Hoping to transfer your business? We outline the steps to follow!

Calling all entrepreneurs! Are you hoping to realise the value of your assets, take a step back, retire, or even take a new direction in life? A business transfer is a natural occurrence in the life of a company, whether a trading or a holding company. Both buyer and seller must follow a few key steps to ensure a successful business transfer.

Step 1: valuation of the company

The valuation of a company is generally based on one of three main methods, or a mix of these.

1. Asset-based valuation. This equates to the value of the assets of the company less its debts. This calculation is based on the company’s balance sheet. A number of adjustments are then required to arrive at the true value of the company. Some items are difficult to value in the balance sheet – this is the case with goodwill, which attributes a value to various items, such as the company’s managers’ knowledge of the market. This method of asset-based valuation is typically used for the sale of industrial companies, where the company’s assets are taken into account (inventories, vehicles and buildings that are owned), or for the sale of real estate companies, where the value of the real estate held by the company is taken into account.
2. Earnings-based valuation. With this method, the future earnings potential of the company is considered, rather than the assets it holds. This method is based on the past, present and future earnings of the company. This provides an earnings base that is then discounted on the basis of certain criteria, such as inflation or the risk that the company will not achieve its targets. This method is generally applied to service companies which typically have few assets and whose value depends on their ability to generate earnings.
3. Market or comparable company approach. This method compares the company to be transferred/acquired with companies that are similar in terms of market, revenues or size. It is based on data for previous transactions.

Depending on the sector in which the company to be transferred/acquired operates, the most suitable method should be used, or a weighted mix of the different methods.

Buyer due diligence provides the opportunity to analyse the actual situation and to plan upfront for the costs to be shared by the vendor and buyer in the future.

Step 2: Due diligence

There are two types of due diligence: vendor and buyer due diligence. Vendor due diligence is carried out in advance of the transaction and provides the opportunity to clarify certain issues which could result in pointless discussions during negotiations. Buyer due diligence provides the opportunity to analyse the actual situation of the target company and to plan upfront for the costs to be shared by the vendor and buyer in the future. In its due diligence, the buyer analyses certain characteristics of the company. During this process, the buyer should consider:

• • Corporate documentation such as (i) the company’s articles of association and any additional clauses, (ii) the minutes of management meetings, (iii) management reports and audit reports, and (iv) documentation regarding subsidiaries, where applicable.
  • Ownership of the shares, consulting the register of shareholders which shows the surname, number and category of shares held by each shareholder.
  • Licences and administrative authorisations. A licence or administrative authorisation is required to operate in certain sectors (e.g. insurance, transportation, air travel, etc.). Any trading company must also hold a business permit.
  • The main agreements signed by the company such as: client agreements, agreements with suppliers and manufacturers, insurance policies, loan and lease agreements, guarantees given or accepted, non-competition agreements, and purchase and sale agreements for companies/assets belonging to the company.
  • The company’s assets such as its real estate (property rights, lease agreements, any mortgages and easements), intellectual property rights (patents, brands, licences, graphics, models and other franchises), equipment (e.g. car fleet) and inventory.
  • Tax considerations, VAT and income taxes.
  • Issues related to personnel, wage taxes and social security contributions (number of employees, employment agreements, any ongoing employment disputes/litigation).
  • Any past, existing and potential disputes involving the company, its managers and staff members.
  • Compliance with legislation regarding data protection (GDPR), KYC and anti-money laundering requirements, where applicable.
  • Public subsidies received by the company and the conditions on which they were granted.

Depending on any risks uncovered, the buyer may decide to withdraw, negotiate a lower acquisition price for the company, or request additional guarantees. It is in the vendor’s interest to carry out due diligence to identify any potential weaknesses in the company and resolve these before putting the company up for sale. This will help avoid major issues during negotiations by resolving these issues upfront wherever possible. Due diligence is thus a key stage in the transfer of any company, for both the buyer and the vendor.

The shareholders’ agreement is made between the parties taking over the business to define the rights and obligations of shareholders.

Step 3: Shareholders’ agreement

This is an agreement made between the parties taking over the business, or between the vendor and the parties taking over if the vendors will remain as shareholders in the company; it defines the rights and obligations of shareholders. In general, the agreement may include the following elements:

• • An appointment clause for members of the management board, defining the number of members of the management board and the procedures for their appointment.
  • A clause defining decision-making procedures such as procedures for appointing management board members (how many administrators/managers can each shareholder nominate?) and decision-making procedures (majority, veto rights of minority shareholders for certain decisions).
  • A lock-up clause, which prohibits the sale of shares for a certain period.
  • An approval clause requiring shareholders wishing to sell shares to obtain the prior approval of the other shareholders.
  • A pre-emption clause giving existing shareholders first refusal on the shares of any shareholders wishing to exit the company.
  • A confidentiality clause requiring parties to the agreement to keep it confidential during a certain period.
  • A non-compete clause prohibiting a shareholder from working for or taking a stake in a structure that is a competitor.
  • An anti-dilution clause that enables a minority shareholder to maintain their percentage of the share capital in the event of a capital increase.
  • A drag-along clause which forces a minority shareholder to sell their shares in certain circumstances.
  • A tag-along clause which enables a minority shareholder to sell their shares in certain circumstances.
  • Share liquidity clauses forbidding the use of the shares as security without the prior agreement of all shareholders.
  • A terms of accession clause defining the conditions for an external party to become a new shareholder in the company.
  • A duration clause defining the length of duration of the shareholder agreement.
  • An applicable law and jurisdiction clause defining the law applicable to the agreement and the competent court in the event of disputes.
  • There may also be clauses covering financing, investor or founding members protection, reporting requirements and other potential issues.

Step 4: Sales agreement

This agreement evidences the transfer of the company from the vendor to the buyer. In the representations and warranties clause of this agreement, the vendor declares and guarantees the veracity of certain information, for example, that they are the owner of the shares being sold, and that the company is validly constituted and complies with all tax, accounting and employment rules in force.

If the warranties given by the vendor are not respected, the buyer may contest the assets and liabilities

If the warranties given by the vendor are not respected, the buyer may contest the assets and liabilities warranties clause for protection from hidden future costs. For example, if the liabilities prove higher than indicated, the vendor undertakes to take over any unknown liabilities arising after the sale of the company which result from events prior to the sale.

Post-closing assistance clauses require the selling managers to remain in the company for a certain period of time, e.g. to facilitate business continuity, transfer their know-how, and maintain the client portfolio.

A non-competition clause prohibits the vendor from forming a new company with an identical business for a certain period of time.

In the event of administrative offences of a civil or criminal nature, illegal arrangements, illegal employment, corruption, fraud, non-compliance with data protection regulations or negligence by the managers leaving the business, the company will bear any penalties imposed, which will burden the future earnings that buyers may have hoped for, or may even endanger the survival of the company. In this case, the buyer may seek compensation from the vendor on the basis of the sales agreement and the representation and warranties provided by the vendor.

The transfer of a company is a complex process requiring upfront planning to ensure that negotiations proceed smoothly. It is generally recommended to take advice on strategic positioning as well as on accounting, tax and legal matters.

This article was prepared by Mr Renaud LE SQUEREN, Partner – barrister, and Mr Matthieu VISSE, Senior Associate – barrister, at DSM Avocats à la Cour*.

* Article translated from French by a BIL service provider