FCA and PRA regulated entities in a variety of sectors use consolidation to drive growth, promote innovation or take advantage of cost synergies. Scale and diversification are key drivers in the wealth management sector, and acquisitions can be very helpful in expanding access to specific asset classes, geographical locations, clients, and the expertise of key managers.
In this series of articles, we look at a variety of aspects of M&A transactions that can affect value for buyers and sellers, and suggest ways to address these in the commercial terms to enhance value. Our first article looked at ways to structure a transaction around value.
In this second article in our series, we look at some of the other key issues to consider when structuring an M&A transaction.
Share sale or asset sale?
A key question for both sellers and buyers will be whether to structure a transaction as a share sale, where the seller disposes of its equity (for instance, shares or partnership interests) in an entity, or as an asset sale, where the individual assets and liabilities of the business are transferred separately.
A variety of considerations feed into this decision. In some circumstances, the choice may be curtailed in practice, for example where the seller is divesting one part of a larger business and an asset sale is therefore the natural structure. Even here, however, there are options if the structure is important, such as a pre-sale restructuring to hive-down the relevant business and assets into a new company which is then sold.
The choice of a share / asset sale will have ramifications for tax treatment and will depend on the need to transfer clients and customers, the ability to leave behind surplus assets and unwanted liabilities, and the regulatory consents and notifications required (and associated timelines).
In this article, we identify some of the key factors that will influence this decision, and touch on some of the advantages and disadvantages of both structures. The process can affect value for buyers or sellers, so we advocate considering the implications of the relevant process at an early stage and factoring any relevant issues into the commercial terms agreed at the start.
Transfer of assets
Share sales are normally considered to be simpler transactions than asset sales. As the whole corporate entity is transferred, whether that is a company or partnership, there is no need to identify specific assets and deal with transfer requirements for each asset individually.
By contrast, in an asset sale each specified transferring asset must be transferred individually. The ease with which this can be done depends on the individual asset. A key focus, and often one of the more important, is likely to be client relationships embodied in the terms of business / client agreement between the target and its clients. Another key issue is the presence and drafting of the transfer provision, and whether a transfer of the rights and obligations of the client agreement is included and on what terms. Where the buyer holds client money or assets, again, the position needs to be assessed carefully to ensure any transfer mechanism is consistent with the FCA’s rules. It is also critical that the buyer has a valid client agreement in place with the transferred clients.
Communications with impacted clients need to be handled sensitively, to maximise client retention on transfer. Typically, the parties will agree a client communication and (if applicable) a consent plan, which will involve close collaboration between the buyer and the seller, usually between exchange and completion, and often beyond. The approach and cooperation of the seller’s front office can make a significant impact on the success rate and should be considered in the wider approach to employees at the seller (more on this in our forthcoming briefing, Employment and incentivisation). The price paid for the transfer may also be impacted, and it is common to see value structures where completion is conditional on a certain percentage of clients transferring, with further deferred consideration achievable on future milestones.
While this client transfer process is less complex in a share sale, it is still important to communicate to clients that the service they receive will not be detrimentally affected by the transaction, and to ensure that the transaction does not cause clients to terminate their contracts with the seller before, or with the buyer after, the transaction. Voluntary notifications should be made to clients, and clients may also need to be made aware of changes to custody arrangements. A share sale will also typically avoid the buyer having to obtain new consents from clients to receive electronic marketing, which can be important if the buyer wants to use the client database to market and sell a wider range of its own products and services. There may however be practical issues following completion, such as the need to move the target’s clients over to the buyer’s standard terms of business. While this may not directly affect the transaction, it may mean a fairly involved post-transaction integration process.
At all stages, clients (including non-responding clients) must be treated fairly and, where retail clients are involved, consistent with the Consumer Duty requirements. It is important that a communications plan is carefully planned and carried out to meet these requirements.
Apportionment of liabilities
While asset sales are more complex in terms of asset transfers, the associated benefit is that asset sales give the buyer and seller considerable flexibility to transfer only the desired assets and, significantly, to leave behind liabilities (latent or otherwise). This is particularly beneficial where liabilities may be significant and difficult to quantify.
A classic example is a defined benefit pension liability. Buyers are typically very wary of taking on such liabilities, and it is often not possible to factor them into the price, as the potential exposure is uncertain. Asset sales allow such liabilities to be left behind, with consideration based on the acquisition of assets without any accompanying liabilities.
Such liabilities are therefore left in the selling entity post-completion, and the approach to them will depend on whether the selling entity contains assets outside of the transaction scope (such that it will continue to trade post-completion), or whether the selling entity will be wound up following completion. Run-off insurance can be considered if the selling entity is to cease trading following the transaction.
Transfer of employees
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) may apply, depending on the nature of the transaction. Where the purchase is structured as a share sale, TUPE will not apply, as there will be no change in the identity of the employing entity. Instead, the same entity (albeit owned by different shareholders) will continue to employ the employees post-sale.
Where the transaction is an asset sale and TUPE does apply, employees assigned to the relevant undertaking being sold will transfer with that undertaking under the “automatic transfer principle” on their existing terms of employment and with their continuity of service intact. Additionally, any purported variation to a transferring employee’s contractual terms is void if the sole or principal reason for the variation is the transfer (subject to certain limited exceptions). As a result, moving transferring employees onto equivalent terms as the buyer’s existing employees (often referred to as “harmonisation”) is unlawful.
In practice, if the changes are beneficial to the transferring employees, they are less likely to object, particularly if there is a meaningful consultation process. However, in some cases, the buyer may wish to introduce detrimental changes, such as more onerous restrictive covenants for key senior employees. One option in such cases is to enter into settlement agreements with the relevant individuals, under which their employment is terminated, and they are re-engaged under the new (more onerous) terms. As part of any arrangement, there will obviously also need to be some incentive for the relevant employee, whether in the form of a one-off benefit or advantages to some of their other terms of employment.
Where the settlement agreement route is being considered, the parties to the transaction will need to agree who is responsible for any payments to the employees as consideration for agreeing to those new terms. Payments falling due to employees after the transfer will be the responsibility of the buyer under TUPE (assuming TUPE applies). If that does not reflect the commercial agreement, it will need to be accounted for in the sale documents. For these reasons, we suggest that the wider process is thought through at a very early stage and the commercial agreement in the heads of terms should reflect the allocation of cost and liability between buyer and seller.
TUPE also provides for enhanced protection against dismissal, where an employee has two or more years’ service and any dismissal is again by reason of the transfer. Compensation for any such claims consists of, in broad terms, a basic award of £571 or £856.50 per year of service (depending on the employee’s age in each year of service) and a compensatory award of up to the lower of 52 weeks’ salary and £93,878.
Tax is a key driver when structuring a deal. The route which secures the best tax treatment for the party in the strongest bargaining position will often prevail.
The tax advantages of a share sale are usually more significant for the seller for the following reasons:
- A share sale is likely to allow the seller to claim either Substantial Shareholding Exemption (SSE) or Business Assets Disposal Relief (BADR) which would reduce tax payable on the sale of the shares. SSE can give total tax exemption on a capital gain made by a corporate seller. BADR can entitle an individual seller who works in the business to pay tax at a discounted rate on the first £1m of gain, with a similar relief (Investors Relief) potentially available to certain non-employees.
- Even where these reliefs do not apply, a share sale can enable the seller to defer the payment of tax on chargeable gains where the purchase price takes the form of shares or loan notes in the buyer company. This deferral is not available on an asset sale, although a similar result can be achieved on an asset sale if the proceeds of sale are reinvested in certain qualifying replacement assets.
- From the buyer’s perspective, a share sale means accepting responsibility for any unpaid tax liabilities of the company (although contractually this would be treated as a seller liability under the tax covenant in the sale agreement) whereas an asset sale offers the buyer a clean break, with the tax liability structurally left as an obligation of the seller.
- An asset sale involves a potential double tax charge for the seller. This is because the selling company could suffer corporation tax on chargeable gains on the sale of the assets and the individual shareholders would then suffer income tax when dividends representing the sale profits are paid out. This is not an issue where the target company is owned by another UK company, as most dividends are exempt from corporation tax, but may be more of an issue in an owner managed business.
Conversely, an asset purchase tends to be more tax efficient for the buyer for the reasons below:
- The buyer can usually claim amortisation relief on the price paid for intangible fixed assets (excluding goodwill and customer-related intangible assets) whereas for a seller who has claimed capital allowances, the sale of assets can trigger a balancing charge and the disposal of intangible assets can give rise to a charge to tax on income.
- An asset sale may be subject to VAT if it does not meet the “transfer of a going concern” requirements. This might be the case if the buyer will not continue to carry on the same kind of business as the seller or if the buyer “cherry picks” assets. A VAT charge would only be an absolute tax cost to the buyer if it cannot recover all of its input VAT.
Finally, individual factors can push the pendulum either way. For example, it may be tax efficient for the buyer to purchase a company where the buyer or the company has trading or capital losses which can be carried forward or surrendered. This can also benefit a seller as they may look to be paid for those losses. Likewise, where valuable real estate assets are included in the sale, the buyer may save tax by purchasing the company, since a share purchase attracts stamp duty at the rate of 0.5 per cent, which compares favourably with the higher rates of stamp duty land tax payable on property purchases.
Where the sale is structured as a share sale, it will be necessary to obtain change in control approval from the FCA, and in a small number of cases the PRA, depending on how the target business is regulated. The impact of UK financial services regulation will be the subject of a future article in this series, but by way of brief summary, any person intending to acquire “control” of a UK regulated target must apply to the relevant regulator(s) for approval. Broadly speaking for private banks and the majority of wealth managers, a person acquires “control” where they come to control, directly or indirectly, 10 per cent or more of the shares or voting power in the target. Therefore, companies in the buyer’s group all the way up the chain of control are potentially caught.
Regulatory change in control approval is a task that should not be underestimated in terms of management time and cost. It also has a potentially significant impact on the timetable of the transaction, as the regulators have 60 days from the receipt of a completed application to consider approvals and have considerable flexibility to “stop the clock” to seek further information.
By contrast, an asset sale will not require a change in control application as control of the regulated entity does not change. This is often seen as an advantage and reason to structure the transaction as an asset sale, but should be assessed taking into account the mechanism to transfer clients to the buyer, including whether individual client consent is needed, which can involve significant time and resource cost.
If you require further information about anything covered in this article, please contact Anthony Turner, Andy Peterkin, Charlie Court, Edward Twigger or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law as at the date of publication. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2023