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Individuals planning to buy a Business have two options:

• Buy the Business’ assets only and not the Business itself; or
• Purchase shares of the target company thereby purchasing the business itself with all its assets, and liabilities.

ASSETS VS SHARES

Pros of buying the assets of a Business:

• The Buyer will get specific assets at the conclusion of the transaction (instead of getting a company that may have unknown or undisclosed liabilities).
• The Buyer gets more flexibility and control over what they are buying; for instance, you can decide that only certain employees or Business assets will be transferred to you.

Cons of buying the assets:

• Certain one-time transaction costs connected to the purchase might be more expensive.
• Purchasing assets only, means you will be contracting with the company that owns the Business, whereas buying the shares means you will be contracting with the shareholders of the company, which requires a high level of trust on information given by the Seller.
• There is also the risk that if the Business becomes insolvent, the Seller, as a private company, may have no other assets (which act had not been disclosed).

Two ways to deal with this risk:

• insist on indemnification from the individuals owning the company; and
• conduct a Due Diligence (legal, financial and tax) exercise on the company.

Asset Purchase Avoids Debts

If you buy another company’s assets, you must:

• properly value the assets being purchased, especially assets like land and customer goodwill.
• transfer the titles to assets such as bank accounts, real estate, intellectual property and vehicles, into your company’s name.
• ensure that any charges and debentures registered against the company’s land and assets are discharged by the Seller and that you are given a clean title.

Note that as a buyer you generally don’t take up any of the debts of the company whose assets you are purchasing especially if you followed the provisions of Transfer of Business Act.

Share Purchase Includes Debts

• If you own a company that purchases the shares (at least 51% of the shares) of a target company, the target company will become your company’s subsidiary.
• You can then use your shareholder voting power to name directors and officers, giving you effective control of the company’s operations.
• The acquired company will still hold all of its assets in its own name.
• A target company may be more willing to authorize a share purchase than an asset purchase. * This is because the:
• • Company will be taxed on the gains realised from the sale of assets at the rate of 5% (Capital Gains Tax) (Note: gains realized on the sale of assets e.g. machinery which are qualified for the wear and tear deduction, will be exempt from capital gains tax); and
  • Buyer will pay Stamp Duty at 1% on the value of the assets.

• The sales proceeds will not be taxed until the point they are distributed to the shareholders when they will be deemed income made or derived in Kenya and thus attract Income Tax.
• On the other hand, the sale of shares of a private company attracts only stamp duty at 1% (a lower tax rate) paid by the Buyer not the Seller.

THE STEPS OF PURCHASING A BUSINESS

The stages one goes through in purchasing or selling of a

Business includes the following:

1. Pre-negotiation stage;
2. Negotiation stage;
3. Drafting (formal agreement) stage;
4. Pre-closing review stage; and
5. Closing stage.

1. Pre-Negotiation Matters

Some of the issues the Buyer must determine before they commence negotiations with the Seller include:

• The Seller’s minimum price, and the Buyer’s maximum price;
• How the value and/or the Purchase Price of the Business was arrived; and
• The Business’ financials, i.e. the balance sheets, cash flow position, income and expense statements, and profit and loss statements.

2. Initial Negotiations

In the initial phase, the Buyer and the Seller need to discuss and decide on the following:

• Documents such as income tax returns for the immediate past five years, tax compliance certificate, real property and equipment leases and title deeds, and employment contracts for key employees.
• Whether shareholders’ and/or board of directors’ approval is required, such as in most asset sales and mergers, and the latest date on which approval must be had.
• If any government approval is required, such as, Competition Authority of Kenya’s approval to the acquisition or merger – which party is responsible for obtaining the approval.
• If any employees of the company will be retained by the Buyer. In such a case, the Buyer will have to draft fresh employment contracts. If not, the seller might have to pay them severance pay or gratuity.
• If any contracts require third-party approval before the Buyer can take over them, like leases or loan agreements, the time within which approval must be obtained.
• Whether the Business is adequately insured.
• What are the terms of the contracts which Seller is a party to e.g. commercial leases, supplier contracts?

Head of Terms or Letter of Intent:

A Head of Terms (Term Sheet/Letter of Intent) is usually drafted by the Parties at this point. This short document states the main terms the Parties have agreed and shows that the parties are serious about the deal. It helps make sure that you don’t waste time and money performing due diligence and negotiating a formal agreement. It is mostly legally non-binding but evidences serious intent.

However, parts of the letter can be made legally binding and enforceable e.g. confidentiality and exclusivity, and it’s a good idea to do so.

Typically, the letter should contain:

• The main terms of the sale agreed in principle.
• The timelines and obligations of the Parties during negotiations.
• A binding promise by the purchaser not to disclose trade secrets, and other sensitive company information, called a Confidentiality Agreement (Non-Disclosure Agreement).
• A binding promise by the seller not to negotiate a sale with any other purchaser for a certain period of time.

Due Diligence

Due diligence is also done at this stage. Conducting Due Diligence helps a Buyer ensure that the company is everything it says it is.

Areas to consider include:

(a) Business Finances and Tax Position – engage an accountant and/or tax expert to review the Business:

• Audited financial statements;
• Tax returns going back five years;
• Cash flows;
• Income and expense statements;
• Find out if there are any outstanding debts, liabilities, or tardy accounts receivables; and
• Take a close look at VAT tax records too (Kenya Revenue Authority may hold the Buyer responsible if the Seller was negligent in remitting VAT).

(b) Legal Issues – engage a commercial lawyer to confirm:

• The Business’s legal and obligations;
• Compliance with legal issues;
• Details about existing contracts, insurance policies;
• Intellectual property rights;
• Licenses, permits;
• Registration;
• Employee agreements; and
• Commercial leases (check, for instance, that leases can be transferred to you).
• Employees:
  • HR-related documentation;
  • employee records; and
  • any Non-Compete Agreements.
• Suitability of the target’s Business Structure – Each Business structure has different legal and tax obligations. For instance, corporations are highly regulated and must maintain proper records.
• Annual Returns have been filed at the Companies Registry etc.

Note:  

(i) Confidentiality Agreement

The Seller may require the Buyer to sign a confidentiality agreement to ensure that the Buyer will not use the information about the Seller’s Business for any purpose other than making the decision to buy.

(ii) Consider Forming and Registering a New Business Vehicle

It may be advisable to create a new entity that will acquire the assets of your target Business.  As a general precaution, forming a Company or a Limited Liability Partnership to buy a Business will minimize your personal risk for the Business’s past obligations unlike a Business Name.

3. Formal Agreement & Pre-Closing

A formal, final Sale and Purchase Agreement or an Asset Purchase Agreement will be end result of the negotiations. It should contain at least:

• the conditions of the sale
• the purchase price
• intellectual property rights (trademarks, copyrights, patents, brand names etc.)
• pre and post-completion obligations of both the Seller and Buyer
• debts of the business to be discharged by the Seller
• date of completion
• restrictions on Seller
• confidentiality and announcements
• apportionments of outstanding payables eg land rates etc.
• dispute resolution mechanisms e.g. negotiations before arbitration
• liabilities of the Seller and the Buyer
• indemnities
• the employees
• conditions: shareholder consent; governmental approval; other consents and clearances; no litigation challenging transaction
• property: conditions of sale, transfer and assignments; the particulars of the properties; encumbrances; planning and use of properties; statutory obligations
• the fixed assets and moveable assets; the leasing and hire agreements; the motor vehicles
• the supplier contracts
• information technology: particulars of the IT system and of the IT contracts
• warranties on the: information supplied; capacity of the Seller; records; accounts; title to the assets; the business contracts, condition of assets; the stock, employees and agents; book debts; insurance; compliance with laws; licences and consents; defective products or services; disputes; insolvency
• environment and health and safety warranties
• taxation and tax compliance

In this stage, there are many details to attend to, such as:

• Stock taking and inspection of the inventory, if it’s to be purchased.
• Ensuring that all leases, contracts, and loans are subleased or assigned to the buyer. An Assignment of Lease and Assignment of Loan (short form) Agreements will be of help here.
• Preparation of a Bill of Sale for assets, if they’re being sold, like fixtures, fittings and equipment.
• Opening of an Escrow Account by the Seller’s and the Buyer’s Advocates, in which account the Purchase monies shall be held until all or specified conditions of the Sale Agreement have been met, such as the actual transfer of the assets to the Buyer.

4. Closing Stage

At closure, the Parties:

• Must ensure that all documents are signed, and witnessed by their advocates.
• Release the Purchase Price from the Escrow Account to pay any creditors; any unpaid VAT; and the balance to the Seller.
• Procure the registration and transfer of titles of land assets and motor vehicles.

10 THINGS TO BE MINDFUL OF WHEN CLOSING A SME BUSINESS PURCHASE 

Items to be addressed in the closing:

1. Closing or Settlement Sheet: This sheet will list all financial aspects of the transaction. Everything listed on the settlement should have been negotiated prior to the closing.
2. Consultation Agreement: If the Buyer and the Seller agree that the Seller will remain on for a specified amount of time as a consultant then the mentioned Agreement will be required.
3. Leases: If the Buyer agrees to take over the Business’ Leases, ensure you procure the Landlord’s consent.  The Buyer or the Landlord may opt to negotiate a new Lease instead of taking over the existing Lease, ensure you have your advocate review the terms of the new Lease.
4. Loan Agreement and/or a Charge or Debenture: It may be that the Buyer will have applied for financing of the purchase by a bank, therefore the three financing documents should have been reviewed by an advocate, signed, and possibly registered.
5. Non-Compete Agreement: For certain Businesses, it is advisable for the Seller to sign an agreement to not compete against the Business or set up a similar Business for a specified time.
6. Intellectual Property: If the Business owns any patents, trademarks and/or copyrights, the Seller should provide the Buyer with signed Transfer Forms.
7. Review Required Documents: These documents must include: a Company Resolution approving the sale, signed Share Transfer Forms (Share Transfer Forms are assessed for stamp duty purposes which is then paid before they can be registered), Tax Compliance Certificate, the mentioned Agreements, signed Discharge of Charges registered against the Business’ land assets, signed Memorandum of Satisfaction for any Debentures/ Charges registered against the Business’ assets.
8. The Final Purchase Price: This Price should include apportioned costs like rent, utilities, and inventory up to the time of closing.
9. Vehicles: If the purchase of the Business includes vehicles, the Seller must deliver to the Buyer signed Vehicle Transfer Forms.

THE LAW

The Transfer of Businesses Act, Cap 500

The Transfer of Business Act (“the Act”) requires the Seller and the Buyer to cause a Notice to be published in the Kenya Gazette (“Gazette”) of the sale and purchase of the Business. The Notice must be published either before or after the date of the transfer, in the Gazette and a national newspaper. The transfer will be deemed to be complete after two months from the publication of the notice.

The purpose of the Act is to prevent fraudulent transfer of Businesses to escape creditors and to give notice to the Business’ creditors of the sale for them to object or request settlement of their dues.

Consequences of Failure to Give Notice

Failure to cause the Notice to be published will lead to the Buyer becoming liable for all the liabilities incurred in the Business by the Seller.

The Notice will serve as evidence for the Buyer and the Seller that the law was followed in case any creditor of the Seller appears later and claims not to have known that the Business was sold.

Lastly, a creditor will not be allowed to sue the Buyer over any liability imposed by the Act after the expiration of six months after the date of the transfer.

Having a lawyer guide and advise you as the Buyer or Seller and to draft and review the mentioned legal agreements and documents is critical.

Disclaimer. The above information is intended for general information purposes only and is not intended to provide, and should not be relied on for tax, legal or accounting advice. Please get in touch with OT Advocates or contact your attorney, tax and accounting advisors to obtain advice with respect to any particular issue or problem.