EveryMonth (December 2013): Exit planning – Step four: The Importance of an Exit Audit

This is the fourth newsletter in our series on planning for your exit.  In the first month we considered the importance of appointing a lead adviser.  In month two we discussed the importance of taking stock and determining your personal objectives.  Month three asked the question, do I need to have my company valued?

Now we turn to the importance of conducting an Exit Audit early in the planning process.   An effective Exit Audit will assess your company’s financial performance, look at its legal affairs and consider whether there are tax compliance issues.

If you know of someone who you think would benefit from this newsletter please do forward it to them.

James Hunt and the team at Everyman Legal

The value of the Exit Audit

As we have discussed, you have four basic options when planning to retire from your own business. Your ultimate goal may be a Trade Sale, an MBO, a family transfer or closure.  We will deal with each of these in turn in future newsletters but first we should deal with the importance of an Exit Audit.

You need, holistically and cost-effectively, to assess whether your company is ready for sale in terms of its commercial financial, legal and tax affairs.

Commercial Performance

A business that is overly dependent on you as owner will not be an easy business to sell.  Do you have a commercially robust business operating in markets where you can achieve the margins that you need for sustained profitable growth?  Do you have a well-balanced management team?  Do you have appropriate and robust systems and procedures in place for all key functions from product innovation and development to marketing and sales, delivery, supplier payments, billing, cash collections and remuneration?

Financial Performance

The starting point for a shrewd buyer who thinks you measure-up commercially, is likely to be a review of your company’s financial performance.  Depending on the size of your company (and whether you can file abbreviated accounts in the form of just a balance sheet) the prospective buyer will be able to do their own due diligence.

It will be a good idea for you, with the help of your lead adviser, to produce a five-year historic review of the financial performance of your company.  Plotting this in terms of a five-year chart will be the starting point and will lead to the question of what adjustments can and should be made to that five- year track record.

This exercise, and explaining the financial performance, is likely to help you focus on the challenges you might encounter as you grow your company to the point of exit.  To be able to present a chart showing rising profits over a period of at least three years will be a powerful means of giving a prospective buyer confidence about the future.  Profits that have been lumpy may lead to concerns that you are trying to sell after just one good year.  Perhaps you have been lucky enough to have one big job.

The review should therefore consider whether there were any exceptional items that materially affected financial performance.  What were these items and what steps have been taken to ensure that they are not repeated in the period leading up to your planned exit?

The Legal Affairs of your Company

The astute buyer will commission legal advisers to undertake a legal due diligence exercise on your company.  By anticipating that exercise you can make sure that the affairs of your company are in apple pie order well before the planned sale.

Putting the affairs of your company in good order should also help you to grow it with lower risk of legal threats.  Here are some examples of things that may be revealed by an Exit Audit and that may throw a significant spanner in the works on your exit planning if not identified and dealt with in a timely manner:

1. Discrepancies over share ownership.  You may have had a former employee or partner who owned shares. But were their shares properly acquired?  Your statutory registers need to be checked and key share purchase contracts examined.  You do not want to discover that someone you thought had sold their shares many years before is legally still a shareholder.

2. A legally flawed constitution where dividends are not being paid properly or are open to legal challenge.  Alphabet share schemes, which allow shareholders who are working directors to receive a greater proportion of dividends than other investors, are a frequent source of problems.

3. Key intellectual property used by your company but with no ownership or effective registration.  Is your trading name protected? Bespoke software may be critical to your company’s performance but is it owned by your company or by a developer?

4. Trading contracts where the liability of your company has not been limited or capped.  A legal claim (or threat of one) may scupper a prospective sale if the   buyer  perceives a material risk.

5. Premises that may be owned by you or your shareholders personally but are occupied by your company.  A formal arms’ length lease is likely to be advisable.

6. Supply contracts that place your company at significant legal risk.

7. Consultancy agreements that HMRC might characterise as employment contracts with a risk of a back‑duty enquiry.

8. Tax compliance: what risk is there of HMRC challenging your past practices?

9. Regulatory risks may be of concern: might a part of your business be liable for registration with an authority but this has not yet been done?

10. No effective drag along clause to allow you to compel minority shareholders to sell their shares when you decide to sell.

The list can be a long one.  The key is to approach the task holistically using an adviser who is familiar with your company and, and through considerable experiences of acting on company sales and purchases, we are aware of the issues that would be likely to concern a prudent buyer.

Hints and Tips

  • An Exit Audit will tell you if your company is ready for sale in terms of its commercial, legal and financial and tax affairs;
  • Prepare a five-year review of your financial performance to demonstrate the company’s future prospects and flag up possible weaknesses that need to be addressed;
  • Check that your legal affairs are in apple pie order well before the planned sale. This will reduce the risk of legal threats at a later stage;
  • Use an adviser who is familiar with your company and can take a holistic view of your operation with a practical focus on risk areas.