The Recurring Pitfall in SME Share Acquisitions and Disposals

The Corporate Commercial team at Woodfines have been heavily involved in SME share acquisitions and disposals in the last 12 months of varying size and nature. We monitor common trends in these transactions and share our experiences to better able our clients to prepare for their own plans in the future in these areas. We have identified that the same issue appears to resurface time and time again. It’s not within the negotiations around price or drafting of the Share Purchase Agreement, but rather in the corporate records of the target company. To be specific, poor record keeping relating to the shares of the target company and transactions around those shares and maintenance of the “Statutory Books” of the company.

Most share acquisitions now involve an entirely digital due diligence process, where the buyer will request certain pieces of information and documents to be uploaded to an online portal, allowing them to investigate and verify the legal, financial, operational and regulatory status of the company they are proposing to purchase. For many SME’s this will involve trawling through endless paper-based records that are often hard to find, fragmented and in some cases, simply non-existent.

In a share acquisition, the fundamental principle is that the buyer acquires the legal and beneficial title to the shares of the target company. It is with the purchase of the shares in the target company that the buyer takes control. To evidence good title, we would expect to see:

• An up-to-date register of members for the target company;
• Share certificates properly issued and signed, held by each of the shareholders;
• Board minutes and resolutions of the target company, approving any share allotment, the issue of new shares or any transfer of shares; and
• Clear and traceable documentation to show the history of the shares in the target company and how each share has come to be held, e.g. stock transfer forms.

SME’s have typically relied on professionals (so solicitors, accountants or others) to deal with the administrative side of their corporate structure and management of the records outlined above. Frequently these professionals  become the keeper of these records and over time, as businesses grow, advisers change, offices change or are reorganised, the vital documents and evidence of share ownership vanish. This can occur for a number of reasons:

• Paper records being misfiled;
• Documents being generated but then forgotten and not updated for a number of years;
• Records being discarded under the professionals or the company’s data retention policies;
• Records and documents not being returned to the company to which they relate when there is a change of professionals;
• Paper documents not being properly transitioned from paper files to electronic files and being lost in the process;
• Key personnel in the professional’s practice or the company’s employment being the only person with knowledge of the records, which means that when that person leaves the relevant firm or the employee leaves the company, no one else knows about them or where they are stored.

Whilst they will often retain documents and store them on behalf of their clients, the professionals are not necessarily to  blame as often assumptions are made as to who is responsible for keeping these records. The ultimate responsibility for maintaining and safeguarding statutory registers, share certificates and corporate approvals rests solely with the company.  This is not well understood and without clear and definite instructions or retainers as to responsibility, it falls through a crack.

For the sellers, holding and maintaining such records is not understood to be vital and hence is not high on the priority list, so long as the business runs and dividends are paid, all is well. But for any buyer and their solicitor, the absence of such documents raises a fundamental question to which the entire transaction may hang ‘Can we be confident that the shares we are buying actually exist and that the seller has the right to sell them?’

In practice, the inability of the sellers and/or company to evidence good and proper title to the shares that are being sold often results in delays in the transaction, increased legal costs, enhanced warranties and indemnities, price adjustments and in some cases, a complete bail out of the deal. If the deal does proceed, it can result in exposing the transaction and/or the buyer to the risk of third-party claims, defective title or challenges to control post-completion.

To save the frustration, expense and delay mentioned above, companies should ensure the maintenance of clear, well-organised corporate records that document the history of share ownership. Those records should be retained in both secure physical and electronic formats, with backups to protect against loss or damage. Access should be given to a number of key personnel to ensure that when one person leaves the business, someone else knows where the records are held. All of which will enable the prompt response to due diligence questions around the shares and ultimately help achieve a smooth and effective sale of the shares.

If you have any questions around the content of this article or would like any advice or assistance with corporate documentation for your business or with SME share acquisitions or disposals generally, please contact Corporatecommercial@woodfines.co.uk