There’s a lot more to a business legal health check than simply finances. As Neil Large an experienced M&A and banking lawyer in our corporate team explains, it provides an essential all-round MOT for your company.
Businesses are always looking to cut expenditure and reduce exposure to risk. Directors often focus on finances alone and the annual account audit as a measure of risk, without examining the wider business. An accounts audit will review historical performance, but a legal health check allows you to plan for the future.
A legal health check will help highlight areas where improvements and cost savings could be made, and what are the strengths to focus on. It will also help identify areas of weakness and exposure to risk, and potential liabilities. Identifying such issues early gives time to formulate strategies to efficiently and effectively manage them in a less costly manner before they start to advsersely impact the business.
It’s also a good idea to carry out a legal health check if your business is looking for a buyer and/or investor, considering a refinance of business or assets, or seeking new finance to fund expansion (whether increasing market share, moving to new premises, or acquiring a business). Buyers, investors and financiers like a clean well managed business with its house in order and fair, accountable, and transparent rules, practices, and processes etc. Identifying and dealing with any problem areas in advance will make the business more attractive, maximise stakeholder value, allow you to take better control of any due diligence exercise on your business, and facilitate an overall smoother, quicker, and less costly, sale or funding process.
A legal health check will typically cover a review of the following key areas of the business:
Structure and constitution: Articles of association and shareholder/partnership agreements are often not updated following incorporation/start up, even when new shareholders/partners come on board or others leave. Typically these matters are not addressed until a dispute over a business decision or financial difficulty arises. A stakeholder stalemate/deadlock can be particularly onerous and settlement can be costly, both in time and in money, at the precise moment the business needs to move quickly and preserve its finances. If control of the business is split between two or more owners, a shareholder/partnership agreement should be put in place to govern the regulatation and managent of it, any potential disputes between the owners, and to set out what should happen if an owner dies or otherwise leaves the business.
Directors’ duties: Directors need to be aware of, and kept up to date with, their duties and responsibilities under the Companies Act 2006. When a company is in good financial health, the 2006 Act provides the primary duty of directors is to act always to promote the success of the company with reference to the interests of its shareholders as a whole. However, if the company enters a period of financial difficulty, directors must also consider their potential liability for wrongful trading and the possible implications of granting preferences, approving transactions at an undervalue, or trading insolvently which can have serious implications on the company and the directors personally.
Regulatory and compliance: Corporate and regulatory filings and registrations should be complete and up to date. Regular reviews should be undertaken to ensure compliance with all applicable laws, rules, regulations, codes of conduct, professional standards etc and to identify policies or procedures to be implemented to make compliance second-nature.
Data Protection and GDPR: All businesses are obliged to comply with GDPR (and the Data Protection Act 2018), and this will continue to be the case after Brexit. A review will identify the specific actions required to make your business compliant, from producing policies and procedures to adapting your business practices. The review will also consider additional requirements arising from any international element to your business.
Books and records: Statutory registers need to be available and up to date and all other records of the business should be adequate, in writing if possible, safely secured and stored, and kept up to date.
Licenses and consents: Has the business obtained all regulatory, professional, government, trade, or association consents, permits, authorisations, accreditations, or licences required for its activities? Are they up to date, in full force and effect, and is the business complying with all applicable terms, conditions and restrictions attaching to them?
Contracts: Ensuring a business’ dealings with its key customers and suppliers are on best possible and enforceable terms and in writing is extremely important. Reviewing and updating existing, or putting in place new, T&Cs and/or written contracts will allow a business to stay ahead of the curve. Having properly drafted, effective, and robust written commercial agreements and/or T&Cs will protect goodwill and market reputation, create value, minimise risk of dispute, facilitate smoother, quicker and less costly dispute resolution, and safeguard relationships/dealings through clarity and contractual certainty. If you trade through a web site there are additional laws relating to selling online relating to data protection, privacy, cookies, electronically concluded contracts, and distance selling to consider. In addition, a review of existing trading arrangements can uncover new opportunities for savings or growth by identifying key terms for re-negotiation, and highlight if a business is overly dependent on one customer/supplier allowing it to diversify before it becomes vulnerable.
Finance: An examination of existing facilities and security can identify opportunities to negotiate new or longer term loans, or release certain items of security, to produce savings and assist in cash flow as well checking that finance is readily accessible when most needed. Many businesses have working capital through bank overdraft facilities which are usually repayable on demand and often the first facilities to be examined by any bank wanting to reduce its exposure. Have all facilities (including HP, hire, rental and leasing) and security been properly documented, available, registered, up-to-date and correct? Any security given by the business which has been satisfied should be removed from any registers.
Employees: A review will ensure employees are properly ‘sponsored’ by the entity which actually employs them, ensure compliance with all employment laws, help identify key employees, examine employment terms and benefits, and ensure the right people are being suitably rewarded. It will also allow you to consider whether adequate and enforceable restrictive covenants are in place to protect the company and prevent key employees from being snatched by competitors, and identify gaps in employment policies and terms. Are employment terms, staff handbooks, grievance procedures, and HR policies/procedures documented, available, up-to-date and correct? Are there written engagement terms/contracts for temporary staff, agency workers, self-employed consultants, or sub-contractors? Does clear information/documentation exist in respect of both contractual and discretionary benefits?
Premises: One of the largest overheads for any business. If you hold a leasehold, a review can identify key areas for re-negotiation. Landlords are keen to hold onto good tenants and this can be used as a bargaining tool to fix your rent for a longer period, extend the term if the remaining term is insufficient (particularly important in the retail and leisure sector where goodwill is largely in the premises), agree to the insertion of a break clause, or even allow for sub-letting if the property is superfluous to your needs. If you hold the freehold, the same analysis applies to any tenants you have, and its important to ensure the business has good and marketable title. Examination of the terms of any property mortgage may highlight opportunities to explore the market for a remortgage on more competitive terms to producing cost savings.
Intellectual property (IP): Are there any branding issues or do any trade/service marks need protecting? Are all trade/service marks, branding styles, logos, and other IP owned by the business, and any licenses of IP (including software licences) granted to or from the business, documented, available, up to date, correct and registered (as appropriate)?
Litigation and disputes: A review will cover any outstanding litigation, investigations, enquiries, debt recovery, disputes, or complaints affecting the business and consider the best, and most cost effective, course of action to deal with them quickly, efficiently, with minimum hassle, and least business disruption - all of which need to be clearly documented with a good paper trail from start to finish.
Assets: Is the plant, equipment, machinery, motor vehicles, telecommunications, IT hardware, and other tangible assets adequate for the business, in good working order, and have they been regularly serviced and well maintained? Are any items in need of repair, replacement or servicing? Are all operating manuals/handbooks and servicing/maintenance records/logs documented, available and up to date? In respect of items owned, are they owned and registered to the correct company and is ownership documentation available? In respect of items not owned, are the HP, hire, rental, leasing and licensing contracts available and up to date? Are there adequate maintenance/support agreements in place?
Insurances: A review will ensure, in conjunction with input from your insurance brokers, that your business has adequate insurance in place covering all business assets and relevant business risks and that you have full and up to date copies of all insurance policies.
Management: A review will allow you to assess if you have a strong and effective management team and the correct management structure in place, and consider how best to incentivise and motivate the team – this could include a ‘success’ bonus payable on exit or the achievement of certain financial targets, the grant of share options, or even a direct allotment of shares.
Growth plans: Are you considering acquiring a business, merging your business with a third party, bringing new shareholders/partners or directors, franchising, or just looking to grow market presence?
Exit strategy/strategic review: Do you have an exit strategy? Are you at a cross roads and need a strategic review to consider options to take the business forward? This could mean the sale of a business to a third party (full or partial exit), bringing in an equity investor, or selling shares or assets to employees or family members.
General take stock: Is there anything specific that you have not got round to dealing with which is now causing some concern and needs to be actioned? Are there any areas of your business processes that could be improved with a legal eye?