During these uncertain times where financial projections are far from reliable, we are seeing an increased pattern of deferred payments and earn-outs where the total purchase price is not paid up front but instead, substantial portions are contingent on timing or financial performance targets being hit between one to three years following the Buyer's acquisition of the business.
- OK, but what if I’m the seller?
Well, in that case, you need to ensure that you are not losing out due to financial factors that may be beyond the control of the business.
Similarly, any deferred consideration calculation mechanism needs to be fair, reasonable and include protections and carve-outs for unforeseen circumstances which may arise during the interim period.
- Hang on, don’t forget the buyer!
There is a natural tension here that needs to be smoothed over and successfully negotiated between the parties. If you are a buyer, you will (clearly) look to ensure that if the particular financial performance targets are not met by the agreed dates then the deferred consideration (or part of it) does not need to be paid to the seller.
Holdbacks, escrow accounts and warranty and indemnity insurance
With no certainty on the sellers' financial position following completion and whether or not they will be in a position to pay up in the event of successful warranty or indemnity claims, many buyers insist on holding back a proportion of the purchase price in a joint buyer and seller escrow account for a certain period of time following completion to be partially or fully released in the event of successful warranty and indemnity claims.
If that happens, the terms of the relevant escrow account and holdback mechanism need to be carefully negotiated to ensure that there is as much clarity as possible to seek to avoid costly disputes following completion.
- Is there another option?
Yes: buy or sell side warranty and indemnity insurance is currently a popular choice to limit the exposure of buyers and sellers in the event of any unforeseen claims.
- During the interim period between completion and payment of the deferred consideration, what protections does the seller have?
Sellers need to ensure that buyers cannot restructure the business during the interim period which would jeopardise or reduce the amount of their earn-out or deferred consideration.
- So, what about the buyer?
Equally, buyers will want to make sure that following completion, there aren’t too many material restrictions on what they can and can't do with the business that they have bought.
Completion accounts 'true-up' mechanism protection
With government guidelines at risk of change with little to no notice, sales, lettings and management instructions may decline and as a result, key members of staff may not be in work and some of them may be key to dealing with the completion accounts calculations.
Sellers and buyers both need to ensure that there is no delay in the completion accounts adjustment following completion by inserting carefully negotiated time extension and notice clauses into the share purchase documentation to limit disputes following completion.
Apportionment of risk through industry specific warranties and indemnities
One size fits all is never the correct approach for specialised businesses like estate agencies. With bespoke software involved in running the business and keeping up-to-date with statutory checks and requirements on the properties, industry specific warranties and indemnities need to be negotiated and inserted into the purchase documentation in order to apportion risk fairly and ensure that any buyer has the necessary protection in respect of items on which it will not have full visibility until it takes over the business following completion.
And of course, in this constant balancing act, sellers need to limit these warranties and indemnities to ensure that, to the extent possible, their liability does not extend to items which were outside of their control during their period of ownership.
As mentioned above, the use of warranty and indemnity insurance products can help bridge the gap between the expectations of the parties.
Seller restrictive covenants
Even sellers wishing to change direction following the sale of their estate agency business will need to ensure that their personal activities and their ongoing trade is not restricted by the covenants and non-competes sought by the Buyer in the purchase documentation.
Sellers and buyers need to find a balance between ensuring that the covenants agreed protect the business acquired and do not restrict the activities and trade of the sellers going forward if they are moving on in a different direction.
Post completion consultancy arrangements
New buyers may find navigating the business a challenge in this unprecedented economic climate. Negotiating a longer consultancy period with the sellers, particularly if they are founders, may assist the buyer and the employees of the business in the transitionary period.
It also allows the sellers to suggest tactics that they have used in the past to boost or maintain the business in previous economic downturns where these actions are local to the sold business.
*Paul Glassberg is partner at Howard Kennedy LLP. Article includes contributions from Nisha Ladha, associate at Howard Kennedy LLP