The recent influx of instructions we have received on the sale or purchase of schools appears to reflect a strong period for M&A in the education sector as a whole. This includes not just schools but also nurseries, higher education establishments and education and training based businesses. The transactions we have advised on include sales to private equity buyers, who continue to see education as a strong investment in an uncertain market, but also private sales between schools, charitable and non-charitable. Such transactions can offer the opportunity to consolidate, expand or to raise funds for investment elsewhere.
So, if you think there might be an opportunity to acquire a local school, or to divest yourself of all or one part of your own school, what do you need to be considering in the earliest stages? Before getting too far in the process we would advise you to pin down the answer to two fundamental questions: what is being sold, and for what price? In both cases there may be more options available to you than you realise and this briefing will hopefully bring at least a few of them to your attention.
What is being sold?
Writing the name and address of the target school at the top of your heads of terms is a good start, but unfortunately is not enough – a school is not in itself an identifiable legal asset. You will need to define exactly what will transfer from seller to buyer and the first question to ask is whether the sale will be of the company out of which the school is operated or of the assets which make up the school.
Company sale – a clean break
As a broad rule, a company sale is preferable for a seller. This is because a company takes with it all of its historic liabilities. The parties can of course agree carve outs from this standard position in the sale agreement, for example through warranties and indemnities. However, as new owner of the company the buyer will be liable in the first instance (financially and practically) for any issues arising after completion.
This is in contrast to an asset sale where a seller will usually retain liabilities relating to the period prior to completion and the buyer will take on the risk from that point. In any kind of sale there can be no guarantee for a buyer that there are no historic or hidden issues which have not been revealed by due diligence. However, as set out above, in strict legal and financial terms in an asset sale the seller will retain liability for the period when it owned the school.
Asset sale - pick-n-mix
As well as the liability divide explained above, an asset sale allows both seller and buyer to choose which assets will be included within the transaction. It is a common assumption that everything will be sold – the property out of which the school is operated; all staff, parent and supplier contracts; all equipment, and so on. In reality, more often than not some assets will not transfer, particularly in a transaction between two schools. If a buyer already has suppliers it is happy with, why would they want to take assignment of the seller's contracts? Equally, a seller may need to retain assets for future use.
Guarantee companies - a complicating factor
For many schools, the legal operating vehicle of choice is a guarantee company (as opposed to a private company limited by shares). Sale of a guarantee company is not impossible but can be unwieldy. Shares are neat economic units designed for sale and transfer. A guarantee company has none and a sale would require identifying each member's economic interest in the company and replacement of all members at completion of the sale. In the case of a charitable guarantee company, whose members do not have an economic interest in the company, the proceeds of sale would have to be put to charitable use and Charity Commission approval to the overall arrangement would be required. This means a company sale is unlikely to be the right choice for a charitable school. (Similarly, it should be noted that where the target school is not operated through a company at all – a Royal Charter school, for example – then a company sale will not of course be possible and an asset sale will be the only realistic option.)
Where possible we would encourage both parties to consider whether a company sale might be best suited to their transaction (although, as noted, this may not be suitable for the sale of a charitable school). As well as the advantages for a seller, as set out above, a company sale offers a level of operational continuity for all involved. The assignment of contracts can usually be avoided, as can the TUPE process (as staff will continue to be employed by the same company). In addition, Department for Education consent may not be required as the legal proprietor of the school is often the operating company and will therefore stay the same.
What is the price?
The market value of a school will of course be a commercial and financial matter. It might be calculated by reference to the school's turnover or profit, or take into account the value of any property transferring. This isn't generally an area where lawyers get involved. However, once the value has been decided, there are legal discussions to be had about how payment will be structured. There does not have to be one full upfront payment on the date the sale completes. A price is not settled until the payment dates and structure are also agreed so it is important to pin down all the details at the heads of terms stage.
What is 'fair value'?
In the context of a school, price discussions will often be brought into focus by the presence of the governors (who in the case of a charitable school will also be acting as the board of trustees). The governors will quite rightly want to ensure that 'fair value' is paid or received for the target school. External professional valuations will be very important in this process. This is particularly the case for any property included within a sale but also applies to other high value assets transferring and, of course, to the value of the business as a going concern.
Professional valuations notwithstanding, a private sale cannot be entered into without a degree of risk and compromise on both sides. The agreed price will reflect market value but also the relative bargaining power of the parties. To a certain extent, therefore, governors will need to understand and accept the commercial reality of the situation. However, they cannot be expected to do so without clear demonstration that all options have been considered and the commercial and financial risks mitigated as far as possible.
You could agree that some of the price will be paid upfront and the remainder at a later date – in one delayed lump sum or in a series of deferred payments. There is no legal limit on what proportion of the payment is deferred or for how long. For a buyer, deferring payment can be particularly useful, allowing them to partially fund the acquisition using revenue from the target school.
Where it is agreed not to pay the whole purchase price upfront, there is always going to be a degree of risk for the seller. However, subject to tax advice, there are options available which offer protection and which will hopefully help reassure governors. These include:
- Securing the deferred payment as though it was a loan from the seller to the buyer – a mortgage over land owned by the buyer is probably the most secure option here though a charge can be given over any valuable asset (it is important to ensure the value of the charged assets at least equals, and ideally exceeds, the amount of the deferred payment); and/or
- A buyer guarantee in relation to the deferred payment – perhaps from a bank (although this may be expensive) or from a company or individual associated with the buyer; and/or
- Linking the deferred payment to inflation or RPI, or providing for interest to be paid on the deferred payment – to ensure that the real value of the deferred payment does not reduce over time; and/or
- An earn out linking the deferred payment to the performance of the school post-completion – this is more common if the seller is going to remain involved with the school after completion, as the earn out can be a form of incentive.
Buying or selling a school is a huge operational undertaking and it can be tempting to jump straight into due diligence and practical considerations. However, it is in neither party's interests to invest too much time and money in the process before the fundamentals are agreed. Nor is it conducive (including in conversations with governors) if key terms are left for consideration late in the day when one or both parties may be under pressure to 'get the deal done'. Hopefully this briefing has given you an idea of some of the options available to you so that clear agreement can be reached on the scope and value of the transaction before more detailed discussions begin.
If you require further information on anything covered in this briefing please contact Emily Jamieson or your usual contact at the firm on 020 3375 7000. Further information can be found on the Schools page of our website.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, October 2017