Employment due diligence during the share sale of a company: the seller’s perspective

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This guide sets out the main HR topics and practical considerations from a seller’s perspective as part of employment due diligence (DD) during the share sale of a company.

Once it has been identified that a sale is an objective or is likely, it is prudent to consider the DD aspects as early as possible. If a seller is unable to deal with DD satisfactorily, or if it reveals problems with non-compliance or otherwise, it can impact price and possibly jeopardise the whole sale process. Therefore, advance preparation to be fit and ready for sale is crucial.

PLEASE NOTE: This guide has been prepared with a focus on a share sale rather than an asset purchase to which the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) would apply. However, most of the content is applicable in a TUPE transfer scenario as well.

The first step as part of a due diligence process is for the buyer to request information and copies of relevant HR documentation via a due diligence questionnaire (DDQ). The seller will respond to the DDQ and also provide copies of any relevant documentation, which is typically uploaded to a virtual data room.

Practical tip: the seller should number its documents with the same number as the question in the DDQ so that the buyer can quickly locate the relevant document in the data room.

Once the buyer has had the opportunity to review the seller’s response to the DDQ and review the documentation in the data room, they may make further enquiries of the seller. 

A seller is likely to be asked questions about the following HR topics/ issues

1. A schedule of employees

A buyer will want to see a schedule of all individuals employed by the target business, together with details of:

  • employee number
  • job title
  • start date
  • number of years’ continuous service
  • salary/wages
  • bonus entitlements
  • pension
  • benefits
  • notice period
  • holiday entitlement.

Practical tip: The schedule should be redacted to protect employees’ personal data.

A seller will need to upload a copy of the employee schedule to the data room at the start of the DD process and may need to update towards the end of the DD process if there have been any material changes. Note that often the seller will warrant the accuracy and completeness of the information in the data room in the main sale agreement, so it is important to get this right.

Practical tip: Mark the schedule “accurate as at [date]”.

A seller may also provide details of any outstanding offers of employment and confirmation of whether any current employee is on secondment, long-term sick, maternity or other leave.

2. Contracts of employment

It is likely a seller will be asked to provide copies of any template contracts of employment. Furthermore, a seller should be prepared to confirm which employees are employed under which template contract of employment.

Practical tip: if you have several template contracts of employment, mark them “Contract A, Contract B, etc.” and then update the employee schedule to confirm which employees are engaged under which template contract.

3. Employee handbook/ policies

A buyer may also wish to see copies of the target’s policies and procedures, including those contained in a staff handbook. A seller should be ready to upload these documents to the data room.

4. Directors/ shareholders

What is going to happen to the target’s existing directors or any employed shareholders following the sale? Are they remaining employed or are they exiting?

How have director/ shareholders been remunerated (e.g. salary and/ or dividends)? If they are also considered to be employees of the target, have they always been paid in accordance with the national minimum/ living wage?

A buyer may ask for details of their current employment terms, together with copies of any service agreements. Where there are none or where existing service agreements are outdated, a buyer may insist that any directors/ shareholders remaining employed enter into new service agreements.

Practical tip: a seller may consider reviewing/ amending/ implementing service agreements in anticipation of a share sale. However, there is no guarantee that a buyer will be happy with the terms and new agreements may need to be negotiated as part of the deal.

Are any of the current director/ shareholder’s family members employed by the target? Can the seller evidence the work that has been undertaken by such family members? Do they also intend to remain employed following the sale?

5. Contractors

Is anyone engaged by the target who is not listed on the employee schedule (i.e. self-employed contractors/ consultants)?

A seller should gather copies of any consultancy agreements to upload to the data room.

A buyer may raise further enquiries to understand how much a consultant/ contractor has been historically paid and to try and understand the risk of claims to the extent that the individuals may be deemed to be employees or workers both for employment rights purposes and tax compliance. A seller should be prepared to answer questions about employment status.

If any of these individuals are engaged via personal service companies, then a buyer may want to understand whether there are any tax risks, specifically if the off payroll working (IR35) rules apply. A seller should gather its employment status determination test results and any subsequent correspondence with its consultants/ contractors.

6. Starters/ leavers

Depending on the size of the target, a buyer may want to know about any offers of employment that have been made, or maybe just offers above a minimum threshold of remuneration or seniority.

A buyer will want to assess the risks of any recent leavers pursuing employment related claims against the target arising out of their employment and/ or its termination. A seller should collect details of any employee who has resigned or has been dismissed within the last 12 months, together with details of each ex-employee’s:

  • effective date of termination;
  • length of service as at their date of termination;
  • reasons for leaving or dismissal; and
  • copies of any relevant correspondence (resignation/ dismissal letters).

Have there been any large-scale dismissals (i.e. redundancies)? If so, a seller might be asked to provide further information about the target’s rationale and consultation process.

A seller may save themselves answering any further DD enquiries if they can provide reassurance to the buyer that is not anticipated that any recent leaver will pursue any employment related claims against the target.

A seller might also be asked for details of any employee currently serving a period of notice.

7. Litigation

Is there any existing, pending or threatened employment litigation?

If so, the seller should be prepared to disclose further details including:

  • the nature of the claims;
  • the sums being claimed by the claimant and the estimated value of the claims with reference to merits of the claims succeeding;
  • any impending case management orders;
  • the date(s) of any upcoming preliminary or final hearings; and
  • the progress of any settlement discussions.

Practical tip: where a target has ongoing claims, a seller could provide this information in a schedule.

Has the target been contacted by ACAS recently in relation to any current employees or ex-employees?

8. Variable pay

The seller should collate copies of written bonus/ commission scheme particulars ready to upload to the data room. It should also ensure that it is clear from the employee schedule which employees are entitled to participate in which scheme.

Does the target make regular overtime payments? Information should be included about overtime or similar payments and any allowances.

9. Holiday pay

A seller should be prepared to explain how holiday pay is calculated. Does it include any variable pay and if so, what reference period is used? It is common for buyers to raise concerns that holiday pay has been based on contracted hours only and not on all relevant aspects of pay.

10. TUPE

Has the target been party to any TUPE transfer within the past three years? This information is requested because it can be more difficult to revise terms and conditions of any employee who was transferred under TUPE into the target, and they may have some unusual terms as well.

Practical tip: a seller may consider identifying these employees on the employee schedule and pointing out where there are any enhanced historic employment terms.

11. Trade unions

A buyer will be keen to understand whether there is any recognised trade union, applicable national or local trade union agreement, staff association, works council or elected employee representatives. A seller should gather copies of all trade union recognition or other collective agreements and be ready to upload them to the data room.

It is important for the seller to keep in mind that the purpose of the DD process is for the buyer to assess risk. Any identified risks may result in a reduced purchase price or a request for a warranty/ indemnity in the share purchase agreement.

A seller should be transparent about any known risks but may wish to consider whether there are any arguments to help give the buyer comfort about: 1) the likelihood of the risk materialising, and 2) the impact on the target if the risk does materialise.

For example, underpayment of holiday pay, where variable pay has not been included within the calculation, is a very common risk identified as part of employment due diligence. Buyers will often seek an indemnity in relation to this risk. However, a seller might consider arguing that the risk is not a material one if it can provide a schedule of all variable pay made to employees over the past two years to show that either: 1) variable pay is not regular, and/ or 2) that the value of such claims would be low.

To discuss any employment due diligence issues, contact a member of our team here, or one of the authors listed below.

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