By Adv. Gadi Ouzan, Partner ,shibolet & Co.

Establishing a business from scratch is not always necessary – if capital for investment is available, the first stage may be skipped, and an existing company or business may be acquired; the following rules will help you avoid mistakes that may cost you a fortune

Acquiring a company or a business or the assets and business of another company is a complex project, which includes several stages. It is important to verify certain issues before carrying out the transaction. In the list below we assembled the main legal issues that a potential buyer needs to verify when entering into a transaction to acquire an Israeli company. A large part of the rules below also apply to the acquisition of business or assets such as intellectual property assets and technologies.

Rule no. 1 – Are the sellers financially sound?

Acquisition agreements often include undertakings and indemnities by the seller, to be fulfilled after the closing of the transaction. In order to be able to enforce such undertakings, it is necessary to verify, already at this stage, prior to the engagement, that the seller is financially sound and credible, and has assets. If the seller is not sufficiently stable, it is important to obtain an owner’s guarantee or other securities to secure the undertakings and indemnities.

Rule no. 2 – Have all the regulatory and banking approvals been obtained?

An agreement for the acquisition of a business often requires approvals from the Israeli regulators such as the Antitrust Commissioner, the Chief Scientist at the Ministry of Economy, the Investment Center, Tax Authorities and other regulators such as the Ministry of Defense, the Ministry of Communication and so forth. It is necessary to confirm that all approvals have been received, to the buyer’s satisfaction, before the transaction is closed. Furthermore, it should be verified  whether approval for the transaction is required by the bank of the seller or the target company.

Rule no. 3 – Have mechanisms been set in place to ensure the retention of key employees in the company?

One of the most critical issues for the buyer is the need to ensure that key employees of the company agree to stay in the business and the company after its acquisition, or join the acquiring group. This is of particular importance in technology companies and startups. It is important to verify that the acquisition agreement conditions the buyer’s obligation to close the transaction on a sufficient number of key employees having agreed to continue working for the company also under the buyer’s control, and that specific key employees will continue working for the company after the deal is closed.

Rule no. 4 – Are the assets free and clear of pledges or other restrictive rights?

When acquiring a business, a company or the assets of a company, attention must be paid to conduct a thorough investigation of the acquired assets. Regardless of whether the object of sale is shares or assets of a company, comprehensive inquiries must be made, and proper representations obtained regarding the assets being free and clear of any pledge, charge, mortgage, lien, attachment etc. With respect to Israeli companies, some of the information is stored on online computerized databases at the Registrar of Companies and the Registrar of Pledges.

Rule no. 5 – Does the company have any debt to any of the sellers?

In an acquisition agreement it is important to make sure that the sellers confirm and undertake that from the closing date onwards, they waive any right or claim against the business, the acquired company or the acquired assets. The buyer’s goal is to enter a “clean” business that does not carry loans or other rights to the previous owners, and that the sellers have no hidden claims against it. For example, it is necessary to verify that there are no shareholder loans left, which were extended to the company by the seller, and if need be, action should be taken to discharge the shareholder loans, while consequently reducing the tax exposure.

Rule no. 6 – Is the buyer required to deposit guarantees in favor of the acquired business?

It is essential to verify whether the acquired company or business obligates the buyer to undertake personal guarantees to suppliers or banks. If the sellers had personally undertaken to guarantee the sold business, the buyer can expect that whoever finances the business will require alternative guarantees from the buyer as well. The costs of depositing guarantees for the company are a part of the cost of the acquisition and should be taken into account and prepared for.

Rule no. 7 – Have the sellers undertaken not to compete?

It is acceptable and even essential in acquisition agreements, to demand that the sellers undertake to the buyers not to compete with the sold business for a number of years. Antitrust law recognizes the legitimacy of such an undertaking, under certain conditions.

Rule no. 8 – Has the due diligence investigation been completed?

Before buying an existing company or business, the buyer is recommended to make sure that financial, accounting, legal, technological and other due diligence investigations have been completed. When acquiring Israeli companies, it is important to place adequate emphasis on checking the compliance with the regulatory requirements which are relevant to that company. The managers of the acquiring entity should receive the executive summary of the due diligence report and make sure that the findings are implemented or addressed as part of the closing of the transaction.

Rule no. 9 – Is part of the consideration deposited in escrow?

A common demand of buyers in agreements for the acquisition of companies and businesses, is that part of the consideration (usually 15-20%, in the absence of special circumstances) be deposited with a trustee, to guarantee the fulfilment of the seller’s post-closing undertakings. For example, should it transpire that part of the intellectual property or the technology is “flawed”, i.e. that third parties have claims against the sold company, and it is proven that the buyer suffered damage, the buyer shall be able to cover its damage out of the escrow funds, without being required to resort to complex and naturally very lengthy collection proceedings.

Rule no. 10 – The state of the company or business, insurance

Just before acquiring a business, it is important to establish the physical condition of the assets, whether they have been properly insured, whether they are protected against fire damage, whether the company holds a business license and other physical investigations. In technology companies it is important to verify that the intellectual property is properly documented. Furthermore, it is necessary to ensure the existence of a directors’ liability policy, which covers the acts of the new directors.

In this list we offer executives a compilation of rules of thumb, golden rules, specifying the main issues which a buyer should be aware of, and attend to, prior to acquiring a new company and closing the deal.