In many company and business sales, deferred consideration forms some of the purchase price, meaning that a portion of the monies are received at a later date, following completion of the transaction. For various reasons, this can come with the risk of the Seller not receiving such payments, as and when they become due under the asset or share sale and purchase agreement.

Typically, it is recommended that Sellers should consider some form of security in an attempt to mitigate this risk.

There are a number of different security options available in asset and share sales where deferred consideration is present. Below, we briefly touch on the ones most commonly used.   

Legal charge over shares

This is a charge over the shares in the company that is being bought and sold. If the buyer fails to make the deferred payments under the share purchase agreement, the seller has the right to enforce the share charge, and take back some or all of the shares in the company.

When enforcing a charge over shares, you will take the business part in whatever position it is at the time. This can present a risk if the business has been run poorly or has taken out finance. Given the Seller’s knowledge of the business, it can be possible to continue to operate the business and potentially sell this to another buyer.

Legal charge over property

This is a security interest in favour of the seller (similar to a mortgage) registered against the property (if any). If the buyer defaults on any of the deferred payments, like the legal charge over shares, the seller has the right to enforce the property charge, enabling the seller to force a sale or take the property to recover the outstanding debt/value of the outstanding deferred consideration.

The process for recovery of a property can, however, be more complicated and will require Court proceedings including an order for sale, so whilst a charge over a property will often provide good quality security, it can be more difficult to enforce.

Debenture

A debenture is a fixed and floating charge that is registered against the company that is being bought or sold under the sale agreement. Typically, a debenture creates:

  • A fixed charge over the assets of the company which are not disposed of in the ordinary course of business.
  • A floating charge over the rest of the company’s undertaking which floats until a default or insolvency event occurs, at which point it converts into a fixed charge, freezing the assets.

Upon an event of default (including a missed deferred payment), a debenture grants the seller rights including the authority to appoint an administrator with wide powers to run the company’s business and realise its assets, seize its assets, or force insolvency proceedings.

Charge Considerations

The above three charges must be registered at Companies House within 21 days of creation of the charge to be legally effective. Property charges in addition, must also be registered at the Land Registry.

When considering any legal charge such as those mentioned above, it is important to note whether there are any existing mortgages or charges, as lenders with a first legal charge will have priority and the primary right to recover their money first.

In addition, consideration should also be given to the fact that between completion and any enforcement of the charge/recovery of the company and it assets, the buyer has had control of the same therefore, if any value has already been extracted from the company, or its assets and property have depreciated for whatever reason, the security may not be as worthwhile it was at the time of completion of the sale and purchase. To try to mitigate this, sellers ought to contemplate including restrictions within the sale and purchase documentation surrounding the buyer’s running of the company and use of its assets post completion.

Personal guarantee

Personal guarantees hold individuals personally liable for the deferred payments if the buyer defaults on these. In the event of default, the Seller could look to pursue the guarantor to recover the deferred consideration due. The guarantor would be responsible to make the payments, and if the funds were not available, would have to look to use their personal assets, i.e. their homes and personal possessions, to generate the funds to be in a position to settle the outstanding deferred consideration due under the sale and purchase agreement.

In considering a personal guarantee, it is important to understand the financial position of and/or assets held by the proposed guarantor. If the guarantor does not hold sufficient assets, this raises the question as to whether they’d be suitable to guarantee the debt (deferred consideration) of the buyer.

Corporate guarantee

A corporate guarantee is similar to a personal guarantee, in that a third party company, guarantees to cover the debt or contractual obligations of another entity (i.e. the Buyer’s outstanding deferred consideration). This is usually the case with group companies where parent companies guarantee the contractual obligations of its subsidiary.

As with personal guarantees, it is important to note the assets held by the proposed corporate guarantor, to determine whether the entity would be suitable to provide such a guarantee.

Retention

A retention would involve the deferred consideration being held by a neutral third party (for example, a solicitor) until the deferred payments are due under the sale and purchase agreement, and the conditions for release are met.

In many cases, however, deferred consideration is usually agreed due to buyer financing and affordability, therefore the monies for the deferred payments are not always readily available at the point of completion for the third party to retain.

Other options

Alongside those detailed above, there are other contractual terms which can be included within the share or asset sale agreement. These include (but are not limited to):

  • Restrictive covenants

These are contractual limitations within the sale and purchase agreement, including post-completion restrictions preventing the buyer from declaring dividends, increasing director salaries, or selling company or business assets until the full deferred consideration amount has been paid to the seller.

  • Accelerated payments

Terms can be included within the sale and purchase agreement to provide that all outstanding deferred payments will become immediately due and payable if one single payment is missed.

Conclusion

It is very common for mergers and acquisitions to include deferred payments and Buyers can propose this in part to protect their position as to the Seller’s cooperation on handing over the business and around the accuracy of the information provided in connection with the business.

As a Seller, you want to have as much protection on any deferred payment as possible. It is impossible to completely eliminate the risk that deferred payments will not be paid, but steps should be taken to minimise that risk.

Consideration also needs to be given to the solvency of the buyer. If the buyer is a well-established trading business, with assets, then the risk on deferred payments made may be minimal. It is, however, important that the issue of security on deferred payments is considered early in the process.

For help and advice with security options in asset and share sales where deferred consideration is present, please get in touch with our company and commercial experts today by calling 0113 284 5000.