As reported in the media earlier in the year, rapper Jay Z’s investment company, Project Panther Bidco Ltd is preparing a “giant lawsuit” against the previous owners of its global music streaming service, Tidal, for allegedly exaggerating the number of subscribers to the service during negotiations of the acquisition. This potential action acts as a high profile reminder of the crucially important role that both due diligence and disclosures by a seller play in any share or business purchase.
Tidal has experienced rapid growth within the music streaming industry since being acquired for $56 million in March 2015 and in July this year claimed to have 4.2 million paying subscribers to its service. This is a giant step up from the 540,000 subscribers reported by the former shareholders of the target company, the Aspiro Group, who operated Tidal’s service under its previous name of WiMP.
It has now emerged, however, that after conducting its own post-completion audit of the business, Project Panther Bidco has calculated that the total number of subscribers was well below the 540,000 reported by Aspiro’s shareholders. As a result, Project Panther Bidco has commenced legal proceedings against the former owners in respect of this alleged wrongful reporting in a claim estimated to be worth around $15 million.
Due diligence and disclosures
For any seller, facing the prospect of handing back money received on the sale of its business is clearly an extremely tough position to be in. Equally, from a buyer’s point of view, it would always be preferable for any issues which could lead to a potential warranty claim being identified and resolved before completion so that the true value of the business is paid at the outset. Buyers should appreciate that unless asked specifically to do so, a seller is under no legal obligation to offer up information on any particular matter during negotiations and the law does not imply any protection for a buyer who has been caught out by failing to ask the right questions of a seller in advance of making the acquisition.
In the build up to completion of any transaction, buyers should ensure that a thorough due diligence exercise is carried out which is bespoke to the target business. A “one size fits all” approach to the enquiries being asked is not enough and buyers should make sure that the process is tailored to focus on the issues which are specific to the target business and the industry within which it operates. In return, a seller should commit time and resources into providing responses with as much detail, clarity and (above all else) accuracy as possible to ensure that the buyer can properly assess the affairs of the target business at an early stage.
Given the opportunity to review the results of a well-co-ordinated due diligence exercise, a buyer and its advisors will then be in a position to tailor the terms of the sale and purchase documentation to properly reflect the issues and possible areas of risk that have come to light. In particular, this should result in the seller being asked to give considered and focussed warranties rather than a wider and generalised set which leaves both sides more open to potential dispute after the event. In addition, the buyer will have the opportunity to propose specific indemnities to protect it in the event of any identified issues crystallising after completion of the transaction, typically this will be in the form of pound-for-pound compensation from the seller which by-passes the limitations, time and costs of bringing a claim for damages. Another option for a buyer seeking to manage an identified risk could be to request that part of the purchase price is deferred or paid into a separate escrow account until such time as the risk has passed. In some cases, it may even be possible for a buyer to successfully negotiate a price reduction of the target company or business.
In providing disclosures to the warranties, the seller should at all times maintain the approach from due diligence of providing as much detail, clarity and accuracy as possible within the disclosure letter. A seller should never assume that its buyer is aware of a matter through previous informal dialogue, any historical course of dealings between them or otherwise, and so should ensure that all disclosures are made as explicit as possible.
So there is a huge benefit to both parties if the buyer can be given clarity and awareness of the key areas of the target business at an early stage. This will have a positive impact on the suitability of the terms entered into at completion and in turn, reduce the risk of possible dispute after the transfer of ownership – an outcome which should be the objective for both sides on any transaction.
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