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Top mistakes made by entrepreneurs when selling a business

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For many entrepreneurs, selling a business is the culmination of a long-term exit strategy and often seen as the route a more stress-free existence.

The process of selling a business can be quite straightforward, particularly if steps are taken at the outset to prepare for an eventual sale, but owners frequently enter into sales having failed to lay the ground or given consideration to what happens in the aftermath of the sale.

Most of the common mistakes we see when advising on sales and acquisitions can be avoided with a little planning. Here we set out the most frequent pitfalls, and how to avoid them:

(1) Non-ownership of intellectual property (IP) negatively impacting sale price

This is a very common problem as the law relating to ownership of IP is counterintuitive. The default position is that IP, such as branding, logos etc., is owned by the designer, not the commissioner of the work. The most famous example of this is when Innocent Drinks discovered it did not own its iconic logo, leading to costly and long-running legal action.

Whether a business owns its IP often only comes to light when a potential acquirer is conducting due diligence. The valuation of the business can be harmed by non-ownership of IP as acquiring the IP once it has become iconic can be expensive.

Designers are normally quite relaxed about assigning ownership of IP to the commissioner of the work at the outset when it has little value. This can be achieved by checking the designers terms and conditions, and asking for an assignment if ownership is not assigned to the commissioner.

(2) Agreeing to excessive deferred consideration payments

It is common practice for part of the sale price to be deferred and paid in instalments. Sellers need to be wary of allowing the buyer to defer too much of the sale price. It is increasingly common in the current market for buyers to attempt to wriggle out of deferred payments, claiming that the seller has breached a warranty. It is therefore sensible to negotiate as much immediate cash as possible, and advisers can help with this.

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(3) Agreeing to onerous warranties

As part of the share purchase agreement, it is normal for the buyer to insist that the seller provides certain guarantees. The seller might be asked to provide a warranty that there are no outstanding legal claims, for instance.

In the euphoria of the moment owners often agree to provisions they later regret. For example, we recently re-negotiated a warranty a seller was about to sign, which would have forced him to continue to work for the business free of charge for two years after the sale.

(4) Neglecting to insert an “anti-embarrassment” clause

With the economy growing, and valuations changing, it is worth considering a so-called “anti-embarrassment” clause, which ensures the seller receives additional payment from any subsequent re-sale of the business.

Buyers are often receptive to such clauses, and they can protect a keen seller who agrees to a relatively modest valuation if the business is subsequently sold on.

(5) Failing to ensure the correct corporate structure

This can be critical if it becomes necessary to carve out the value of the business pursuant to any subsequent re-sale in which the original seller might be entitled to a consideration. We recently acted for a sole trader selling a business, who we advised to incorporate prior to the sale, so that shares could be issued and valued. Carving out the value of an unincorporated business would have been impossible.

(6) Failing to consult with employees

The sale of a business can be an uncertain time for employees and many will be concerned about potential job losses. Unfortunately, during a sale employees can be an afterthought. Problems can arise when redundancies are made without sufficient consultation.

Consultation is fundamental to the fairness of any redundancy process. Employers have to engage with an open mind and should not present redundancy as a fait accompli. If employees consider the process unfair, they may have legitimate claims. During a sale process employment lawyers often only get involved once claims have been made, whereas their limited involvement at the outset can minimise costly disputes.

Sarah Miles is anAssociate at law firm Nockolds.



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