While selling your business can be a very positive move, opening up new opportunities and possibilities, it can also prove to be stressful, time consuming and complicated, throwing up commercial and legal issues.
Selling a business isn’t like selling a house, and the director’s objectives for the sale will have implications on the structure of the deal, the restrictions and liabilities for the final agreement. Personal objectives are vital and you need to decide your position in the company after the sale. While some may want to simply walk away with no further dealings, a business is an emotional entity, and most want to retain an interest in the company they built up.
PREPARING TO SELL
The first step is to get a true indication of your business’ market value. Many businesses in the games industry don’t actively seek out a sale, but have been approached by an interested party. In this instance, the valuation is vital. Financial advisors are able to help in this area, as well as assisting with identifying possible buyers and other details that require specific attention.
The valuation will cover such things as property, equipment, stock, debtors, creditors and goodwill. While it is good to be prepared for any question a potential buyer may have, make sure you do not reveal any confidential information until a non-disclosure agreement has been signed.
Be realistic in your expectations but equally realise value wherever possible by thinking about what a potential purchaser would be looking for. For example, a purchaser may be looking at your studio because of the expertise that you have in a particular genre. The purchaser may be looking to acquire that expertise to expand its product range or strengthen existing depth in that field. If the former, it would be looking for a target which had competitive advantage in the market. This was probably one of the key drivers for the acquisition of Creative Assembly by Sega, for instance, as it gave Sega a strong foothold in the PC strategy gaming genre.
Another reason for a publisher (particularly if it is a public company) to purchase a developer is to increase the publisher’s net income. Since a public company’s performance is measured by growth and profitability, if, by acquiring your company, it can increase net profits the publisher will be rewarded by their shareholders and the City. The higher the perceived value, the higher their share price.
This may have been an important consideration when Microsoft was looking to buy Rare, which had sales at the time averaging 1.4 million units per title and total units sold since the founding of the company reaching more than 90 million units. However, as we all know the real value that a publisher will be looking for is in the IP.
Before going to market, sellers should focus on the quality and level of legal protection of their IP assets, ideally well in advance of any transaction. This includes making sure that all relevant IP registrations are up-to-date and paid for and documentation evidencing ownership or licence to use third party intellectual property is available and in an accessible form. The risk for businesses without this evidence could result in potential buyers discounting the asking price sought.
FREEDOM TO OPERATE
IP due diligence is an essential part of determining the value of the business assets. This process includes a ‘freedom-to-operate’ analysis, where the potential buyer needs to determine whether it can make, use, or sell the selling business’ products without infringing the IP rights of any third party. This analysis requires an IP clearance search for a variety of things including unexpired patents and published applications. Also it is vital to check for pending or threatened litigation, especially where the target business has been accused of infringement.
RIGHT TO EXCLUDE
‘Right-to-exclude’ analysis is also carried out. It will be important for the buyer to know if there are rights to exclude others from competing with a particular product or technology. This analysis involves a review of the business’ IP portfolio, where a list of the company’s IP will be provided, along with a separate analysis by actually reviewing the IP files and by searching patent and trademark databases, possibly throughout the world.
Preparation is vital – and you need to be ready for any possible question that a buyer will ask. Preparation has its benefits, not least because it makes your business look professional and well organised. Being ready for questions quickly will save you time and minimise the time spent in the overall sales process, which needless to say, is a distraction from the normal running of the business. You need to think about all your IP arrangements, sometimes referred to as ‘Licences In’ (third party IP that you have licenced for use in your products and in your business) and ‘Licences Out’ (licenses that you have granted to third parties to use and exploit your products or technology).
SAHRS V. ASSETS
There are two ways for your business to be acquired - by selling the shareholders’ shares in your company or by selling the assets of the business, and there are distinct differences between the two:
l For a share sale, the selling company passes to the buyer all its assets and liabilities. However, for an asset sale, the buyer may try to pick out the assets it wants and leave other liabilities with the seller.
For an asset sale, the assets have to be actually transferred to the buyer and this may require the consent of third parties. For example, customer contracts may not be transferable without the consent of the customer, and the transfer of a leasehold property may require the consent of the landlord – the property lease must be checked at an early stage. Whether consent is ultimately granted by third parties may, in some part, depend on the financial strength of the buyer.
With regards to tax, for a share-based sale, the company’s tax liability is passed to the buyer, whereas on an asset-based sale, the tax liabilities of the selling business normally remain with the seller. If the company has tax losses, prospective buyers may want to purchase shares instead of the assets, thus setting off tax losses against the buying company’s profits.
A majority of sellers prefer to sell their shares, whereas buyers prefer to buy assets.
Thus there are fundamental differences, with compromises always needed. The ultimate decision will depend on the bargaining strengths and the nature of the involved business.
THE LEGAL PROCESS
Prior to the heads of agreement, there may be a need to make some provisions legally binding. The selling process involves the hand-over of many sensitive items of information, so make sure to keep this information confidential; confidentiality agreements need to be signed before proceeding with negotiations. A seller may also request that the buyer pays a deposit to cover costs if they pull out. Additionally, the buyer may want a period of exclusivity during which the seller must not negotiate with another party, and must pay the buyer’s costs if they do.
After a deal has been agreed in principle, lawyers move in to draw up a heads of agreement. This agreement will outline the main issues, the deal structure, price and times, while acting as a guideline for the entire transaction. Apart from the areas which deal with confidentiality and exclusivity, the heads of agreement will not normally be a legally binding document. However, the signing of the agreement will demonstrate both parties’ commitment to the process and evidence of preliminary agreement on the main deal terms and structure.
Once this heads of agreement has been finalised, the buyer will proceed to carry out an investigation of the business and the lawyers will prepare the sale agreement.
When the documents have been finalised – after many weeks of due diligence and negotiations, the completion of contracts takes place. Upon completion, the buyer will transfer the agreed price and the seller will transfer the agreed assets or shares.
The length of the process can vary considerably between transactions, but you should normally allow for at least six weeks from the signing of the heads of agreement until completion.
Communication is vital during this process, and you don’t want your staff finding out about your intentions to sell the business on the grapevine, as this will affect their morale and motivation. You need to agree a time and a process to tell staff and to clearly inform them what this means for them.
If you are selling assets, as opposed to shares, you have to formally consult with employees before completion, and you may not want to start this process until exchange of contracts to maintain confidentiality.
SHARE/BUSINESS PURCHASE AGREEMENT
The business purchase agreement is probably the most important document in the transaction. This document will set out the key commercial terms that have been agreed between the parties, including the conditions of the sale, the price and payment, completion accounts, apportionments, book debts, property rights, staff and restrictive covenants and warranties requested by the buyer.
There can be many sticking points in each of these areas. As an example, the buyer may want the final price to depend on the value of specific assets, such as IP, which fluctuate over time. These will be valued on completion using ‘completion accounts’, with the final agreed price being adjusted corresponding to the change in value which the parties have agreed prior to closure.
With a share sale, employees remain employed with the company after acquisition; with an asset-based transaction, the TUPE regulations require that employees’ contracts are transferred from the seller to the buyer on completion. Sellers can’t dismiss employees immediately before completion, and they must consult employees about the sale. Advice should be taken in this area at an early stage.
While there are numerous benefits of selling your business, a successful transaction relies on good legal and financial support and appropriate preparation. This will help ensure you get the maximum market value for your business and benefit in the long-term.