be focused on the following key areas:

Determining the underlying profit performance of the business.

Assessment of the cash flow cycle, the ability of the business to turn profits into

cash, and working capital requirements.

Robust analysis of any forecasts to assess deliverability and key risk areas.

Evaluation of the balance sheet to identify any over-valued assets and under-

valued liabilities or “black holes”.

Analysis of the tax position of the business and tax consequences of the deal.

Review of financial systems and controls.

A full report will also typically include information about the history of the business, its

structure, products and services, markets, management and employees.

In most cases the due diligence will be undertaken by the buyer or their accountants.

However, in an auction sale the seller may have commissioned an independent firm of

accountants to prepare a vendor due diligence report. This will be made available to

interested parties during the auction process and then signed over to the winning bidder

with the reporting accountant assuming a duty of care to the buyer. For the seller this

arrangement helps to maintain control over the sale process and eliminates the risk of

unforeseen matters coming out of due diligence at a late stage.

PRIVATE M&A


While vendor due diligence reports contain useful factual information for a buyer they are

usually devoid of opinions and recommendations and may not address all of the buyer’s

particular concerns. For this reason it is not uncommon for buyers to commission “top

up” due diligence to cover any outstanding areas.

6.10.2. Legal due diligence

The process for undertaking legal due diligence usually involves the buyer’s lawyer

sending a detailed questionnaire to the seller’s lawyer covering all aspects of the

company and its business. The questionnaire will cover matters such as:

Corporate structure and legal constitution

Accounts and financing arrangements

Contracts

Licenses and approvals

Business assets

Property

Employees, including pension schemes

Intellectual property

Information technology

Litigation

Insurance

Environmental issues

Competition matters

Health and safety

Bribery and corruption

Taxation

The buyer’s lawyer will then typically prepare a legal due diligence report based on the

seller’s responses which highlights the key issues for the buyer and its funders.

6.10.3. Other due diligence

Depending upon the size and nature of the target company and the buyer’s knowledge of

the market and country, additional due diligence may be required to support the

acquisition business case or investigate areas of potential concern. In the UK the most

commonly seen other due diligence reviews are:

Commercial/market due diligence: to validate the market size and growth

prospects, the target’s competitive position, customer relationships, and

assessment of competitors.

Operational due diligence: assessment of target’s manufacturing or other

processes, including health and safety.

Insurance: to confirm adequacy of insurance cover.

Environmental: to assess the risk of land contamination or air pollution from the

business.

PRIVATE M&A


Actuarial/pension review: where the target company is a participating employer in

a defined benefit/final salary pension scheme.

6.11. Sale and purchase agreement

In order to effect the transaction a sale and purchase agreement (for a share sale) or

business transfer agreement (for a trade and assets sale) are usually required together

with an accompanying disclosure letter. In addition, there may be a separate tax deed, or

this can be included within the sale and purchase agreement.

6.11.1. Format of sale and purchase agreement

This is the main contractual document and must contain all of the detailed terms of the

transaction that the parties wish to rely upon. The document usually sets out:

The parties to the transaction.

The purchase price, form of consideration (cash, loan notes, shares etc.) and

mechanics of payment.

The mechanism for adjusting the purchase price, that is, completion accounts or

locked box arrangement.

For a trade and assets sale, the assets to be transferred and liabilities to be

assumed.

Procedure for closing the transaction.

Warranties and indemnities.

Limitations to the seller’s liability.

Tax covenant or deed

Restrictive covenants imposed on the sellers.

Details relating to specialist areas such as property, pensions, employees,

intellectual property, and environmental matters.

The largest sections of the sale and purchase agreement cover warranties and

indemnities.

6.11.2. Warranties and indemnities

Warranties are assurances about the target company or its business provided by the

sellers to the buyer. As no warranties are implied in English law for corporate

transactions it is important that all relevant issues are documented in the sale and

purchase agreement. The remedy for a breach of warranty is a contractual action for

damages requiring the buyer to demonstrate that the warranty is untrue and this has

reduced the value of the company, which may sometimes be difficult to establish. It is

unusual to have general warranties on an indemnity basis (i.e. pound-for-pound

recovery). In the UK, indemnities are usually reserved for specific issues identified by the

buyer that affect the deal price and for taxation matters.

In addition, warranties should encourage the sellers to provide further information about

the company or business through the disclosure letter which might not otherwise have

come to light during due diligence. The scope of warranties will depend upon the

commercial deal struck between the parties, the price, and the respective bargaining

power of buyer and seller. At one end of the spectrum, an IP will give virtually no

warranties regarding the trade and assets being sold while a trade buyer paying a

PRIVATE M&A


premium to enter a new market will expect a full set of warranties from an owner-manager

or corporate vendor.

Representations are statements of fact or opinion usually made to induce a party to enter

into a contract and are different from warranties under English law. The measure of

damages in relation to representations is different from warranties and may sometimes

give rise to the remedy of recession. In the UK, a seller’s lawyer will strongly resist

agreeing to any representations in the legal contract.

The seller will seek protection from any warranty claims through the following methods:

Disclosure letter: the buyer cannot make a claim for a breach of warranty that is

notified by the seller to the buyer before closing through the disclosure letter.

Limited warranties: certain categories of seller, such as private equity funds, IPs,

and trustees may only provide very restricted warranties.

Liability cap: the maximum amount a buyer can claim for breach of warranty is

restricted to the price paid. Depending upon the parties and their respective

bargaining positions, the cap may be set lower than 100% of the consideration for

certain warranties.

Thresholds: there is usually a minimum claim level (individually and for the claims

in aggregate) that must be reached before a claim can be made against a seller.

Time: in most cases, other than in relation to taxation, the time limit for bringing a

claim is between one and three years from completion.

Alternative recovery: if the seller has the ability to recover its loss from another

source, such as insurance, it must do so in preference to making a warranty

claim.

Unlike warranties, indemnities are generally not qualified by the seller’s disclosure letter

and may not be subject to a minimum claim level.

6.11.3. Restrictive covenants

When purchasing a business the buyer will want to ensure that the seller is not going to

compete with the acquired business which might impair the value of the goodwill that has

been acquired. Typically, this is secured by undertakings from the sellers that they will

not:

compete against the acquired business;

solicit away any customers, suppliers, or employees of the business;

use the trade names of the business; and

disclose any confidential information about the business to third parties.

In order to be enforceable under English law, these undertakings must be reasonable in

scope, duration, and geographical area. If the restrictions are too extensive they could be

considered unreasonable and a restraint of trade and would, therefore, be invalid.

6.11.4. Completion Accounts

The valuation of a business in an M&A transaction is usually based on the assumption

that the target has a certain level of net assets, working capital, or cash at closing. The

purchase agreement will usually provide for this to be verified through the preparation of

completion accounts that set out the net asset value (and other relevant balances) as at

closing.

PRIVATE M&A


The purchase agreement should state who is responsible for preparing the completion

accounts, the time limits for doing so, and the procedure in the event of a dispute

between buyer and seller. However, the most important part of this section is the

methodology for preparing the completion accounts, which typically includes:

Specific accounting treatments for certain items as agreed between buyer and

seller.

The historical accounting treatment as adopted by the target business in his past

accounts.

Generally accepted UK accounting principles.

An alternative approach would be the use of a “locked box” mechanism. The deal price is

agreed between buyer and seller based on a historical balance sheet, such as the latest

audited accounts or management accounts that have been reviewed by the buyer before

closing. There is then no post-closing adjustment, effectively the buyer takes on the

financial risk or benefit of the target business from the locked box date. The buyer is

protected from the sellers extracting value after the locked box date (such as through

dividends or excessive salaries) by an additional set of warranties and indemnities.

The locked box mechanism is most commonly seen in a seller’s market and where the

target is a stand-alone business with robust accounting records.

6.12. Disclosure letter

As noted above, this is a letter from the seller to the buyer which acts to qualify the

warranties and is typically supported by a large bundle of accompanying documents that

provide detailed information regarding any known matters that may give rise to a breach

of warranty.

The letter is an important part of the seller’s protection and so a properly advised vendor

will seek to include as many matters as possible that could give rise to a warranty claim.

For a buyer, there are two main objectives during this stage of the transaction:

To ensure that any material matters are disclosed as early as possible in order

that they may be properly evaluated.

To ensure that the disclosures are specific and detailed. Vague and all-

encompassing disclosures are of little use to the buyer in assessing risk and may

unintentionally give the seller much wider protections than is desirable.

6.13. Tax deed

In most share sales there will be a deed of tax indemnity (or tax covenant) that may be

included in the share and purchase agreement or prepared as a stand-alone document.

The usual market practice in the UK is for the sellers to indemnify the buyer on a pound-

for-pound basis for any pre-closing tax liabilities in the target company not arising in the

ordinary course of business and tax liabilities not disclosed or included within relevant

accounts. There is no tax deed for a business asset transfer as any tax liabilities remain

with the selling company. Historically most deeds incorporated a seven year period for

making claims in line with the period that HMRC has to make enquiries into a company’s

past tax affairs. However, HMRC has recently reduced its usual enquiry period to four

years and there is some movement in M&A transactions to reduce the indemnity period in

the tax deed accordingly.

PRIVATE M&A


As tax legislation is constantly changing it is important to obtain professional advice on

the contents of the tax deed rather than relying on a past precedent.

6.14. Financial assistance

Following the implementation of the Companies Act 2006, there is no longer a general

prohibition on a UK private company providing financial assistance for the purchase of its

own shares. In M&A transactions such financial assistance would normally be in the form

of a loan from the target to the acquirer where the target business has surplus cash

funds, or target permitting its assets to be used as security to enable the buyer to raise

finance from banks and other external parties. However, the target company’s directors

must still fulfil their statutory duties and ensure that the proposed transaction is in the best

interests of the company and that it does not constitute an unlawful distribution.

A target public company (whether listed or unlisted) and its public and private subsidiaries

are still prohibited from providing financial assistance for the acquisition of shares in the

target public company. A public company is also prohibited from providing financial

assistance for the acquisition of shares in its private holding company. In order for a

public company to provide financial assistance it would first need to re-register as a

private company, which may not be possible until after closing of the relevant transaction.

FINANCING THE ACQUISITION


7. Financing the acquisition



7.1. Funding sources

Where an overseas acquirer needs to raise third party financing to support an acquisition

it has a wide range of available sources in the UK including:

Commercial banks

Asset finance houses

Private debt funds

Debt capital markets

Private equity funds

7.2. Commercial banks

The five largest bank funders for acquisitions by volume of deals are Lloyds, HSBC,

Barclays, The Royal Bank of Scotland (including its subsidiary NatWest Bank), and

Santander. In addition, there are a wide range of smaller and specialist lenders to the

commercial and corporate sectors including Yorkshire Bank (part of National Australia

Bank), Allied Irish Bank, Bank of Ireland, and Aldermore Bank.

For acquisition finance the banks will generally provide loan facilities, although alternative

structures such as overdrafts, revolving credit facilities, invoice discounting/factoring, and

hire purchase/finance leases may also be offered.

A term loan will be a committed facility over the life of the loan, generally drawn at its

inception and which may be repayable in instalments over the life of the loan (amortising)

or as a single bullet repayment at the end of the term. The term of commercial

mortgages (a loan secured on property) can be up to 10 years with most other

commercial loans having a term of one to five years. The banks can be flexible on most

terms in order to tailor the loan to the needs of the client.

Banks will generally assess the amount of funds they are prepared to advance by two

criteria:

Security: the amount and quality of the tangible asset security offered for the

lending, including property, plant & machinery, and accounts receivable.

Serviceability: the ability of the borrower to service the debt measured by

reference to key metrics such as interest cover and the ratio of debt to operating

profit.

With the recovery in the financial position of most banks since the 2007/9 financial crisis,

their appetite to lend has increased. While leverage levels for most small and mid-market

deals are lower than before the financial crisis, the main commercial banks remain the

first choice of debt funding for many acquirers in the UK.

7.3. Asset finance houses

There are a wide range of asset finance providers in the UK ranging from international

groups such as GE Capital to national “challenger” banks such as Shawbrook and

specialist boutique funders.

The principal focus of most of these funders is lending against accounts receivable.

However, many funders have expanded their product ranges and provide additional

funding against plant and machinery, inventory, and, in some cases, property.



For small and mid-market transactions the process for securing asset finance is generally

quicker and less expensive than for bank loans.

7.4. Private debt funds

While significantly less developed than in the USA, there has been a growth in the

number of private debt funds in the UK since the 2007/9 financial crisis. This growth has

been driven by both the lack of funding from the main commercial banks, particularly for

leveraged deals, and the poor rate of return that investors were receiving from traditional

asset classes.

Private debt funds have been established by the banks, insurance companies and other

financial institutions, and high net worth individuals. Originally focused on supporting

private equity sponsors and corporate acquirers with lends of £50 million plus, their

lending sizes have reduced over the past few years.

The features that make private debts attractive to acquirers are:

Amount of lending: typically a fund will advance a greater sum than a bank by

combining a senior loan with a mezzanine loan in a single instrument

(“unitranche”).

One lender: a unitranche arrangement means the borrower only has to deal with

one lender, rather than two or more if it needs to secure senior and mezzanine

loans, making the decision making process simpler.

Speed: as loans are provided by one fund the borrower can achieve certainty of

funding quicker than if dealing with multiple senior and mezzanine funders or a

loan syndicate.

Flexible terms: the funds can be flexible in covenants and capital repayment,

making them suitable for complex business structures.

Lower debt service burden: usually non-amortising with bullet repayment at the

end of the term which preserves cash for acquisitions and capital expenditure.

Debt funds operating in the UK include Ares, HayFin, Alcentra, European Capital

Beechbrook Capital, M&G Investments, H.I.G., and BlueBay.

7.5. Debt capital markets

This form of funding involves the issue of tradeable debt securities to investors in return

for loan capital. Interest is paid during the term and the capital is repayable on the

specified maturity date.

This form of financing may be preferable where a company has direct access to a range

of investors. If the issue is large and the maturity of the debt varied then the cost of the

capital may be lower than for private debt or mezzanine financing. In addition, the

security and covenant requirements will be less restrictive than for bank or private debt

lending.

The offering of bonds to the public is regulated by the FCA and requires the issue of an

approved prospectus. Certain exemptions from regulation may be available if the bonds

are only issued to institutional investors. If the bond is to be listed on a stock exchange to

enhance its marketability, the approval of the UK Listing Authority (which is operated by

the FCA) is required.



7.6. Private equity funds

The UK has a large and well developed private equity market, ranging from funds that

support early stage and technology businesses through to international investors that

support multi-billion pound leveraged buy-outs. Most private equity firms in the UK are

independent, raising their funds from banks, insurance companies, pension funds, and

individuals.

As private equity funds generally seek most of their return through a capital gain secured

on the growth in the equity value of their investments they may not be suitable funders for

many corporate acquirers. However, some private equity funds have provided finance to

companies for acquisition and investment, structured as a minority shareholdings with

loans or preference shares. We have advised on a number of corporate venturing type

deals between companies and private equity funds, and so this source of finance should

not be rejected by overseas acquirers, particularly where the availability of normal debt

finance may be limited.

COMMON DEAL ISSUES IN THE UK


8. Common deal issues in the UK



8.1. Overview

The UK is generally an open country in which to conduct business and undertake

acquisitions with limited restrictions on who can acquire UK firms and how deals are

conducted. However, there are a number of particular aspects to some UK laws and

business practices that overseas buyers need to be aware of that can sometimes hinder

or break potential deals.

8.2. Accounts

In the UK, the annual accounts of companies may be prepared in accordance with

International Accounting Standards (“IAS”) or under UK Generally Accepted Accounting

Practice (“UK GAAP”). For companies reporting under UK GAAP, the default position is

that they prepare accounts under Financial Reporting Standard (“FRS”) 102, or FRS 101

for relevant qualifying entities. If the company meets the appropriate criteria it may

prepare accounts under the Financial Reporting Standard for Smaller Entities (“FRSSE”)

or the Financial Reporting Standard for Micro Entities (“FRSME”) but they are not obliged

to do so. For unincorporated businesses, such as sole traders and partnerships there are

no prescribed accounting standards.

The UK reporting regime as at September 2015 can be summarised in the diagram

below.

1Certain types of incorporated bodies and business undertakings are not permitted to report under FRSME or

FRSSE even if they meet the relevant size criteria.

2Limits increase to £10.2m turnover and £5.1m balance sheet total as from 1 January 2016.

Owing to the differing reporting regimes for business entities in the UK it is possible that a

target company’s accounts may not be prepared in a manner that is consistent and

comparable with an overseas acquirer. In addition, as the reporting regime in the UK has

changed over the years up to 2015 it is possible that the accounts of a UK company may

not have been prepared consistently year-on-year.

Incorporated

businesses

including

companies and

limited liability

partnerships

Unincorporated

businesses

International

Accounting

Standards

UK Generally

Accepted

Accounting

Practice

(“UK GAAP”)

IAS and IFRS

FRS 101

FRS 102

FRSSE1

FRSME1

All companies with securities listed

on a recognised stock exchange

Meets two of: (i) turnover less than

£632,000; (ii) balance sheet total under

£316,000; and (iii) less than 10 employees

Meets two of: (i) turnover less than £6.5m;

(ii) balance sheet total under £3.26m (net);

and (iii) less than 50 employees2

All incorporated businesses not entitled to

prepare accounts under FRSSE or

FRSME

Qualifying companies that wish to use the

recognition and measurement bases of

IAS/IFRS but with reduced disclosure

Not applicable

Income Tax

(Trading and

Other Income)

Act 2005

All unincorporated businesses including

sole traders and partnerships

Business EntityReporting

RegimeRegulation Application



8.3. Employee issues

As noted previously, there is legislation which protects the rights of employees on a

transfer of a business - Transfer of Undertakings (Protection of Employment) Regulations

2006 as amended in 2014 (“TUPE”). These rules do not apply on a share sale because

personnel remain employees of the target company – there is no change of employer.

The main provisions of the TUPE rules are as follows:

All employees of the business that is sold transfer automatically from the seller to

the buyer.

The transferred employees retain all their current employment terms, salary level,

and benefits (with certain special rules applicable to pension arrangements).

The transferred employees are treated as if they had continuous service. This

may have significant financial implications for any redundancy costs which are

calculated by reference to length of service.

There is an obligation to inform and consult with employees before the transfer.

While it is fairly straightforward to establish most employment costs, such as salary, in

order to assess the financial impact of the transferred employees, other costs may be

more problematic. For example, if the transferring employees participated in the seller’s

share option scheme then an equivalent scheme or payment will need to be made in

compensation.

For a buyer, after closing this may result in certain employees doing similar roles with

similar experience having substantially different remuneration arrangements. If it is

necessary to equalise employment terms the only option is usually to “level up” the lower

paid employees which clearly has cost implications for the enlarged business.

In certain cases the buyer and seller may agree that some employees of the transferred

business should remain with the seller in new roles. However, employee consent is

required here and despite any agreement between the seller and buyer the affected

employees have a statutory right to move their employment to the buyer. Likewise, an

employee has the right to object to a transfer.

Any employee made redundant in the context of a TUPE transfer (which may happen

before or after closing) can make a financial claim for unfair dismissal.

8.4. Pensions

In broad terms there are two forms of pension scheme in the UK, the defined benefit

(“final salary”) scheme and the defined contribution (“money purchase”) plan. Defined

benefit schemes are supported by a sponsoring employer that is obliged to meet the cost

of any deficit on the scheme in order to provide a set retirement income to members. In

contrast, under a defined contribution plan the employer’s liability is limited to the agreed

contributions and the relevant employee’s pension is not guaranteed.

A combination of tax changes, increasing life expectancy, and falling investment returns

pushed many defined benefit pension schemes into deficit in the late 1990s and early

2000s. As a result, most private sector schemes have been closed, although such

arrangements continue in place for many public sector employees in the UK.

Where a target company has a defined benefit pension scheme, the pension trustees

have considerable power in the M&A process. They will examine the transaction with the

support of specialist lawyers and forensic accountants to determine whether the deal may

have a negative effect on the scheme and the employer’s ability to support the pension



fund. The trustees may seek a wide range of assurances, commitments, and actions to

mitigate any risk to the scheme, which could include increased contributions or taking

security over the assets of the sponsoring employer.

The relevant regulatory body for pensions in the UK is the Pensions Regulator. While the

regulator generally prefers scheme trustees to act in order to protect the position of the

pension fund it does have wide ranging powers to intervene in M&A transactions,

including increasing or extending liability for funding a pension scheme to other parties

and approving corporate transactions under its clearance process. The Pensions

Regulator will intervene if it considers that the pension scheme trustees are not being

robust in protecting the position of the relevant pension fund.

Where a target company has a defined benefit pension in scheme in place specialist

advice should be obtained and early dialogue with the scheme trustees and the Pensions

Regulator may be necessary.

From 2012 onwards, all employees in the UK not already contributing to a pension

scheme must be automatically enrolled in a defined contribution pension scheme by their

employer (“auto enrolment”). The dates for companies to begin enrolling employees

have been phased between 2012 and 2017. Employers must make a contribution to the

pension scheme starting at 1% of the employee’s salary and increasing to 3%.

8.5. Tax schemes

In common with many countries, companies and business owners in the UK put in place

a variety of planning arrangements to reduce or eliminate tax liabilities. Historically the

legal position has always been very clear with planning to minimise tax that is within the

strict definition of the law being permitted (tax avoidance) and outright concealment of tax

obligations being illegal (tax evasion). However, a combination of Government budget

deficits, media reports about the tax affairs of international corporations (such as Google

and Amazon), and public pressure has blurred this distinction such that many previously

legitimate tax planning arrangements are now being challenged.

One formerly popular tax planning tool was the use of Employee Benefit Trusts (“EBT”) or

remuneration trusts. In essence, such arrangements allowed companies to make tax

deductible payments into the trusts that would then make tax-free loans or payments to

employees, including the business owners. Companies would sometimes make regular,

large payments into these trusts over several years. All of these arrangements are now

under challenge by HMRC as unacceptable tax avoidance. In the event that a trust

arrangement is overturned by HMRC the company would be liable to pay all under-

declared tax together with interest and penalties (which could double the amount due to

the tax authorities). We have seen instances where M&A transactions have collapsed

because the potential liability for the purchaser was greater than the proposed

consideration being offered for the business!

Where the company’s accounts indicate that such tax planning tools may have been used

by the owners, early investigation is advised before the deal progresses too far.



8.6. Property

In the UK, property law and contracts are favourable to landlords over tenants.

Therefore, where a target company operates from leased property it is advisable to

carefully review the relevant legal documents for any hidden or contingent liabilities.

The majority of leases require the tenant to maintain, repair, and insure a leased

property. In addition, at the end of a lease the landlord can require the tenant to return

the building to its original condition as at the start of the lease. Where there have been

substantial alterations to a building during the lease term this rectification cost may

represent a significant liability for the tenant. In most cases such contingent liabilities are

not recorded in the company’s accounts.

Commercial leases are generally for a minimum of five years and many will be for 10

years or more. In the absence of a break clause, the cost of exiting a lease early for a

tenant may be substantial. However, in many cases it is possible to negotiate a deal with

the landlord, particularly in areas going through re-development.

TAX CONSIDERATIONS FOR OVERSEAS BUYERS


9. Tax considerations for overseas

buyers



9.1. Overview

There are a wide range of tax considerations for an overseas buyer, including the

structure of the deal, financing arrangements, and remitting funds to a home jurisdiction.

This section contains a brief summary of some of the main issues but specialist advice

should be obtained before taking any action.

9.2. Transaction structure

As noted in Section 6, prior to 8 July 2015 the purchase of trade and assets rather than

shares offered certain tax benefits to a purchaser. This distinction has now been

removed. For deals closed after 8 July 2015, there is no tax deduction for the

amortisation of purchased goodwill, neither is there any tax deduction for the amortisation

of goodwill arising on consolidation or the write-off of the cost of investment in

subsidiaries.

Stamp Duty at a rate of 0.5% of the total consideration (including any deferred and

contingent consideration) is payable on share purchases (excluding purchases of

companies listed on AiM). Stamp Duty Land Tax at rates between 1% and 4% is charged

on commercial property purchases. Residential properties held in a corporate entity

attract a variety of punitive tax charges.

9.3. Acquiring entity

An overseas buyer with no existing operations in the UK could acquire a UK target

company directly, or through a newly incorporated wholly owned UK company.

A new UK company has a number of attractions, notably it makes it easier to raise

funding in the UK to finance the acquisition. In addition to acting as a natural currency

hedge, the interest cost of local borrowings can usually be offset against the target

company’s trading profits and so reduce the UK Corporation Tax charge. However, there

are a number of anti-avoidance rules in the UK to be considered and so this is an area

where specialist advice should be obtained.

For a highly leveraged operation where debt is pushed down to the acquired company

there are a range of hurdles to be overcome by a foreign owned UK company in order to

obtain a full interest expense deduction against Corporation Tax. The ability of the UK

company to secure a full tax deduction for interest and royalty payments made to an

overseas parent costs will depend on a number of factors, notably whether the group of

which it is a part falls within the transfer pricing rules and the total amount of group debt.

A future sale of the acquired business by a UK acquisition vehicle will be within the scope

to UK taxation and so a tax charge may arise on any profit made on the disposal.

However, subject to compliance with certain conditions, notably having owned the

divested company for at least a year and the seller continuing to be a trading group, the

gain can be exempt from tax under the Substantial Shareholdings Exemption. A sale of a

UK company by a non-UK shareholder is outside the scope of UK taxation.

9.4. Withholding tax

Dividends paid between UK companies are exempt from tax. Dividends paid by a UK

company to its non-UK parent company do not attract any withholding tax.

Where acquisition finance is provided by a non-EU parent company, a withholding tax of

20% applies to certain interest payments unless there are provisions to pay interest gross



or deduct a lower percentage of tax under a double tax treaty. This withholding tax

regime also applies to royalty payments.

9.5. Deal costs

The costs associated with an acquisition fall into two main categories:

Acquisition costs: such as legal fees incurred in preparing the sale and purchase

agreement and due diligence reviews.

Funding costs: the costs of raising finance, such as bank arrangement fees.

The acquisition costs for a share purchase transaction are added to the purchase price

and form part of the overall cost of investment. There is no Corporation Tax deduction

available for these costs either when incurred or as they are amortised. In an asset

purchase transaction, some deal costs may be allowable against tax if they can be

allocated against qualifying acquired assets.

As a result of the restricted regime for offsetting acquisition costs against tax, for

overseas buyers it may be preferable to incur the acquisition costs in a home regime if

this allows for such expenses to be offset against tax.

Funding costs should be capitalised on the balance sheet of the acquiring entity and

amortised over the term of the relevant financing instruments. The amortisation expense

is tax deductible in the UK.

Providers of acquisition advice and services, such as accountants and lawyers, are

usually required to charge Value Added Tax (“VAT”) at a rate of 20% on the costs of

services provided. This VAT may be recoverable by the acquirer, however, there are a

number of current legal cases on this subject in the UK and the matter is complicated.

Advice from a specialist VAT consultant should be obtained at an early stage in the

acquisition process to ensure engagements with advisers are arranged correctly.

9.6. Consideration structure

The form and structure of the purchase consideration offered to a UK seller can have a

significant impact on their tax liability, particularly for private individuals.

As of September 2015, individuals are charged Capital Gains Tax at a rate of 18% for

basic rate taxpayers and 28% for higher rate taxpayers on any profits made from the sale

of shares and business assets. If shareholders qualify for “Entrepreneurs’ Relief” their

effective rate of tax falls to just 10% on lifetime gains up to £10 million, and so most

sellers will wish to ensure any deal secures them this relief. The main conditions for

obtaining Entrepreneurs Relief are:

The company is trading, that is, not an investment business, property company or

similar undertaking.

The shareholder has been a director, officer, or employee of the company for at

least 12 months up to the date of sale.

The shareholder has at least 5% of the ordinary share capital enabling them to

exercise at least 5% of voting rights.

When assessing the tax position of the seller attention needs to be given to each form of

consideration offered. Any gain on the cash part of the consideration received is subject

to tax when the cash is received and the tax would be due for payment in the January

following the end of the tax year. For non-cash consideration (e.g. shares and loan

notes), the selling shareholder may be able to defer payment of any tax until these are



converted into cash. Therefore, sometimes a seller who is subject to UK tax may request

non-cash consideration in order to delay a tax bill.

However, on occasions a seller may wish to pay tax early even if they are receiving non-

cash consideration, for example:

They believe tax rates will increase in the future or reliefs may be withdrawn.

The shareholder will lose entitlement to Entrepreneurs’ Relief after closing

meaning that any gains on non-cash consideration could be taxed at 18% or 28%

when turned into cash in the future.

The situation can become particularly difficult for a shareholder in relation to contingent

consideration, including earn-outs. If the seller does not qualify for Entrepreneurs’ Relief

after closing (which will be the case if they have sold 100% of their shares in the

company) then when the earn-out comes into value and is converted into cash they will

be taxed at a rate of 18% or 28% on the gain, unless they have paid the tax upfront

based on an estimate about what they are likely to receive.

Where earn-outs are used any performance measures should be company/business

related and not linked to the personal performance of the sellers. If earn-outs are linked

to the seller’s personal performance any receipt will be taxed as employment income at a

much higher tax rate than that for capital gains.

9.7. Tax clearances

In the UK, the rates of Capital Gains Tax are generally lower than income tax, which

sometimes acts as an incentive for business owners to devise ways of converting income

into capital gains. There are detailed and extensive anti-avoidance provisions in place

designed to prevent such tax advantages arising from transactions in shares and other

securities. Where non-cash consideration is offered by a buyer, particularly if that is in

the form of shares, the seller is likely to seek “tax clearance” from HMRC in order to gain

comfort on how their proceeds will eventually be taxed and that anti-avoidance measures

will not be invoked against the selling shareholder.

It can take up to 30 days to receive the clearance from HMRC. However, HMRC can

raise queries which could delay closing and so sufficient time should be built into the deal

timetable to allow for this possibility.

9.8. Tax groups and joint liability

For most taxation purposes, including the calculation and payment of Corporation Tax,

companies are treated individually. However, companies may automatically become part

of a group for Corporation Tax purposes if one company owns 75% or more of the share

capital of another company or both are 75% subsidiaries of a parent company. The latter

grouping may apply if the parent is overseas but both subsidiaries are in the UK.

Companies may also voluntarily become grouped for VAT purposes. Such group

arrangements provide certain benefits, such as the ability to use trading losses in one

company to offset Corporation Tax liabilities in another company.

However, care should be taken when purchasing a company that was previously a

member of a VAT group. The target company remains jointly responsible for VAT

liabilities incurred by the whole group while it was a member. While protection such as

an indemnity can be sought, if the vendor group is in financial distress it may be unable to

stand behind any such assurance leaving the acquired business with a potentially large

tax exposure if the vendor group were to fail.

ADVISERS


10. Advisers

ADVISERS


10.1. Benefits of a local adviser

Overseas buyers may need to rely more heavily on advisers for cross-border deals than

they might for purely domestic transactions. Using UK based advisers for the purchase

of UK companies offers several benefits:

Knowledge of relevant laws and regulations for conducting M&A transactions.

Understanding and experience of local customs and accepted market practice for

buying and selling businesses in the UK.

Ability to identify and research companies for consideration by the buyer.

Local resource to project manage the deal, prepare documentation, and

undertake due diligence.

Capability to handle UK regulatory authorities, including HMRC, the Pensions

Regulator, and the Panel.

10.2. Financial or M&A adviser

This person or firm will usually act as the lead advisor for the transaction and their role

will typically include:

Identifying and approaching targets.

Negotiating the deal or acting as lead adviser to the buyer in the commercial

discussions.

Undertaking valuations or deal pricing analysis.

Drafting offer letters and Heads of Terms.

If required, arranging finance for the deal.

Where relevant, acting as financial adviser for offers subject to the Code.

Project managing the transaction through to closing.

Advising on the financial, accounting, and tax aspects of the transaction and legal

documentation.

The majority of M&A advisers in the UK have a financial qualification, typically as

chartered accountants or bankers, and will operate within an investment bank, corporate

finance boutique, or accountancy firm.

Selection of a suitable firm is a key consideration in making your UK acquisition strategy

a success. An international investment bank may seem an attractive choice for its depth

of resources and brand, but such organisations are unlikely to devote any senior level

resource to a transaction of less than £100 million. The larger accountancy firms in the

UK have substantial resources but are mainly focused on sell-side mandates and

supporting a select number of major corporate and private equity clients. Given their

extensive client portfolios, the large accountancy firms often encounter conflict issues on

acquisition assignments. There are several good quality corporate finance boutiques,

although often they are focused on one particular industry or sell-side only mandates and

may not have sufficient expertise in areas such as tax.

There are also many independent advisers and brokers of variable quality in the UK, so

overseas buyers should always choose an adviser who is supervised by an appropriate

regulatory body, such as the FCA or Institute of Chartered Accountants in England and

Wales.

ADVISERS


10.3. Legal adviser

It is important to select a firm and individual legal adviser with specialist M&A experience,

rather than a general commercial lawyer. As with financial advisers, you need to select

the right size firm – it is better to be towards the higher end rather than the bottom end of

the adviser’s typical deal size range as that will ensure you receive senior level attention.

In addition to drafting the transaction documentation your legal adviser will carry out the

legal due diligence.

10.4. Investigating accountants

It is possible that the financial due diligence could be undertaken by your M&A adviser

provided that the firm:

has the appropriate skills, experience and resources to handle both roles; and

is not being remunerated for its M&A advice on a contingent/success only basis

because this could be seen as compromising the independence of the due

diligence review.

Otherwise, a separate firm of accountants should be engaged to undertake the financial

due diligence review. It is important to ensure that the due diligence firm has sufficient

experience in such projects and the necessary resources to undertake the project – small

generalist firms that use audit staff for investigations may be unable to devote attention to

a deal during audit busy periods. You should also ensure the firm has sufficient

professional indemnity insurance in place.

10.5. Commercial and market due diligence

While generally trade buyers would conduct their own market due diligence, it may be

that the acquisition of a UK business opens up a new geographical or industry sector

requiring additional investigation. The UK has a large number of commercial due

diligence firms ranging from international strategy houses to industry specific consultants

that have experience in M&A due diligence for trade buyers and private equity firms.

10.6. Public M&A transactions

For transactions subject to the Code the acquirer’s financial adviser must be authorised

by the FCA to make the offer and advise the board of the bidder accordingly. Certain

additional parties are required to be engaged by the bidder for public M&A transactions

as follows:

Solicitor to the financial adviser: to provide legal advice on offer related matters.

Receiving agents: to receive acceptances from shareholders and arrange

payment of the consideration.

Stockbroker: if necessary, to make market purchases of shares.

Security printer: to print the offer document.

Financial PR advisers: depending on the nature of the transaction (e.g. if hostile)

and target.

APPENDICES


Appendix A

Companies legislation

Companies Act 2006

The Act primarily covers the establishment of limited companies and matters relating to share capital,

accounts, audit, directors’ duties, and shareholder meetings. However, there are certain provisions

specifically relating to acquisitions and mergers.

A1 Scheme of arrangement (Part 26, ss. 895-901)

Provisions for changes in the structure of a company or group of companies in order to facilitate a re-

scheduling of debt, takeover, de-merger, or return of capital. A scheme of arrangement is overseen

by the Court and may sometimes be used as an alternative to an offer for a listed company or

acquisition by contract of a private company – see section 5.

A2 Mergers and divisions of public companies (Part 27, ss. 902-941)

This part of the Act contains additional provisions for schemes of arrangement involving public

companies in the UK

Two types of merger transaction are envisaged. Firstly, merger by absorption, where the assets and

liabilities of one company are transferred to another company in return for the issue of shares (and

sometimes cash) to the shareholders of the transferor company. The second method is merger by

formation of a new company under which the trade, assets and liabilities of two or more public

companies are transferred to a new company in return for the issue of shares (and sometimes cash)

to the shareholders of the transferor companies.

Under a division, the trade, assets, and liabilities of a company are transferred to two or more entities

that are either existing public companies or newly incorporated companies (which may be private or

public).

This part of the Act is not to be confused with The Companies (Cross Border) Mergers Regulations

2007 which apply to a merger between at least one company incorporated in the UK and one

incorporated in a different European Economic Area (“EEA”) state.

A3 Takeovers (Part 28, ss. 942-991)

This part of the Act places the supervisory and regulatory activities of the Panel on Takeovers and

Mergers (“the Panel”) or a statutory basis. The Panel’s main function is to issue and administer the

City Code on Takeovers and Mergers (“the Code”) and ensure fair treatment for all shareholders in

takeover bids. See section 5.

Financial Services and Markets Act 2000 and the Financial Services Act 2012

The legislation introduced in 2000 primarily related to listed and financial services companies,

covering areas such as the powers and role of the regulator, the promotion of investments,

authorisations to give investment advice and the regulation of authorised firms and individuals, the

procedure for listing on a stock exchange, and controls over the acquisition of banking and insurance

businesses.

The Financial Services Act 2012 updated the 2000 legislation, replacing the single regulator with two

new bodies, the Financial Conduct Authority and the Prudential Regulation Authority.

APPENDICES


Criminal Justice Act 1993

This Act contains current UK legislation regarding insider dealing which may be relevant in listed

company takeovers.

The Companies (Cross-Border) Mergers Regulations 2007

These regulations implemented the EU Merger Directive 2005/56/EG which concerned cross-border

mergers of corporations.

Prior to this legislation, there were no comprehensive provisions in UK company law relating to

mergers. In particular, unlike in many countries of the EU, there was no concept of a “legal merger” in

which the assets of two distinct companies are amalgamated and one or more entities disappear.

Historically, the usual process in the UK was to begin with a share acquisition in order for the acquirer

to bring the target into its group, which may then be followed by a transfer of trade and assets from the

target to the acquirer.

APPENDICES


Appendix B

EU merger regulation thresholds

Combined worldwide

turnover of all undertakings

concerned exceeds

€5 billion

Community-wide turnover of

each of at least two

undertakings concerned

exceeds €250 million

Combined worldwide


concerned exceeds

€2.5 billion

Combined worldwide


concerned exceeds

€100 million in each of three

member states

In each of those three

member states, at least two


each have turnover

exceeding €25 million


each of at least two


exceeds €100 million

More than two-thirds of


each undertaking is

achieved in the same

member state

Community dimensionNational competition

rules apply

No

No

No

No

No

No

No

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Original turnover thresholds Secondary turnover thresholds

GLOSSARY


Glossary

Term Description

AiM Alternative Investment Market, a sub-market of the London Stock

Exchange for smaller growing companies

Auto enrolment Compulsory pension plan for employees without existing pension

arrangements being phased in between 2012 and 2017

BIS The Department for Business, Innovation, and Skills, the

Government ministry that oversees business in the UK

CA 2006 or the Act Companies Act 2006, the principal legislation relating to the

establishment and operation of companies

Capital Gains Tax Tax levied on individuals on capital gains, including the profit arising

from the sale of shares or relevant business assets

Code The City Code on Takeovers and Mergers, also called the City

Code, which governs the takeover of public companies

Corporation Tax Tax levied on company profits

CMA Competition and Markets Authority, which regulates competition

policy in the UK

Companies House The UK companies registry

EBT Employee Benefit Trust, generally used a tax planning device

EEA European Economic Area, which comprises the 28 countries in the

European Union plus Iceland, Liechtenstein, and Norway.

Enterprise Act 2002 Legislation relating to bankruptcy and competition

Entrepreneurs Relief A tax relief that allows qualifying shareholders to pay a reduced

Capital Gains Tax at an effective rate of 10% on the profit arising

from the sale of shares or business assets

EU European Union

Eurozone Also referred to as the Euro Area, comprising 19 out of the 28

countries in the European Union that have adopted the Euro as their

single currency. The UK is not in the Eurozone

FCA Financial Conduct Authority, a regulatory body that supervises

financial firms and maintains the integrity of financial markets and

also acts as the UK Listing Authority

FSMA Financial Services and Markets Act 2000, legislation relating to

financial services, banking, insurance, and investments

Heads of Terms Also called Heads of Agreement, Term Sheet, Letter of Intent, or

Memorandum of Understanding, a summary of the main commercial

points of an M&A transaction

HMRC HM Revenue & Customs, the UK’s tax authority

IAS International Accounting Standards

ICAEW Institute of Chartered Accountants in England and Wales

Insolvency Act 1986 The main legislation in the UK dealing with insolvent companies

IP Insolvency Practitioner, a person authorised to act in relation to an

insolvent company under the Insolvency Act 1986

GLOSSARY


Term Description

ISDX ICAP Securities and Derivatives Exchange, a trading platform

typically for small companies (formerly PLUS Markets)

Listing Rules Regulations covering companies listed on a UK stock exchange and

overseen by the UK Listing Authority

Panel The Panel on Takeovers and Mergers, which oversees the

implementation of the City Code on Takeovers and Mergers

Pensions Regulator Regulatory body responsible for overseeing all pension funds

PRA Prudential Regulatory Authority, the main regulatory body for banks

and insurance companies

Prospectus A document prepared for the issue of securities and governed by

the Prospectus Rules which implement the EU Prospectus Directive

Stamp Duty Land Tax A transfer tax on property transactions

Stamp Duty and Stamp Duty Reserve

Tax

A tax on the transfer of certain shares and other securities

Substantial Shareholdings Exemptions A tax relief available for qualifying companies which exempts from

Corporation Tax any gains made on the divestment of a subsidiary

undertaking

TUPE Transfer of Undertakings (Protection of Employment) Regulations

2006 as amended in 2014, which protects the rights of employees

on a business transfer

UK GAAP UK Generally Accepted Accounting Practice, comprising Financial

Reporting Standards 101 and 102, the Financial Reporting Standard

for Smaller Entities, and the Financial Reporting Standard for Micro

Entities

UKTI UK Trade & investment, the Government body that supports inward

investment into the UK

VAT Value Added Tax, a tax on the sale of goods and services

www.burgisbullock.com

Information in this publication is intended to provide only a general outline of the subjects covered. It should

neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of

professional advice. Burgis & Bullock Corporate Finance Limited accepts no responsibility for any loss arising

from any action taken or not taken by anyone using this material.

© 2015 Burgis & Bullock

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Burgis & Bullock - Guide to Mergers and Acquisitions in the UK

Economy & Finance