Whether you are looking to sell your business or take on investment, you should consider if your contracts are “investment/acquisition ready”. A business’s contracts are part of its foundations and will often determine whether an investor/buyer is willing to proceed with their investment/acquisition, and the price they are willing to pay.
On corporate transactions where we are acting for an investor/buyer we are often asked to carry out due diligence on commercial contracts of the company to identify whether they are fit for purpose or expose the business to unusual risk. In our experience, there are four key areas to watch out for which may impact a buyer/investor’s willingness to proceed with a transaction or the value which they ascribe to the business.
1. Termination Rights
If your business has key customer relationships which are generating significant revenue or key supplier relationships which are fundamental to the operation of the business, an investor/buyer will want to know that those relationships have been secured for the long term. For instance:
- they will expect to see appropriate notice periods. If a contract allows a key customer or key supplier to serve 30 days’ notice at any time to end the contract on a “no-fault” basis, it may make investors/buyers uncomfortable;
- they will want to make sure there are no unacceptable termination “triggers” in contracts. A common example is a clause which allows a party to terminate a contract if the other party undergoes a change of control (i.e. investment or sale). Ideally, “change of control” clauses should be drafted so they only apply in narrow circumstances where the change is a clear detriment to the terminating party (e.g. on a sale of target to a competitor); and
- “material breach” clauses are often problematic because they are drafted in such a way as to allow the contract to be terminated for what are often issues which the parties could have been relied on to correct. Material breach clauses should be linked to a good dispute resolution procedure which requires the parties to discuss and correct most issues before triggering the nuclear option of termination.
2. Intellectual Property (IP)
IP will arise whenever something new is created (such as inventions, software, designs, logos, names, images and documentation). For most businesses, their IP is a fundamental asset which underpins value. It is therefore important to demonstrate to investors/buyers that the business owns its full IP portfolio.
The default position under English law is that all IP created by an employee in the course of his employment belongs to his employer. By comparison, the default position for consultants is that all IP created by the consultant belongs to the consultant (and not the business engaging the consultant). It is therefore important to make sure that contracts with consultants (and service providers) contain appropriate IP assignment clauses to transfer ownership of the IP to the business.
3. Data Protection
The General Data Protection Regulation (GDPR) introduced on 25 May 2018 has significantly changed data protection law. Under the GDPR, data protection compliance must be “built into” every part of a business. Businesses not only have to comply with the GDPR but they must be able to demonstrate they comply with the GDPR. As part of this positive compliance obligation, businesses should be considering and documenting data protection compliance in all their contracts. For example, when a business shares personal data with a third party, the parties must make sure the contract clearly sets out what data will be shared between the parties and the rules which apply to the storage and use of that data.
With the increased public focus on data protection compliance and the eye-watering fines for a breach of the GDPR (up to 4% of global turnover or €20M (whichever is more)), investors/buyers are now more focussed on data protection compliance than ever before.
4. Liability Caps
If a business supplies goods, services or digital content to third parties, investors/buyers will want to see acceptable limitations of liability in contracts to make sure the business is protected in the event of a claim against it.
Limitations of liability should be proportionate and relate to the value of the goods, services or digital content supplied and the amount of fees received or receivable. A good way to achieve this is to set the limitation of liability as a multiple of the fees receivable over a pre-defined period (such as the 12-month period before the date when a claim arose).
Provisions which attempt a too extensive limitation of liability can be problematic as there is a risk that they will be legally unenforceable as an “unfair contract term” and the business will then be exposed to unlimited liability.
This article is current as of the date of its publication. The information and any commentary contained in this article is for general information purposes only and does not constitute legal or any other type of professional advice. Marriott Harrison LLP does not accept and, to the extent permitted by law, excludes liability to any person for any loss which may arise from relying upon or otherwise using the information contained in this article.