Tag Archives: business sale

How to make due diligence a walk in the park

due-diligence-walk-park Due diligence for an SME could be a “Minefield” or a “Walk in the Park”. Which, is down to the preparation of your management team and the keeping of good and up-to-date records.

SMEs, will usually only experience being the subject of such detailed investigation into the affairs of their company when it is either seeking funding or the sale of its business. The level of such due diligence will also differ depending on whether it is one or the other.

What is due diligence?

Due diligence is the act of scrutinising all aspects of a target business ("Target") by a potential investor or buyer (“Dealer”) carried out to reduce risk and help them make a more informed decision in respect of that deal. Areas covered will not just be business records, but the Target’s market, management, prospects and competitive advantage. In certain circumstances, their Target should also check into the Dealers credentials to see what, in addition to cash, they could bring to the table, and if they will be compatible to the intentions of the business and their existing stakeholders

Any investigation prior to an exit by a potential buyer will normally be far more extensive than may be expected by an investor, and the quantum carried out by investors will vary relative to the type of investor and the sums being invested. Small subscriptions by a Business Angel may only attract a cursory review, whereas that carried out by a Fund Manager or Institutional Investor will be more thorough.

It's never too early

Whichever it may be, you can never start too soon preparing for such a review, and the earlier in the life of your business you commence collecting together copies of the relevant documentation the easier it will be. Having such information ready, available and easily accessible will not only impress the potential Dealer but make it easier for them to say yes, both to proceed with the deal and to the valuation. Some Dealers expect to find issues whilst carrying out DD, allowing them to seek a discount on a previously agreed value. Make it hard for them to do this.

Start from day one preparing files, either paper copies of the potentially required data or a scanned electronic version of the same papers. Making paper or scanned copies of current documentation as they arise is always much easier than hunting for such records many months later. Do however remember to update, replace or remove such documentation as they are renewed or overtaken by events. Too many times I have seen management put under pressure, and waste valuable time, trawling through filing cabinets, desk draws and their file explorer trying to pull together relevant contracts, leases, correspondence, or other required information before the due diligence team arrive to review it.

There's no hiding!

One final tip, management should consider is never hide skeletons in a cupboard from the due diligence team. Always be up-front about negative issues, highlighting what steps are being/can be taken to mitigate the problem. By doing so, it will be taken into consideration by the Dealer when agreeing on a price and thus cannot be used at later date to chip away at the valuation.

What areas could come under investigation?

In addition to accounting and statutory reports and records, reviewers will want to consider details on:

  • management and your employees
  • asset ownership
  • legal contracts
  • insurance
  • any litigation issues
  • your market and competitive advantage.

Although this may seem comprehensive, it is not necessarily an exhaustive list of the potential areas that you could expect to be the subject of the deepest level of scrutiny. So think about what you would want to know about a competitor if you were going to acquire them and apply that logic to yourself, indeed sometimes interviews of key customers and/or suppliers may be requested.

Such a list may seem daunting, but if you create documents as they arise it will make your due diligence process much easier and quicker to prepare for.

Make it easy for them to say "yes"

Remember, Dealers look for an excuse to say 'no', so if they are “impressed” it is much easier for them to say “yes”. As your Finance Director, your FinanceHead can prepare your documents and support you and your management through the due diligence process. Contact Michael to find the right FinanceHead for your business.

Stephen Foale
FinanceHeads Director and Original Member

Project Exit: Planning your business exit strategy

Business Exit StrategyThe best time to start planning your business exit is the day you start your company.  If that is not possible then a planning horizon of at least 1-5 years but the longer the better.

This will give you the time to groom your business to show its best face, maximise buyer interest and take advantage of valuable tax planning opportunities.  In addition, a clear exit plan gives you a framework to guide decision-making and helps develop a coherent strategy for building your business.

Some entrepreneurs want to sell their business during their lifetime, taking advantage of the generous tax rate of 10% under Entrepreneurs Relief.  This may leave them cash rich, but Inheritance Tax (IHT) planning is advisable together with considering the funding of long-term care when elderly.  For those that want to retain a business to pass to the next generation, planning for IHT and checking the availability of Business Property Relief would be wise.

However, where the plan is to pass the business down to the next generation, there will be a need to consider IHT.

Inheritance Tax is a tax at 40% on estates above the nil rate band of £325,000 on death.  Your estate for IHT purposes will include a valuation of your company shares/business interests on death for tax purposes, together with certain gifts made within 7 years of death.

However, for entrepreneurs, there is a valuable Business Property Relief (BPR) of 100% or 50% against the valuation of relevant business property, which reduces the chargeable estate.

Business property qualifying for the 100% relief rate includes:

  • A trading business, i.e. a sole trader or a partnership
  • Shares in an unquoted trading company, including shares listed on AIM

This relief covers family companies.  There are various conditions which pose traps for the unwary, including;

  • It must be a trading business or company rather than one whose business is the holding of investments or dealing in securities
  • The business or shares must have been owned for two years before death
  • A business with excessive cash balances or other assets not fully deployed or necessary in the business, will also not qualify

Business property qualifying for the 50% relief rate includes:

  • Shares or securities giving more than 50% of the voting rights of a quoted company
  • Land, buildings, plant and machinery which was used for the purposes of a business carried on by a company of which the deceased then had control or by a partnership of which they were a partner
  • Land, buildings, plant and machinery which, was used for the purposes of a business carried on by the transferor and was settled property in which he had a beneficial interest

Key takeaway: don't assume that your business will qualify for BPR.

Seven Common BPR Pitfalls

Many entrepreneurs are aware of BPR, but are ignorant of the many pitfalls, meaning their IHT bill may be significantly higher than they have planned for when it comes to their business exit. The seven most common BPR pitfalls are set out below.

1. Is it a qualifying “business”?

A business or company will not qualify automatically if it includes elements of:

  • Dealing in stocks and shares, or
  • Dealing in land or buildings, or
  • Making and holding investments

The legislation does not directly refer to the situation where some of these activities may be present in an otherwise qualifying business or company.  The legislation refers to “wholly or mainly”, which is usually understood to be more than half.  In practice, HMRC’s interpretation will turn on the facts and the writer has seen them argue that more than 20% is the tipping point, so expert advice is essential.

For example, a business investing or dealing in property would not qualify for BPR, but confusingly, a property development business would. The difference being the act of development, rather than just buying and selling.

This lack of clarity presents a planning opportunity.  For instance, if a trading company owns an investment property, then in some circumstances 100% BPR will be available on the whole value of the shares in the company.  However, if the investment property is owned outside the company, no BPR would be available.

2. Are there any “Excepted Assets?”

BPR is not available on the value of certain assets owned by a business but not essential to the business.

Excepted assets often include:

  • Property partially used by the business and partially let to other occupiers
  • Assets used mainly for the benefit of the business owner or his family such as a holiday home
  • Cash balances surplus to those needed for trading. However, if the excess is say, part of a sinking fund for future investment or replacement, or can otherwise be shown, as needed for some future business use then BPR will be available.  Expert advice is essential.

3. Directors loan accounts

Directors’ loan account credit balances, also can be a trap for the unwary.  Typically, when the company has borrowed money from a director shareholder, or where a business and its goodwill is transferred to the owner’s company, creating a large credit balance in favour of the owner.

This is often to allow the extraction of cash from the company without suffering income tax.  The problem here is that the director shareholder’s estate includes this balance as an asset.  However, it is not one that normally qualifies for BPR.  Where the balance has little likelihood of repayment, it might be worth considering converting the loan to shares, which would qualify for BPR.

4. Resolutions to wind up a company

A resolution to wind up the company, before death will prevent BPR applying, unless they are part of an insolvency procedure to allow the business of the company to carry on post restructuring.

5. Binding contracts for sale

Property that would otherwise qualify for BPR does not qualify if it is subject to an unconditional contract for sale at the time of the owner's death.

6. Shareholder agreements

Shareholder’s agreements or partnership agreements often provide for surviving shareholders or partners to take over the deceased’s interest in the business.  These “double-option” or “cross-option” type arrangements need checking.  Properly drafted, they should form a “binding contract” for the deceased’s share to be sold to the survivors, which allows BPR to apply.  However, the writer has seen some poorly drafted ones where BPR would be lost.  Your lawyer can give advice on this.

7.  Property owned outside the business

It is common in family companies to find key business assets owned outside the business.  Often the shareholder personally owns the business premises or the intellectual property rights and receives a rent for their use.

There are good risk avoidance and tax planning reasons for this type of structure, but the applicability of BPR is often forgotten.  Because the assets are owned outside the business the BPR rate is 50% rather than 100%.  However, that only applies if the owner of the property had a controlling interest in the business or company.  If there is only a 50% partnership share or shareholding, this does not give control and no BPR is available on those outside assets.

Top tip: make sure there is a casting vote in the partnership agreement or in the company’s articles for shareholders, as case law has confirmed that this does confer a controlling interest and will preserve the BPR!

BPR is an extremely valuable tax relief for family businesses, but don’t just assume it applies, get advice from an experienced FinanceHead. For guidance in selecting the right FinanceHead for such a job please contact Michael Cartwright.

Paul Teasdale
FinanceHeads Member


N.B. These are general guidelines, always take advice from an expert before proceeding.