Options for Buying a UK Company with Multiple Selling Shareholders
In the United Kingdom, the issues and considerations involved in the acquisition of a private company with multiple selling shareholders can be complex. Some of the issues that arise in such acquisitions are similar to those that are considered with publicly traded companies, but would not typically be encountered in the acquisition of a private company with few shareholders.
This article briefly considers four possible ways of structuring an acquisition of the entire issued share capital of a company by a potential purchaser where there are multiple selling shareholders:
Obtaining signatures or powers of attorney from each selling shareholder
Using the drag-along provisions (if they exist) contained in the company’s articles of association or shareholders’ agreement
Carrying out a scheme of arrangement
Making a contractual offer to all of the shareholders
Determining which method is preferable will depend heavily on the facts of the individual transaction, and consideration should be given to a number of factors, including the number of shareholders of the target company, the ease of identification and communication with these shareholders, the timing requirements of the transaction and the importance to the buyer of obtaining full warranties from all selling shareholders.
The main focus of this article is how to ensure that all selling shareholders are bound by the deal in a practical, cost-effective way. This article also briefly touches on other relevant considerations, such as timing and buyer recourse. It does not cover situations where the UK Takeover Code applies to the target company or where the target company’s shares are listed, nor does it cover any listing or Takeover Code requirements applicable to a buyer.
Powers of Attorney
If the shareholders are a homogenous and cooperative group, each shareholder could simply sign the sale agreement (SPA). In practice this seldom happens, because it is often undesirable and unwieldy to negotiate the details of an SPA with a large number of shareholders, and because the buyer doesn’t want to wait until the SPA is almost fully negotiated and finalized only to find that one or two shareholders are unwilling to sign.
As an alternative, it is possible to obtain powers of attorney (PoAs) from each of the shareholders in favor of a third party (often the majority shareholder leading the sale process) once the main terms of the deal are commercially agreed upon, but prior to finalizing the SPA. Doing so allows the buyer and the parties driving the sale to enter into detailed negotiations of the SPA with the assurance that the shareholders will proceed with a sale of the target company.
PoAs are best entered into at a relatively early stage in the transaction. The drafting of the PoAs therefore should be specific enough to cover the contemplated transaction and ensure that the signature on the transaction documentation by the person acting under the PoA is valid, and at the same time broad enough to accommodate changes in the structure or deal terms during the course of the negotiations.
The use of PoAs is limited to the sale and purchase of a target company where the shareholder base is relatively confined, and those shareholders are readily identifiable and reachable at the outset. The shareholders also must be willing to cooperate for this method to be successful and to avoid having to rely on alternative methods (for example, drag-along rights) to complete the acquisition.
Where all shareholders sign the SPA themselves or by the person appointed under the PoA, the approach to warranties may be quite similar to that on a “normal” private M&A deal, with all shareholders giving fairly extensive warranties, but on the basis that each shareholder suffers proportionately if there is a breach. A buyer will not want to have to pursue a multitude of defendant shareholders in the event of a breach. An escrow for warranty claims or other deferred consideration mechanism can be useful in these circumstances.
One great advantage of all shareholders signing the SPA (either themselves or by a person appointed under a PoA) is that once all signatures are obtained, the buyer gains control of 100 percent of the target company, often on the same day.
Drag-along rights are often contained in a company’s articles of association or shareholders’ agreement and are common in companies with multiple shareholders. A drag-along right typically applies where a buyer makes an offer to buy a target company and a majority of the shareholders (the precise threshold varies) wish to accept the offer. In such scenarios, the majority shareholders would have the right to force the remaining shareholders to accept the offer and to transfer their shares to the buyer on the same terms.
Using the drag-along procedure can be the most straightforward and cost-effective way to acquire 100 percent of a target company from multiple shareholders. The buyer need only negotiate with the majority shareholder(s). Once the requisite majority has agreed upon the terms, the minority shareholders would be required to transfer their shares on the same terms without further negotiation or delay. This assumes that (i) one or a small number of shareholders own enough shares to reach the drag-along threshold, and (ii) the drag-along right is correctly drafted, which is not always the case.
Many drag-along clauses fail because the drafting does not properly cover a situation where a minority shareholder fails to execute a transfer, leaving the buyer at risk of ending up with less than 100 percent of the target company. Similarly, some drag-along clauses contain prescriptions on the type of consideration offered in order for the right to apply, meaning there is no drag-along right if the consideration offered by the buyer contains a non-cash element.
Relying on a drag-along procedure might delay the completion of the acquisition because, for example, certain time periods might need to elapse before the authority to sign on behalf of an unwilling shareholder comes into effect. As a practical matter, the use of drag-along rights might make it more difficult to obtain warranty protection than some of the other routes, and might also make escrow or deferred consideration arrangements more difficult. However, if properly drafted, the drag-along right has the great advantage of enabling the buyer to purchase the shares of dissenting shareholders (or shareholders who cannot be found).
Schemes of Arrangement
Schemes of arrangement are an increasingly popular means of acquiring a private company with multiple shareholders. A scheme of arrangement is a court-sanctioned process whereby a company makes a compromise or arrangement with its shareholders. A buyer typically negotiates with major shareholders and/or the board of the target company to agree upon the terms of the acquisition, then the target company proposes the scheme to its shareholders and recommends that they approve it. The terms of the acquisition are published to the shareholders in a scheme document that is lodged with and approved by the court. A general meeting of shareholders is held to approve the scheme, and a further court hearing is held to sanction the scheme. There are two principal types of schemes used for acquisitions:
A cancellation scheme, whereby the existing shares in the target company are cancelled and new shares are issued to the buyer
A transfer scheme, whereby a transfer of shares from the target company’s shareholders to the buyer takes place
Cancellation schemes are more common because currently no stamp duty is payable by the buyer—the shares are cancelled and reissued rather than transferred. However, the UK government has indicated that new regulations, planned for early 2015, will prevent the use of cancellation schemes for acquisitions, so this particular tax advantage will almost certainly no longer be available in the future.
A scheme’s principal advantages are (i) that it delivers certainty that a buyer will acquire 100 percent of the target company on completion, and (ii) that only 75 percent of the shareholders by value, as well as a simple majority by number of those represented and voting at the shareholders’ meeting, must approve a scheme in order for 100 percent of the shareholders to be bound by it. This test often makes a scheme easier to achieve than a statutory squeeze-out, where the threshold of acceptance is 90 percent. However, because of the test’s two-part nature, a number of small shareholders working together can derail the process by voting against the scheme at the shareholders’ meeting (even if more than 75 percent by value are in favor of it). Care must be taken at the outset to address this risk (for example, by use of irrevocable undertakings to vote in favor).
If the acquisition is structured as a share-for-share exchange, or if a portion of the consideration is composed of shares in the buyer, another major advantage of a scheme is that a prospectus is not required (broadly, a prospectus would otherwise be required if shares are offered to more than 150 people in the United Kingdom).
The principal disadvantage of a scheme is that it can be a lengthy (and costly) process. The shortest possible timeframe to complete a scheme is approximately eight weeks from the date the scheme document is sent to shareholders to the final court sanction. This does not include the time spent prior to this date on negotiating the deal terms and drafting the documents. The stamp duty saving available on a cancellation scheme has typically been thought to outweigh the timing and cost implications. However, since this saving will almost certainly soon no longer be available, the popularity of schemes will likely soon diminish.
Warranties as to the ownership and transfer of the shares will usually be given as part of the scheme documents. However, if extensive business warranties are required, these will generally be dealt with outside of the scheme by way of a separate warranty deed. Who gives the warranties, how the liability will be shared by the selling shareholders and what redress is available to the buyer will depend on the facts of the deal. In a cash deal, monetary damages could be sought, whereas in a share-for-share deal, a warranty claim could instead be addressed by way of adjustment of the parties’ relative shareholdings. Again, a buyer will not want to pursue multiple shareholders in the event of a warranty claim, so escrow or deferred consideration arrangements might also be appropriate in this context, particularly in a cash deal.
A buyer can choose to make an offer for the entire issued share capital of a target company where there are multiple shareholders and then rely on the statutory squeeze-out procedure to ensure that if a certain level of acceptance is received, the remaining shareholders are bound. There are strict rules that must be complied with in order to ensure that the offer qualifies. For example:
It must be made for the entire issued share capital (other than any shares which are already held by the buyer).
The terms must be the same for all shareholders (or the same for each class of share).
It must be communicated to all shareholders (or class of shareholders), subject to certain limited exceptions.
There are further legal complications where there are foreign shareholders, where there are a number of share options or where the offer is not for cash consideration. Discussion of these topics is outside the scope of this article.
The risk of the offer not being accepted by the requisite number of shareholders can be mitigated by having the shareholders enter into irrevocable undertakings, in advance of the offer being made, that create a binding agreement that they will accept the offer. In comparison with the PoA method, which requires the positive consent of the entire shareholder pool, a buyer only requires 90 percent of the shareholders (or where there are different classes of shares, 90 percent of the shareholders of each class of shares) to have irrevocably undertaken to accept the offer in order to be sure that it will acquire 100 percent of the target. Once the offer has been made and accepted by 90 percent of the shareholders (which could happen on the same day), a buyer will be in control of the target company and will also be able to exercise its statutory right to compulsorily acquire the shares of the remaining minority shareholders under the Companies Act 2006 (squeeze-out).
Relying on the offer and squeeze-out procedure provides a clear advantage where it is known that at least 90 percent of the shareholders will accept the offer. The advantage over schemes in particular is that, provided the required 90 percent majority is secured in advance, the deal can be closed much earlier to give a buyer control (but not 100 percent ownership) of the target company. Obtaining 100 percent ownership will take approximately six weeks more. However, the buyer can be confident that this will be achieved.
Notwithstanding the foregoing information, it is important that the offer is structured and executed correctly and that the squeeze-out is carried out in accordance with the Companies Act 2006 to prevent procedural challenges from disgruntled shareholders. Although this method can be more streamlined than a scheme where there is a large shareholder base, a buyer should consider the advantages against the different acceptance threshold needed on a scheme.
The issues (and solutions) relating to warranties under an offer are similar to those under a scheme.
None of the structures described above is necessarily preferable to the others. The best approach will be determined by the facts of the deal. In any event, early thought should be given to this issue and advice sought as appropriate.