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ensure all costs are captured in the accounts. Paul Weller of Leaders says, “You need to check that the cost base is just the one you’ve been told about and is the agency properly operating the non-resident landlord scheme?” Some agencies have a habit of telling landlords who they know are foreign residents to give a UK address; that exposes them to action from HMRC. Weller points out, though, that there are
two different ways of structuring an acquisition; buying a limited company – “in which case you inherit all the liabilities” he says; “or just buying the assets and goodwill.” Which structure is chosen will dictate what due diligence needs to be done.
FILLING THE GAPS Client funds in any lettings agency also need to be checked. Weller says that quite often there is a gap to be filled when the client funds are not intact. He explains, “Providing the business is worth more than the deficit, we can still complete on the acquisition.” Due diligence is not just about the financial
accounts. Commercial due diligence covers a number of other areas. Weller says, “You need to get under the surface of the business and assess its quality, procedures, compliance, unfair contract terms; you’ve got to be an expert in the Housing Act. The last thing you want to do is buy a business that’s been mis-serving Section 21 notices for ever.” Weller also points that as in most takeovers staff transfers on the same terms and conditions employment contracts need to be checked; pensions liabilities are often an issue. IT also needs to be checked, in particular, whether the business actually has licences for the software it is using. The business premises need checking out.
There may be a potential dilapidations claim by the landlord; there may be lease terms
“We were approached by a company that couldn’t produce any figures at all, no revenues, no profit,
prohibiting assignment or subletting; the lease might be in the name of one of the partners, not the business name. Winkworth’s James Trimble came across one lease which prohibited putting advertising material in the window, pretty much ruling out estate agency use. Planning permission also has to be checked. More broadly, the target business’s business needs checking out in detail, the type of properties it sells or rents, the fee structures and the type of clients it attracts. Leaders’ Weller says, “Fee structures are something we’ll pay a good deal of attention to because they have to agree broadly with our own.” Lettings agents with very low fees may attract poor quality landlords, or ‘accidental’ landlords who will exit the business as soon as property prices head upwards again. While due diligence is similar for both sales and lettings agents, letting agencies need more detailed vetting for compliance with regulations such as deposit schemes, gas certificates, and segregation of client money. Gonsalves says membership of regulatory bodies is a good sign. “NALS or ARLA gives us quite a lot of comfort when someone calls; it means that somebody independent is checking up on them.” Belvoir will still always do its own checks, though. Gonsalves says that even with reputable lettings agents, “When you lift the lid you
no balance sheet, nothing.” Dorian Gonsalves CEO Belvoir
often find they haven’t been reconciling their client accounts.” Belvoir’s auditors always track ten randomly selected rentals through the client account and VAT returns, to check that rents are properly accounted for and VAT returns are being correctly filed. If this identifies a potential weakness, more checks will be carried out. More broadly, though, Belvoir’s auditors assess the quality of systems and processes. For instance the property management software might say there is not a gas safety record, but the certificate is actually held on file, that is an issue, but not nearly so bad as if the certificate has never been filed at all. Checks also include Financial Services Authority documents, EPCs, tenancy agreements, and terms of business. The legal contracts are important because
they define the business – Gonsalves says, “What you’re buying is the goodwill; you’re
“One lease prohibited advertising material in the window, pretty much ruling out estate agency use.”
not getting any assets. You’re buying landlords, which are defined by the terms of business, and lettings, which are defined by the tenancy agreements; if those contracts aren’t there, or aren’t valid, the acquisition is substantially devalued.” Ensuring all the terms and conditions are legally enforceable is crucial. Yet still, some agents do not have any
understanding of the situation. Gonsalves recalls examining an acquisition and asking if the potential suitor had its terms of business on file. “Is that similar to a tenancy agreement?” was the response to Gonsalves from the selling agent. Such a naïve answer sends a fairly simple message to the potential acquirer – walk away. But there are few cut-and-dried correct answers in due diligence. Weller says that with many issues, the acquirer has to take a value judgment. He asks, “Has this happened because their management is slack, or did we have a suspicion that these people are rogues or was it a single transgressing employee?” Occasionally, he says, problems in the business accounts reflect marital breakdown
www.the-negotiator.co.uk TheNegotiator l June 2012 l 23
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