Understanding the Legalities of Business Exit Plans | Hilton Smythe

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Understanding the Legalities of Business Exit Plans

Legal pitfalls exist when exiting a business, which could cost you money. We examine some of the legal factors you must consider when planning any exit.

Entrepreneurs can depart their businesses in any number of ways, but one of the most common is the merger and acquisition exit. In other words, another business purchases your business to create a greater entity. This is most often how business owners sell their interests.

The UK saw a tremendous COVID-19 bounce back in this respect, with M&A deals reaching record highs in 2021 before returning to pre-pandemic levels. Yet selling is not as simple as signing a contract. Legal pitfalls exist, which could cost you money, headaches, and even the complete collapse of a potential deal.

In this guide, we examine some of the legal factors you must consider when planning any exit.

Why considering legalities in exit plans is important

Departing your business without proper due diligence means that your deal of a lifetime could be scuppered. Any exit planning team will bring multiple legal experts into the fold for this reason.

Even if you have never executed an exit plan before – and 48% of business owners planning to sell have yet to create one – everyone can agree that everyone seeks a frictionless exit.

So, what are the consequences of failing to factor in the legal side of your exit plan?

Exposed business activities

One of the first steps a solicitor will recommend is to employ a non-disclosure agreement (NDA) to ensure that if the deal falls through, the potential buyer cannot disclose any details to other parties.

Business owners that fail to consider this risk face the buyer revealing important aspects of the business and the negotiations. The consequences could include but are not limited to:

  • Loss of business
  • Loss of reputation
  • Negative impact on a future sale

Poached employees

Did you know some buyers enter into purchase negotiations in bad faith to learn about competing businesses?

Again, this is something a proper legal strategy protects you against. The scheme works by a potential buyer learning about your business operations, backing out of a purchase, and then poaching key employees to save on purchasing your business.

Ironclad agreements prevent this from happening.

Transfer of relevant assets

Entrepreneurs seeking a clean break may want to transfer everything to a buyer. This is fine, but what if you only seek to transfer a portion of assets?

Plenty of business owners that have failed to account for the legal side have found themselves unwittingly signing over the transfer of assets they never intended. This is more likely to happen when divesting from more complex business operations.

Legal experts ensure that both parties are on the same page regarding assets.

Tax planning

Your windfall is your reward for a job well done, but how are you being compensated for your service

Some entrepreneurs will take a cash lump sum, whereas others will receive compensation in the form of shares in the new, larger company. Alternatively, a business owner may opt for a combination of the two.

Regardless, every type of package will have tax implications. Your legal advisor can support you in ensuring that any move you make to reduce your tax burden is legal and will not land you a hefty bill later.

Loss of contracts

Any gentlemen’s agreements with suppliers, vendors, customers and staff may have worked for years without a formal contract because of the mutual trust you had built up.

However, before engaging in any exit plan, these agreements must be formalised; otherwise, you risk damaging both the business and the other parties involved.

Without legal advice, these business relationships risk crashing and burning during the exit process.

Put the business on the right footing for success

Whether the business continues to trade under its current name or the remnants are absorbed into a larger entity, most departing business owners want to see their customers and staff succeed after they’re gone.

Not having a system in place for handling long-term debt, failing to renew building leases and failing to update the shareholder register are just some of the catastrophes that await in the future.

Deploying a business solicitor to manage your exit plan ensures you get what you deserve and do right by those you leave behind.

How do business exit advisors help with legal factors?

Business exit advisors support your team in managing your exit strategy from start to finish. They work closely with other experts on your planning team, including strategists, accountants, solicitors and your senior leadership team.

But, how do they help with legal factors?

The sales process

Throughout the sales process, your exit advisor remains a constant. Before you get around to the process, they can explain the various business exit options available to you and the pros and cons of each option. Additionally, they can explain the various payment methods and tax considerations.

The buyer also relies on these legal experts to perform functions such as:

  • Clarifying business ownership.
  • Review outstanding share options.
  • Examine corporate and commercial agreements.
  • Identify risks and liabilities.
  • Ensure full compliance with all regulatory requirements.

Once you reach the stage where both parties are happy, the exit advisor will involve themselves in negotiating legal documents and analysing every word to ensure nothing comes back to bite you.

Manage your property

One of the most complicated parts of the process is managing your property, including any leased properties.

These contracts can be extraordinarily complex, with some including break clauses. Your advisor can help you to understand how including or extracting property in a business deal can impact you.

If you already have property disputes, this is something else your exit advisor can help you resolve.

IP issues

Intellectual property is often the cornerstone of what makes a business so valuable. Including IP as part of a business deal will require acquiring a proper valuation, to what extent the business owns it, and how to protect your IP interests.

This is especially important if you patented your inventions under your name before turning them into a business. For this reason, the buyer will likely want to conduct their due diligence before committing to a deal.

Wealth planning

Successful entrepreneurs often find themselves looking at a windfall of six or seven figures. Naturally, if this is more than £125,140, you would fall into the higher rate tax bracket of 45%.

Without sound legal advice on wealth planning, departing business owners risk having a huge tax bill that can vaporise a massive amount of their gains.

Exit advisors can provide guidance on how to manage your wealth and ensure that more of the money paid ends up in your pocket.

Legal factors to consider when planning an exit strategy

During the final quarter of 2022, the UK’s M&A market was worth £10.1 billion, which was £2.1 billion more than the previous year. It indicates this is a prime market for business owners looking to sell their stakes for the highest possible value.

With this in mind, if you’re planning to move on or are just considering creating an exit strategy, here are the legal factors to consider.

What is included in the sale of the business?

The sale of a business will include a long list of various parts of the business that will be transferred to the new owner. While this may seem obvious, things get more complicated if you plan on retaining certain assets.

Moreover, in some cases, break clauses in a lease may give a landlord the right to break a tenancy if the business changes hands.

The contents of what is and is omitted have been the source of numerous legal disputes, meaning you must get everything in order as part of your exit planning.

Some of the aspects that could be included are:

  • Business name.
  • Stock.
  • Business goodwill.
  • Property.
  • Fixtures and equipment.
  • Client information.
  • The training period for new owners.
  • Agreements, such as retail or supply agreements.

Since this can be such a contentious part of an exit strategy, most UK businesses will include a separate document to be distributed to interested parties that details everything that comes with the deal before entering a legally binding agreement.

Restraint of trade

Adding a restraint of trade clause may be common in places like America, but these are far more suspect in the UK. If drawn up incorrectly, a restraint of trade would not be enforceable in court.

Based on the current legal advice, a restraint of trade clause would only be enforceable if it was highly limited in scope, time-limited and reasonable.

For example, banning a party from ever opening or joining a company within the same industry for life would never be enforceable. On the other hand, preventing a seller from operating a competing business within five miles for the next 12 months would likely be deemed reasonable.

This is a highly contentious legal point, so it’s vital to consult a professional if this is part of your exit strategy.

Training periods

Departing business owners may sweeten any deal by promising to train a buyer to manage and operate the business. The same could also apply if you are leaving via a management buyout.

Your agreement could include a training clause that sets out the requirements of any training program and how long it runs. Some examples of requirements could include:

  • Introducing the new owner to the business’s top 10 suppliers and customers within 14 business days of completing the sale.
  • The new owner must receive a minimum of 20 hours of training in using the core software and equipment of the business.

Every situation is different, but if this is a part of your exit strategy, it should be documented in your exit strategy. Remember, you’re entitled to be charged for your time, so the contract can also include compensation for training.

Employees

The future of your employees also requires careful legal consideration. Generally, a simple takeover will mean your employees continue their employment.

The new owner will be required to honour their contracts for the duration and comply with all UK legislation protecting employees. However, if your employees are to be made redundant when you leave, you must factor in their redundancy pay.

Any transfer of employees must be listed as part of any sales agreement, meaning that your exit strategy should have a clear plan for their futures.

Commercial assets

Whether you lease or own your main commercial assets, the documentation surrounding them must also be worked out.

It could include whether the lease on a warehouse will be transferred to the new owner or if a company car will even be part of the sale.

Likewise, your exit strategy should involve getting your paperwork in order and resolving any outstanding disputes.

Documentation

Paperwork is another legal issue that can cause disruption when executing an exit strategy. If your paperwork isn’t ready, or you’re dealing with lost or misplaced paperwork, it can deter a buyer from proceeding.

Some of the tasks your legal team must manage while exit planning includes:

  • Renegotiating debt agreements.
  • Extending commercial leases (to make the business more attractive).
  • Formalising informal agreements.
  • Updating the shareholder registry.
  • Protecting IP with patents and trademarks.

Generally, legal compliance relies on a mountain of paperwork that protects you from all possible legal pitfalls. Managing this yourself isn’t recommended, so ensure you have a team covering all the bases.

Taxes

Most exit strategies will come with Corporation Tax and Capital Gains Tax obligations. These are levied whenever you profit from divesting from your business, whether you’re selling a stake or the whole thing.

Exit strategies aren’t just designed to benefit the business, but also to benefit you. Any good exit strategy will include how you will manage everything on the tax front.

Managing the Legal Side of Business Exits with Hilton Smythe

We understand how challenging it can be to manage exit strategies, let alone the complexities of the legal side. That’s why you need a team to guide you through the minefield that is exiting your business.

At Hilton Smythe, we support entrepreneurs seeking to achieve a smooth departure. To learn more, speak to our team now.

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