Sale of a tech company to a US listed buyer

Having just advised the four Founders (and investors) on the sale of a tech company to a US listed buyer, we thought it might be helpful to share some insight.

I led the deal assisted by my excellent senior associate Doris Chan; with additional support from Nigel May at Gravita ABG LLP on tax and employee options.

Andy Dupre and colleagues at McCarter & English LLP assisted on Delaware law.  Andy had the perfect credentials.  He is Delaware and English qualified and advises on Delaware litigation (ideal for ensuring that liability for potential claims under Delaware law was covered) and as well as corporate transactions.

Challenges

We encountered a few challenges:

1. The buyer wanted to buy the company under a Delaware law agreement despite the target being an English company (albeit with international operations through its subsidiaries).
2. The buyer needed to sign an SPA in a week (that was fun, it was 82 pages). They then conducted due diligence between signing and closing, with a right to walk away had they not been satisfied with the due diligence.
3. A Founder shareholders’ SPA was signed with all the mechanics for the working capital, an earn out and comprehensive business representations, warranties and indemnities. A pre-closing condition was to get the remaining shareholders to sign up.
4. The other shareholders comprised a mix of SEIS and EIS investors, option holders, holders of convertible loan notes and a venture capital fund. There were 39 shareholders in total and they were in multiple jurisdictions, esp. in Asia where the management team was based.
5. The shareholders had a shareholders agreement which provided that non-Founder shareholders would not give representations, warranties and indemnities on the business. The company also had venture capital type Articles of Association with three classes of shares and complex consent rights plus drag along provisions (which we managed to avoid using by getting all shareholders to sign up to the sale).
6. Before closing and after the due diligence, we had to get separate SPA’s for the remaining 35 shareholders with just title and capacity warranties which cross referred to the Founder SPA for the price adjustments.
7. We agreed with the buyer that they would get R&I insurance for the business representations, warranties and indemnities since the Founders could not take on the full coverage for potential liabilities. This was arranged between signing and closing on terms reasonably satisfactory to the shareholders at the buyer’s cost.
8. Signing of over 100 transaction and closing documents was effected electronically.
9. To manage the remittance of funds to the 39 shareholders, we used a trustee account with a payment services institution authorised and regulated by the Financial Conduct Authority.

Delaware Law SPA

It turns out that a share sale and purchase agreement under Delaware law is not so different to one under English law.  Concepts such as caps on claims, de minimis, baskets etc. are up for negotiation in the usual way.  That said, it needs careful consideration to ensure that the seller protections and R&I insurance operate effectively.  Similarly, whilst the concept of disclosure against the representations and warranties is similar, there is a bias in US SPA’s towards specific disclosure.  Instead of a stand alone disclosure letter, the disclosures are schedules in the SPA.  In this deal because due diligence and disclosure took place between signing and closing, the process of disclosure was separate although broadly followed the US concept of schedules.

IP and Data Protection

The target company had developed a proprietary software product using open source software.  Although it had trademarks and domain names, it did not otherwise have registered IP.  From a diligence perspective, we arranged a clean room environment for IP consultants appointed by the buyer to diligence the proprietary software with access to the source code being withheld until closing.  In common with many fast growth companies, registered trademarks and domain names were in the names of the founders rather than the target company.  That simply required transfer to the target company prior to closing.

The target company outsourced some software development to an associated company in the Indian sub-continent.  That required some contractual tidying up to ensure the target company group was protected to the level required by the buyer.

Venture Capital Relief

The target company had raised money from investors within three years of the sale which had an impact on the tax reliefs that SEIS and EIS investors would benefit from on the disposal of their shares to a new controller, the buyer.  Under the shareholders’ agreement, this meant that the sale needed investor majority consent.

Ultimately, the financial terms of the transaction were sufficiently attractive to get SEIS and EIS investors to consent notwithstanding the impact on the available reliefs.  However, this is a significant point for companies that raise money from EIS investors in later equity rounds rather than from non-EIS investors such as private equity.  If a company is looking to an exit, it is generally better to raise equity from investors who are not looking for venture capital relief within 3 years of the projected change of control.

Option schemes

The company had two option schemes: (1) an Enterprise Management Incentive (EMI) option scheme; and an unapproved option scheme.  The unapproved scheme was used for non-UK tax payers and persons who could not qualify for the EMI scheme.

An EMI option scheme has significant tax advantages for UK tax payer employees.  In particular: (1) HMRC will approve a valuation of the shares which can be used as the strike price to exercise the options; (2) unlike unapproved options, there is no income tax or National Insurance charge at exercise provided the option holder pays no less than the HMRC- approved market value at grant; and (3) when the shares are sold they are subject to capital gains tax, but may be eligible to claim business asset disposal relief which reduces the rate to just 10% by utilising the  period between grant and exercise of the option.

Vesting and exercise of options issued under both schemes had to be carefully managed so that the option holders became shareholders immediately prior to the sale.

Convertible loan notes

The company had raised capital by issuing convertible loan notes (CLN).  The CLN holders could either redeem on a change of control (which would require the company to repay the CLN) or convert at the valuation on a sale.  It was necessary to give the requisite notification to option holders and to ensure that the conversion took effect immediately prior to the sale.