The market for buying and selling fashion businesses is much more active than last year. Given that a fashion garment is first designed and manufactured to meet a customer’s expectations before being marketed to the public, when considering the sale of a fashion business a similar process should be followed.
Designing the deal
Company share sales are structured differently depending on what the seller and buyer are trying to achieve and the vision which they have in mind for the future of the company. Sometimes, a buyer would want certain founding shareholders and/or key employees to remain with the company post-sale in order to benefit from the creativity and know-how these individuals possess. In such cases, it is common to see the founding shareholders/key employees retaining some of their equity interest (be it shares or options) in the company and being incentivised in line with the future profits of the company. Typical examples of this type of deal are LK Bennett and Cath Kidston. In other instances, the founding shareholders may want to exit the business and have a “clean break”, in which case the shareholders would want to sell all their equity interest to the buyer and be paid upfront.
Whatever the deal struck between the parties, it is important that the terms are clearly recorded in writing in what is referred to as “heads of terms” or “term sheet” and that legal advice is obtained from the outset to ensure that the agreed commercials may be legally effected without any difficulty.
Marketing the business
Part of the sale process will be a review of the legal position of the company. Similar to the way a customer looks at the fabric, cut and quality of a particular fashion garment before deciding to purchase it, the buyer will want to inspect the company to ensure that there is no unquantified risk in the key areas of the target business before proceeding.
When there is more than one interested party, the normal procedure is for the company to set up a data room containing the important legal and financial documentation. This is made available for review by potential buyers. Like a shop floor and its mannequins, it is important that the information in the data room is well presented and in good order because it gives buyers an insight into how well the target company is run.
The use of material in the data room will be subject to a set of rules including non-disclosure agreements. Sellers will need to plan ahead and be happy with the level of confidentiality to be imposed before completing the compiling of information for the data room. If this is not done in good time it will normally be too late to rectify a problem. What sort of problems are common?
A typical problem area is employment contracts. These need to be reviewed for compliance with legislative and case law developments. Do the contracts include restrictive covenants for key employees? If the restrictive covenants were drafted say, three years ago, has the law changed so as to render them unenforceable? This would leave the company’s customers and goodwill open to attack by former employees. How long will it take to re-negotiate restrictive covenants with the relevant employees?
Another area where there may be gaps in legal protection is intellectual property. Designs are always important assets in the fashion industry and the company needs to have a written assignment of the design rights from any consultant or third party involved in developing the design. If this has not been done, a third party may own part of the company’s assets and the company may be unable to prevent that part of the design appearing in a competitor’s product.
Brand protection and trademarks can be another problem area of intellectual property. What is the scope of the trademark protection for the business? Are there trademarks registered in the countries where the company does substantial business? Trademarks can be under the control of distributors. It is not that unusual to find an unauthorised trademark which may have been registered by a distributor or a third party. A similar exercise needs to be undertaken with domain names.
What is the risk profile of the business for claims from suppliers or customers?. The obligations and liabilities of the company under the contracts entered into with suppliers and customers need to be reviewed. Warranties and indemnities given to third parties should be checked to assess how onerous the obligations are and the potential liability of the company under the warranties and indemnities it has given. Terms and conditions should be checked to ensure they will not expire or require renegotiation just as a new owner takes control. All trading, business and other arrangements with third parties should be put in writing where possible. The company should ensure that all contracts are signed and dated and that any amendments or variations are documented and formalised.
Whilst some of these problems can be rectified more easily than others, they will almost all lead to a delay in the transaction. The delay may prove fatal if the buyer (or investor) finds an alternative target for its interest during this time. Many of the typical problems can be averted by the company putting in place a legal risk management plan. Where a plan is not in place, a company contemplating a sale or share offering should conduct an early review of possible problem areas to prevent complication or disruption after the sale or offering process has begun.
This article was written by Doug Preece, a partner in the Fox Williams LLP Corporate deaprtment and also by Eniga de Montfort, an associate in the Corporate department