l NEWS EXTRA LEGAL AUDIT: WHY SHOULD YOU?
Adam Bernstein investigates why a legal audit can be a good idea for busineses, regardles of whether they want to sell or not.
AT SOME POINT, every privately- owned business – unless it is shutdown – will need to be passed on to new owners. Before any sale or transfer is completed buyers are going to want to know that the business is in fine fettle. A legal audit can deal with issues so that a business is in a saleable condition. Done properly, a legal audit could be a positive force for change.
According to Mary Elliott, an associate in the Corporate department of law firm Fox Williams, there are a number of key areas ripe for examination in any business, small or large.
The first place to look, says Elliott, is the company’s constitution/ shareholders agreement. “With surprising regularity, small companies discover too late that when there is a disagreement on how to manage the company there is no agreed mechanism to find a solution.” The problem is that directors find themselves facing deadlock just when decisions need to be made quickly. Elliott’s advice here is simple: “If control of the company is split between two or more shareholders, a suitable a shareholders agreement should be in place to govern disputes.” It’s easy to be wise after the event but firms and directors need to be alive to the fact the time critical issues can be very expensive to resolve.
Directors duties Throughout their period of office, directors must be aware of their obligations to the company under the Companies Act 2006. Never is this more important than when a company is facing financial difficulties.
Says Elliott: “When a company is in good financial health, legislation says that directors must act in a way which would be most likely to promote the success of the company. But as soon as a company hits the buffers, directors must consider their potential
liability for wrongful trading and the implications of showing someone preference or completing transactions at below value.” Directors must be fully aware of their duties both in good times and bad and that their activities are sufficiently monitored to ensure nothing is missed.
Management
In difficult times the management of the business and all employees becomes increasingly important. Regular reviews of reporting processes should be conducted to ensure that critical information is passed up to the chain of command in a timely and accurate manner. As Elliott explains, “it is often the workers on the ground that first notice when things are amiss and, when the going gets tough, it is vital that key management decisions are based on accurate and up to date information.” She says that where companies have grown over a period of years it is not uncommon to find layers of management meaning that critical information passes through several hands before it reaches the decision makers, by which time it may be distorted or out of date.
Key employees
Unless the company is run entirely by a sole director, it will rely on key members of staff and third parties such as the accountant. Just one departure of a key member can bring a firm to its knees. She adds that a legal audit is designed to identify key individuals and examine their contracts of employment. It’s not uncommon to find that contracts aren’t written down or are poorly constructed.
Good employees are invaluable assets and companies should be aware that the more important the employee the greater the poachable target.
“Examine your contracts,” says Elliott, “to ensure that the
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right people are being suitably rewarded while checking whether enforceable restrictive covenants are in place to prevent them from being snatched by competitors.”
Key suppliers
As important as employees may be, a business will flounder if it cannot trade on the best possible terms. As well as ensuring that standard terms enjoy sufficient legal protection, a review of existing arrangements can uncover new opportunities for savings or growth by identifying key terms for re-negotiation. On this Elliott reckons that a legal audit can “identify where a business has become overly dependent on one group of customers or a single supplier allowing the company to diversify before it becomes vulnerable.”
In difficult times the knock-on effect of a key supplier going under or a shift away by the customer base can be profound. Just as the Bank of England has warned that consumer credit is being tightened, and interest rates are rising, so it might have a double impact upon on a business. The housing market is already softening and it’s possible that this could translate into a slowdown in new build and other construction. As Elliott notes, “a legal audit can help identify new financing opportunities, as well checking that a company’s finances are readily accessible when most needed. Overdrafts are a classic vulnerability. They’re repayable on demand and are often the first facilities to be examined by any bank wanting to reduce its exposure.” She advises firms to act now and lock in any borrowing before rates rise further. And for firms trading with overseas suppliers in non-sterling currencies, it’s also worth seeking out a good foreign exchange broker to reduce exposure to currency fluctuations.
Premises
No matter if leasehold or freehold property is occupied, premises are a business’s largest outgoing. It’s sensible to consider if it is at risk from a lease that’s about to end or whether it is in a location where it could take advantage of vacant properties to lower the rent. Says Elliott: “Landlords are keen to hold onto good tenants and this can be used as a bargaining tool to fix rent for a longer period, agree to the insertion of a break clause or even allow for sub-letting if the property is superfluous to your needs.”
Compliance
Lastly, it makes sense that when a business is focused on staying afloat compliance can often be overlooked until a regulator or creditors come knocking. Elliott’s position here is clear: “A legal audit will check that your company is update to date with all its corporate and regulatory filings and identify what policies or procedures should be implemented. This will ensure that compliance becomes second-nature and does not fall by the wayside.” As she explains, the last thing a company needs, when focused on keeping financial problems at bay, is a hefty fine.
Summary
While the annual audit of accounts will give a thorough picture of how a company has performed in the previous year it will not provide it with a roadmap to a secure future. Far too many companies do not realise the potential danger their day-to-day activities and management styles pose until it is too late.
By its nature, a legal audit focuses on the legal position of a company and will provide a second set of business eyes which can spot company behaviour that has become entrenched over the years, but which could prove costly in times of difficulty. BMJ
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