Corporate records due diligence when buying a business: ownership and transfer rules

When you buy a business, the corporate records are one of the first things your solicitor will review, and for good reason. The company's own internal documents can stop you buying the shares, and very often the sellers do not know those restrictions exist. Pre-emption rights, board approval requirements and restrictions buried in the articles of association can all block a deal. This is the first part of my due diligence series, and it covers what corporate records are, the questions to ask the seller, the documents to inspect and how to fix problems before completion.

What are corporate records and why do they matter?

Corporate records are the internal documents that govern how a company is run. They tell you who owns the shares, what rights attach to those shares, and what rules the company must follow.

When you buy a business through a share purchase, you are buying the shares from the existing shareholders. That means you need to confirm two things: that the people presenting themselves as the sellers actually own the shares, and that they have the right to sell them to you. You also need to understand what restrictions exist around transferring those shares, which are typically found in the shareholders' agreement or the articles of association.

Corporate records vs property title deeds

The comparison I use with clients is buying property. You would check the title register and title deeds at the Land Registry before you paid for a house. Corporate records serve the same purpose for a company: they prove ownership and reveal any restrictions that could affect the transaction.

If the corporate records are messy, incomplete or inconsistent, treat that as a warning sign. It may mean the company has not been properly managed, and it can create problems after the deal completes.

Do the sellers legally own the shares?

The first check sounds obvious, but you would be surprised how often there are discrepancies. You need to verify that each seller is recorded as the legal owner of the shares they are selling.

• Check the company's register of members in the statutory registers.
• Compare it with what the sellers have told you.
• Compare both with the information held at Companies House.

If there are any mismatches, investigate them before you proceed. Paying the wrong person, or paying for shares the seller does not legally hold, is not a problem you want to discover after completion.

What are pre-emption rights?

Pre-emption rights give existing shareholders a right of first refusal when another shareholder is transferring or selling their shares. They matter most where the company has more than one shareholder, because if not everyone is on board with you becoming the owner, the rights can be used to get in the way. Even where every shareholder is selling to you, the rights still technically apply to each transfer, so they have to be dealt with rather than ignored.

These restrictions are typically found in the articles of association, which are accessible through the company's Companies House profile, or in a shareholders' agreement between the shareholders. A shareholders' agreement is not publicly available, so you will need to request a copy from the shareholders.

How to waive or disapply pre-emption rights

If pre-emption rights exist, the other shareholders will need to waive them. In practice that means:

• Including waivers in the share purchase agreement.
• If necessary, following the process set out in the pre-emption provisions themselves.
• Where the rights are in the articles, it may simply be a case of passing a special resolution, at the same time as the board approves the sale, stating that the pre-emption rights in the articles are disapplied for this transfer.

Board approval for share transfers

Beyond pre-emption rights, there may be other restrictions on transfer. Some articles require board approval before shares can be transferred. In fact, the vast majority of articles of association require a board meeting at which the directors approve the transfer. So you need the directors of the company to be on board with you becoming the new owner as well as the shareholders. In a small owner-managed company the directors and shareholders are usually the same people, but the approval still has to be given formally and minuted.

Conflicted directors and quorum

Some articles go further and say that a director who is also a shareholder cannot approve the sale of their own shares, because of the conflict of interest. If that is the case, you will need to make sure that either the conflict of interest provisions are disapplied by special resolution, or there are enough unconflicted directors present at the meeting to form a quorum, so that decisions can be validly made even if the conflicted director is not counted.

Risk of an invalid share transfer

In short, you need to understand what hoops you have to jump through, and then jump through them properly, exactly as the relevant documents require. The risk of missing a hoop is that the transaction is later held to be invalid. That is typically what happens if the correct procedure is not followed and someone decides to challenge the transfer.

Articles of association: what to check

The first document to inspect is the articles of association. These are the company's rule book: they tell you how shares can be transferred and what approvals are needed. Pay close attention to any bespoke provisions around share transfers and pre-emption rights. If the company has complied with its filing requirements, the articles should be available on its Companies House profile.

Shareholders' agreement: drag along and non-compete

Not every company has a shareholders' agreement, but if one exists you must review it. It often contains additional restrictions on share transfers, drag along rights and non-compete obligations.

What is a deed of adherence?

This becomes especially important where there are multiple shareholders and one of them is staying. Suppose a minority shareholder with 1% intends to remain in the company. The shareholders' agreement will usually require a new shareholder, meaning you as the buyer, to sign a deed of adherence: a short document that says you will adhere to the existing shareholders' agreement.

The effect is that when you enter into the share purchase agreement, you are also entering into the shareholders' agreement through the deed of adherence, and you will be expected to comply with whatever it says. So read it before you sign, not after.

Statutory registers: members, directors and PSC

Lastly, review the internal statutory registers: the register of members, the registers of directors and secretaries, and the register of people with significant control. The register of members is the main one. It lists the existing shareholders, how many shares each holds and what class of share they hold.

This is how you confirm who all the sellers in the transaction are, and whether there are share classes or minority shareholders you were not aware of and have yet to meet.

Share certificates and indemnities

As a bonus check, make sure the sellers have their share certificates. Share certificates are the evidence of ownership of shares, and the details on each certificate, the holder's name, the number of shares and the class, should match the register of members you have just checked. If anything is missing, the sellers should give you an indemnity to cover you.

How to fix messy corporate records before completion

What if the sellers do not have their corporate records at all? This is actually quite common, especially with smaller companies. Your solicitor will need to work with the sellers and their solicitors to either tidy things up before completion, by reconstituting the registers and dealing with any missing approvals, or put in place indemnities that protect you as the buyer if a problem surfaces later.

Next steps

Before you spend money on the rest of your due diligence, get the articles, any shareholders' agreement and the statutory registers from the seller and check that the people selling are the people who own the shares. Then map out every approval and waiver the documents require, so that the share purchase agreement and the completion board minutes deal with each one. A corporate solicitor should do this review for you; it is routine work, but it is where otherwise sound deals go wrong.