There are some issues that I frequently encounter in start-ups/ entrepreneurs’ businesses when conducting legal due diligence for buyers seeking to acquire such businesses. Here are some of the issues:

1. No Separation of Legal Entity

A founder may own several companies at the same time. It’s common for a founder to treat all the companies as a single legal entity although, from the legal perspective, they are not.

For example, a founder is the sole shareholder in Company A and Company B. In practice, Company A deals with customers and suppliers. However, Company B is the one that enters into contracts with customers and suppliers. This gives rise to legal implications, including determining the actual entity with rights and obligations vis-à-vis the customers and suppliers.

This issue becomes pertinent when the founder is seeking to dispose of only one of the companies. The buyer would want to ensure it is acquiring the correct legal entity with its book of business.

2. Inconsistencies in Contract documentation

Another common issue is inconsistencies in contract documentation, which is related to issue No. 1 above where a founder treats all legal entities controlled by the founder as one single entity.

For example, it’s not uncommon to find the first page of a contract stating Company A as the contracting party, while the signing page oddly bears the name of Company B or the founder as the executing party. This raises the issue of who is the actual party to the contract.

 3. Common breaches of Companies Act 2016

Some of the common breaches of the Companies Act include:

• No declaration of directors’ interest in contracts where a director is interested in the contract, in breach of s221. This is common when a founder is a director of several companies and these companies enter into contracts with each other.
• Shareholder approval has not been obtained when a company acquires property of a substantial value or disposes of a substantial portion of the company’s property, in breach of s223.
• Directors’ approval has not been obtained for directors’ fees and benefits where the company is a private limited company, in breach of s230.

These issues are usually rectified and addressed in the sale and purchase agreement. However, entrepreneurs who want to dispose their business may well start preparing early by avoiding the common issues set out above.

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This post was posted on LinkedIn on 13 March 2024.