25 October 2023

Sign on the line: why good contracts are crucial to boosting your sale value

At a glance

  • Contracts are important for any business to protect their interests. And agreements that secure relationships and assets can boost your firm’s sale value.
  • Buyers may be particularly interested in agreements that protect your business’s assets, including intellectual property. Shareholder agreements are also an important consideration, as shareholders could block a sale.
  • It’s not too late to retrospectively put in place key third-party contracts with customers or suppliers that agree terms and limit your business’s liability.

By the time it comes to exiting your business, many SMEs will likely have written agreements with employees, suppliers, customers and shareholders. Unfortunately, many firms end up with a confusion of contracts, some drafted with legal input but others cribbed or badly written.

The result is that many agreements are not tailored to the business’s needs, creating problems that put off buyers or enable them to negotiate the price down. In contrast, well-drafted contracts that secure business relationships and revenue streams – for example, assuring minimum-purchase commitments from customers – can boost your sale value considerably.

Purchase agreements

As your exit approaches, you will need another well-drafted document: the purchase agreement. This outlines the terms and conditions of the sale, defining the rights and responsibilities of the buyer and the seller. It should at least define:

•    What you are selling, for how much and payment terms
•    Conditions, warranties, indemnities and covenants
•    Post-completion obligations
•    How to resolve disputes

A purchase agreement also often requires a confidentiality clause or non-disclosure agreement to protect sensitive business information by obliging parties to keep it confidential.

Sarah Naylor, Head of Commercial at law firm Switalskis, says tailored purchase agreements are usually essential to address the specific nuances and risks associated with each deal, providing clarity and protection for all parties and reducing potential conflicts.

For example, selling a family business to new owners requires tailored agreements, including a buy-sell agreement, and shareholder agreements to address issues such as ownership transfer, valuation and decision-making authority. Or, if you are transitioning into a partnership or joint venture, a tailored agreement is necessary to specify each party’s contributions, responsibilities and profit share, plus dispute-resolution mechanisms and exit strategies.

Contracts to protect corporate assets

Carla Murray, Head of Commercial at Myerson Solicitors, says a buyer will want to understand which critical assets your business owns or is entitled to use, including intangible assets such as intellectual property.

For example, if you use content or software commissioned from third parties, the buyer will want to see a contract assigning ownership of the IP in that content or software to your business. If you don’t have this, you must remedy the situation before you can sell. “Putting such a contract in place ‘after the event’, in preparation for a transaction, is possible,” says Carla. “But it can be time-consuming and weaken your negotiating position.”

Employment contracts

Well-drafted employment contracts are essential for retaining key talent during a sale. They provide stability, clarity and motivation, which can encourage key employees to stay through times of change.

Your buyers will want to see that key employees’ contracts also contain restrictive covenants and non-compete clauses to protect your business’s value by stopping individuals damaging the business if they leave. These clauses protect trade secrets; prevent competition and poaching of customers or staff; and give legal recourse for a breach.

Patrick Byrne, Senior Associate in Employment at Myerson Solicitors, says: “While obligations are implied into every employment contract, they are limited in scope and protection, and most will not apply once employment ends. So tailored, well-drafted restrictive covenants are vital to protect your commercial interests. They may also deter an employee from leaving, or a competitor from becoming involved with them lest they expose themselves to claims of inducing the individual to breach contract.”

Shareholder agreements

The contracts in place with any shareholders your company has are crucial when it comes to your exit, as they could potentially prevent the sale from going through.

James Johnson, James Johnson, Corporate and Commercial Law Partner at Wilsons Solicitors, says: “We often see no shareholder agreements or poorly prepared shareholder documents, which can often hinder the sale process if shareholder rights have not been properly set down. “Any shareholder agreement needs to be reviewed carefully, as it may allow investors to block important decisions, including a sale. A well-drafted shareholder agreement or articles of association will also often contain so-called ‘drag along’ rights, whereby a majority of shareholders can require the minority to accept an offer from a buyer. This is useful, as most buyers want 100% of the company. But the provisions need to be carefully studied and followed.” A shareholder agreement and articles of association can also ensure employees who hold shares in your business and who leave before a sale return those shares to the company. That enables the remaining shareholders to sell the firm without having to discuss it with former staff members, and retains equity for those working in the business..

Third-party contracts

If you have clear contracts with third parties, such as customers and suppliers, your SME will be much more desirable to buyers.

Sarah says: “It’s never too late to formalise implied contractual arrangements with clients or suppliers. Let your partners know your intention to formalise your relationship, explain the benefits and reassure them of your commitment to working together.”

Define your terms, including pricing, payment terms, deliverables, quality standards and time frames, plus anything necessary to protect your interests, such as exclusivity, confidentiality, IP rights and termination or renewal terms. Mitigate your liability for what you supply to customers, especially if you sell something inherently risky. Define all this in a legally binding document.

Change of control provisions

A buyer will want to know how easily your customers can exit contracted arrangements or renege on a deal.

Andrew Solomon, Legal Director in the Corporate and Commercial team at Kingsley Napley, says that ‘change of control’ provisions in customer contracts can be disruptive, as they entitle a customer to terminate the contract immediately following a change.

“An SME owner working towards exit should ensure their terms of business exclude these provisions and resist their inclusion in customer contracts,” he says. “Where such provisions are present, seek customers’ consent to the sale as a priority. This should alleviate buyer concerns and prevent them trying to reduce the purchase price or walking away.”

How we can help

We can assist you in planning your exit and managing your personal and business finances tax efficiently speak to us today.

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SJP Approved 19/10/2023

By Matthew Forbes