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Tuesday, 23rd April 2024
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Maximising value for the seller Back  
Traditionally due diligence is a process carried out by the purchaser so that he may assess the pig before he purchases the poke. There are many advantages to a vendor in commissioning due diligence in advance of a sale, including due diligence on the taxation aspects.
Why vendor due diligence?
A vendor might reasonably ask why he should bother commissioning a tax due diligence of his business prior to its sale, when the purchaser would be doing this anyway. That question already suggests at least one answer.

There will probably be more than one potential purchaser. Indeed if value is to be maximised for the vendor, a competitive bidding situation may be essential. That may mean a number of successive potential purchasers each commissioning due diligence. This can be disruptive for the client’s business, as well as drawing out the sales process.
Where the vendor can present potential purchasers with an independent due diligence report, this should enable, in some cases, all purchaser due diligence to be rendered unnecessary, and in most instances should at least ensure that only the highest bidder will carry out at least a limited due diligence of their own. The initial expressions of interest and indicative bids from potential purchasers will come from an informed base and are therefore likely to be higher, and realistic.

The negotiations
The second major advantage of carrying out due diligence in advance of putting a business up for sale is that the normal process of negotiation is simplified. That process usually consists of a bid being made sufficiently high to attract the vendor’s attention but subject to due diligence etc. Thereafter a process of attrition follows as the due diligence by the purchaser produces issue after issue all apparently justifying a reduction in the bid. Because the vendor has not an opportunity to adequately research matters, his negotiating position is weakened.

Where in contrast the vendor has had his own due diligence carried out in advance, the uncertainties are identified at a time when they can be researched in detail, and steps can be taken to resolve them. In so far as there are any unresolved problems or disadvantages identified, the vendor at least will have had an opportunity to calmly consider their true relevance to the value of the company.

In so far as uncertainties and doubts and potential problems have been resolved by investigation, or by negotiations with the Revenue Commissioners, the value of the business is enhanced. In so far as unresolved problems have at least been investigated, the vendor is in an informed position entering the negotiations.

Warranties
Many sale agreements for a business include warranties and indemnities granted by the vendor to the purchaser.

Warranties and indemnities can turn out to be hugely expensive subsequently. They can turn an attractive bid for a company into a cheap sale and can ratchet up legal fees.
This nightmare situation is most likely to occur where the vendor has not carried out an adequate due diligence of his own business, and therefore is not aware of the potential for claims on foot of the warranties and indemnities which an attractive offer price might induce him to agree to.

A good vendor due diligence, done in advance, can also help persuade a purchaser that warranties and indemnities are not required, or can be limited.

Whistle-blowing
It is prudent for a vendor of a company to carry out a due diligence so as to, as far as possible, identify any past failures in tax compliance and to clear them up in advance of the sale. There is one very practical reason why a vendor should be concerned that any such past failures should be rectified while they are still in control of the company, rather than after they have parted with it. Once they have sold the company, they will no longer have free access to the company’s records and may find that their ability to justify themselves to the Revenue Commissioners, or to the Director of Corporate Enforcement, much reduced and hampered.

Tax assets
Vendor due diligence is also about identifying the tax advantages which the business may have, and ensuring that they are taken into account in offers made for the company. In contrast, a purchaser’s due diligence will focus on highlighting the problems and the reasons for reducing the value of the company.

Tax assets can take many shapes. The most obvious are losses forward, or “charges” on income relating to past periods but whose tax advantages have not yet been crystallised, pending payment. Where the company has patents based on Irish research, there can be an opportunity to minimise corporation tax, and to provide shareholders with tax-free income, through a patent dividend scheme, if properly structured. There can be advantages in foreign subsidiaries which have paid tax in high tax jurisdictions. Ireland’s on-shore pooling for tax credits, introduced in the Finance Act 2004, can enable (where conditions are met) the benefit to be obtained of such past high tax payments in repatriating income from overseas low tax subsidiaries of the purchaser.

Structuring the disposal
A proper due diligence carried out on behalf of the vendor will also assist in ensuring that the disposal is structured in a way which is tax efficient. The disposal by a group of a subsidiary can crystallise capital gains tax charges within the subsidiary in relation to assets transferred intra group in the previous ten years. With proper structuring this can be avoided in many cases.

The sale of a company can also involve the clawback of capital duty or stamp duty reliefs granted on previous reorganisations. In a private company context, a sale can involve the clawback of capital acquisitions tax business property relief on previous gifts or inheritances. If these issues are identified in time, they can usually be avoided.
Although stamp duty on shares, at a rate of 1p.c., is significantly lower than stamp duty on other property (typically 9p.c.) it is nonetheless a substantial expense on many transactions. Provided the issue is addressed in time it can be possible to structure a disposal so as to minimise that stamp duty cost.

Traditionally purchasers of a business have preferred to purchase the business, rather than the company which owns the business. This is because the purchase of the company typically exposed the purchaser to the possibility of undisclosed and unidentified liabilities within the company. With the large disparity in stamp duty rates between a transfer of shares (1p.c.) and a transfer of assets (9p.c.) purchaser attitudes are beginning to change. A vendor due diligence on which a purchaser can put reliance can help persuade a purchaser of the merits of acquiring shares, thus freeing up potentially an 8p.c. premium to be shared between purchaser and vendor in negotiation of the price.

VAT is often the forgotten tax in transactions. The professional fees relating to transactions can be substantial, both for the purchaser and vendor. Such fees carry VAT at the rate of 21p.c.. Advance planning can help to ensure that the recovery of that VAT is maximised for the purchaser and for the vendor. If the issue is not addressed until after the event, it will usually come into the category of “lost opportunity”.

The advantages of a vendor due diligence in the tax area (and other areas also) are considerable. Anybody considering the sale of a business should give serious thought to the impact it can have on maximising the value of their sale.

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