Background Checks

You decided you want to sell your business, you have a buyer ready to buy the business and he is paying your asking price. What else do you need? Before you go any further, you need to carry out some background checks, to see whether the buyer is able to fulfil his commitments. Ideally you want to check the creditworthiness of the buyer, the reasons for their interest in your business, carryout some industry reference checks and any other checks you think are necessary to ensure the buyer is serious about purchasing your business.Â
In particular, the seller must ensure the buyer provides evidence to the seller he has the appropriate funds to complete the purchase and identify where these funds are coming from. Â In the vast number of transactions, it is likely that the buyer would approach a bank or other finance house for some form of loan or overdraft facility.Â
However, the buyer may also have obtained funding from a venture capitalist that will advance money to the buyer in return for an equity stake in the company. They are likely to want at least a 30% return on the investment per annum, while also placing heavy restrictions on the decisions of the buyer’s management team. When a buyer is receiving funding from a venture capitalist the buyer should also take the following into account:
  • Short to Medium term investment – the venture capitalist is usually looking to get his money back as quickly as possible and has an exit strategy in place prior to investing.Â
  • Subscription agreement – this is a customizable document setting out details of the agreement between the venture capitalist and buyer, it provides legal certainty to a “handshake agreement” between the parties.  A subscription agreement would set out the following between the buyer and the venture capitalist:
    • the amount of money to be invested
    • the number of shares the venture capitalist is likely to receive
    • any consents the buyer requires from the venture capitalist
    • the number of seats on the board
    • how often management accounts are produced
    • list any warranties and expectations
    • payment of dividends and
    • amount of borrowing.
  • The list of issues will need to be negotiated between the parties and the subscription agreement helps in formalising these terms in one concise document.
Other types of funding could include the buyer personally investing in the transaction, a management team buying the target company they are employed to run or an outside management team coming in and taking control of the business. The type of funding and return on investment is likely to depend on the buyer’s business plan.
Where a management team is involved in the acquisition of the target company they should be made aware of the potential conflict of interest they have as prospective owners and their roles as directors and employees.
The buyer should carry out any necessary background checks with regards to the seller. Â If the buyer is dealing with an administrator or liquidator the buyer should note the following points:
  • The transaction almost always involves the sale of assets.
  • The administrator’s advisers prepare the sales agreement.
  • The cost of buying the business is usually much lower.
  • The risk to the buyer is greater as an administrator does not give any warranties as he is clearly not in a position to do so.
To ensure no time is wasted and the transaction proceeds smoothly, the seller should carry out adequate background checks and the buyer should ensure adequate funding is in place to complete the transaction.

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