In this segment of our blog series, we’ll look into the Legal stages of an IFA acquisition. This is a topic taken from our recent YouTube video “Legal processes for retiring IFAs” which is part of a wider collaborative series with prestigious UK law firm Herrington Carmichael.
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What are the legal stages in an IFA acquisition?
To cover this topic, who better than Alex Canham, Partner at Herrington Carmichael and specialist in Corporate and Commercial Law:
- Heads of terms
“So, following an offer being made, the parties normally proceed to heads of terms which is a really high-level document that sets out, effectively, the nuts and bolts of the offer. Including what they’re buying, what they’re paying for it, when they’re paying it and giving an outline of the various different structure and assurances that the buyer is going to want. So, within the contract – what are they expecting to get from you as the seller that might involve various warranties, indemnities, covenants and things like that in legal jargon. But it should just give an overview and a flavour as to what that transaction will actually look like. It’ll also commit the parties to a period of exclusivity so the buyer will normally then be given a period typically around three months to go and proceed with its due diligence and then progress on to completion of the transaction.”
- The diligence phase
Alex continued “Following heads of terms, the buyer will then normally move into its diligence phase, they will more often than not start with looking at the regulatory and financial aspects and essentially validating what you’ve told them already. Particularly around the finances, making sure that your recurring revenues and EBITDA and other metrics are as you’ve told. But also then looking at the regulatory side of things and not only validating what you’ve told them about the nature of your business and any central high-risk areas that you’ve advised on but also then going into looking at your processes, your systems, doing some file reviews and just getting a real feel for not only the letter of the compliance law around that, but also the spirit and the culture in which the businesses continue to operate. Because I think that ultimately for buyers tends to give them a very good feel of what is the culture, right? In terms of how they’ve addressed compliance and things, of course, the specifics are important. But if you’ve got a good culture around compliance and regulatory finding, that then generally speaking, that bodes well for the rest of the diligence due.”
“With heads of terms themselves, very little is formally binding I guess is the start point for the heads in terms document because it’s just that expression of intent actually really only the exclusivity period and potentially the confidentiality clause, so like a non-disclosure saying you won’t talk about the transaction with other parties, is actually binding on the parties. So you’re not really committing to sell or buy as the case may be. You’re not committing to ultimately what those numbers will be in stone because those are indications effectively these are the basis on which everybody’s expecting to conclude the transaction. And as the diligence phase progresses, the buyer will validate and make sure those numbers are still accurate & fair and of course, the longer transaction takes sometimes actually recurring revenues or profit can increase, for example. The seller could take on new funds under management as well. So, all too often we see as a transaction progresses, you know, the deal, the principles of it remain the same, but the actual number is increasing slightly because the market has risen over a period of three to six months whilst the transaction is being concluded. So, in terms of the actual binding terms, it’s really just granting that by the period of exclusivity.”
What about penalty clauses?
We here at IFA Acquisitions sometimes see in the heads of terms there will be a clause stating that if the vendor pulls out from the deal, then there’s going to be a penalty to cover some costs, for due diligence and solicitors. We asked Alex if he thinks that that’s a reasonable clause to have in there:
“I wouldn’t say it’s normal. We see some buyers use clauses like that and primarily it’s to make sure that the costs they’re incurring during the due diligence phase are recovered, if a seller terminates discussions at any stage. Buyers would have engaging lawyers, regulatory consultants and accountants to validate the target business. So, if a buyer has no intention of committing resource to it, obviously they’re concerned that from a seller’s perspective they won’t be proceeding properly. Conversely, though, the buyer wants to know the sellers are committed to the transaction. So, what they don’t want is instead of withdrawing at an early stage after they’ve incurred those costs and, and fees in terms of whether it’s reasonable I think it has to be used appropriately. I think it needs to reflect a shared risk approach because it can send the wrong message. It can suggest that actually, the sellers don’t have that discretion to proceed and if things come out in due diligence as well, which means the buyer has to adjust the terms, seller’s then feel like they’re trapped into a contract, which whilst they had the terms not strictly binding, they feel that there’s a penalty to effectively exit. I think there are questions around enforceability and whether buyers would actually enforce those provisions. I think it’s more often than not where I’ve seen them use that to focus the mind and whilst I’ve worked with a couple of sellers who have accepted those clauses on the face of it, actually, when things came down to it, the buyer agreed to part ways and they were never enforced. So, I think it’s about setting the tone rather than intending to actually recover it that would be my experience.”
Areas that slow IFA acquisitions down and how to overcome them
“So, the primary concern around delay, I would say, is probably an inability to put your hands on the right information. So, at the beginning of the process, sellers not being able to gather the due diligence information as its quite a labour-intensive process. I completely get that it’s easy for me to say ‘Just go and get this long list of information.’ But in reality, if you can do a bit of preparation before you start the private transaction process or even talk to your lawyer before the diligence questionnaire comes out, they will know more often than not what key questions are going to be asked about the shares; who owns them, staff, employees, property, key contracts, those sorts of things are going to be relevant regardless of who’s acquiring the business. So, if you can go away and collate that information at the outset, that always takes a little bit of time. I think the other one I would say as well is, around making sure that you’ve got the time and availability to do the transaction. We see a lot of advisors who start a transaction and then we will go on holiday for a month over the Christmas period for example, and I completely get it, but at the same time that can cause a little bit of delay because by the time you get back you then have client work and other things to do, so if you are going to go through a transaction process, I think just bearing in mind that it is going to take a lot of time, you know, it’s dependent on if you’re the sole advisor or shareholder.”
It is important to add that we accept that everybody has still got their day job to do but it is inevitable that you will. This does need to be done and in order to actually pursue the process that it just needs to happen.
In this blog, we covered the main two legal stages of an IFA acquisition; heads of terms and the diligence phase, penalty and what legal areas slow IFA acquisitions down and how to overcome them.
Contact us to discuss this further:
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Herrington Carmichael disclaimer
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.
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