The trend of consolidation in the trust, fund and corporate services sector has shown no sign of abating over the last 18 months. Whilst the Isle of Man has seen a number of multi-jurisdictional players looking for bolt-on acquisitions to increase their global client base, we at DQ have also seen a significant number of local Isle of Man providers joining forces or exiting the market via a share or asset sale.
The rationale for a smaller firm acquisition or ‘merger of equals’ varies from deal to deal but it could be an opportunity to acquire a client book in a complementary sector, to improve economies of scale in an increasingly regulated environment, or even to build a book of business of a scale to attract an on-sale to private equity, with PE firms currently sitting on record-high levels of ‘dry powder’ – that is, committed funds for investment.
From a seller’s perspective, a share or business sale can provide a solution to complications arising from succession planning, whereby the principals of a boutique provider are looking to manage their retirement from the sector whilst realising the value of their client book. This can lead to a tension with the buyer’s objectives; as clients are used to dealing with the existing owners, there is risk of client flight after the business is acquired. A solution to this problem is to require the outgoing owners to sign up to restrictive covenants and to also have a proportion of the consideration deferred over one or more years, payable on satisfaction of prescribed performance hurdles. These key commercial considerations are typically set out in the heads of terms.
Heads of Terms
Heads of terms typically take the form of a letter from the buyer countersigned by the seller setting out a broad outline of the commercial principles upon which the deal is to proceed. This may be of comfort to both buyer and seller before they incur costs associated with the transaction. Heads of terms are typically expressed to be non-legally binding and subject to contract, save for certain limited matters which may extend to abort fees, a period of exclusivity and (if not covered elsewhere) non-disclosure obligations.
Warranties, Disclosure and Indemnities
A well-advised buyer will require the seller to give comprehensive warranties in relation to the shares or assets which are the subject of the transaction and these will be set out in the sale agreement.
A warranty is a contractual statement or assurance given by a seller to a buyer that a certain state of affairs exists. In the event that a warranty proves to be inaccurate, untrue or misleading, the buyer may seek to claim for a breach of warranty against the seller. The buyer’s remedy for breach of warranty will ordinarily be in damages to put the buyer in the position it would have been in if the warranty had not been untrue or misleading. The amount of damages can be considered to be the difference in the market value of the shares or business with and without breach of warranty.
The seller will need to carefully consider each warranty it is being asked to provide, and prepare a disclosure letter to the buyer setting out both general and specific disclosures against the warranties in the sale agreement. If the disclosure is accepted this will operate so as to exclude the seller from liability in respect of the matters disclosed.
The buyer will need to assess the risk associated with any such disclosures as part of its due diligence exercise, and may seek an indemnity from the seller in relation to any latent or potential risks which cannot be addressed or mitigated prior to entering into the deal. An indemnity is a contractual promise to compensate another party for particular loss or liability. The buyer will be compensated on a pound for pound basis for the loss which falls within the scope of the indemnity. The key advantage for the buyer is that an indemnity is not subject to the usual rules on causation, remoteness of damage and the requirement to mitigate loss; the buyer simply has to demonstrate the specific loss covered by the indemnity has taken place.
Exchange and Completion
Deals involving regulated entities are typically structured with a split between exchange and completion, with the completion being conditional on any necessary regulatory notification or consent. There are a large number of practical considerations for both buyer and seller at completion, all of which should be addressed in the drafting of the sale agreement.
How DQ Can Help
DQ has a highly experienced team and considerable experience in advising on mergers and acquisitions. Our team has been instructed on a significant number of deals involving fiduciary service providers and other local businesses over the last 18 months and we are regularly called upon to assist with the following aspects:
- reviewing heads of terms
- legal and regulatory due diligence
- drafting and negotiating the sale agreement
- assisting with exchange and completion
Adam and Barry recently presented an online webinar to the Isle of Man Association of Corporate Service Providers which can be accessed here.