K12 merger and acquisitions – a transaction refresher

15 JANUARY 2020

| 5 min read

With 2020 expected to bring investment into kindergarten to year 12 (K12) we take a closer look at key aspects of a typical M&A process for sellers of, and investors in, nurseries and schools in England and Wales.

Having arrived in 2020 with a new majority Conservative Government firmly in place, operators of and investors in K12 institutions are quietly getting back to business. Although the recent fraught and hotly contested election campaign naturally had Brexit as its centre-stay, sector stakeholders were acutely aware of the Labour manifesto promise to charge VAT on school places alongside discussions as to whether charitable status for independent schools should be removed.

While arguments for and against VAT on fees and charitable status can and have been made, removal of the uncertainty surrounding the tax and charitable status of independent schools is allowing investors and operators to move forward with fewer concerns of a more challenging (from a fees perspective, at least) educational landscape on the horizon. We – as a law firm operating in the education sector – have seen this clearly evidenced in the sudden release of instructions embargoed pending the December 2019 election and satisfaction of milestones that will allow transactions and investments to proceed.

The transaction process and timeline
Although there is no ‘one-size-fits-all’ when it comes to K12 M&A – for instance, different milestones and documents will be required if the school is a private school generating profit for shareholders or a charitable institution, if the sale is a sale of a company or of assets, or if the buyer or seller are institutions or a collection of individuals – all transactions broadly fall into the same pattern:
- Initial DD, Price and Heads of Terms – agreeing and recording the key sale terms;
- Due diligence – the buyer checking for skeletons in the school’s closets;
- Negotiating the sale documentation – recording the sale terms;
- Disclosure – the seller’s opportunity to put the buyer on notice of key concerns against warranties sought by the buyer;
- Completion – signing the documentation and moving forward.
One question we get asked a lot is how long the process will take. A sale of a single site with few issues can be completed within a month or two if the parties are sufficiently motivated. However, we generally recommend that parties allow between four and six months for a typical and relatively smooth process to complete.
Initial due diligence, price and Heads of Terms

Before anything else…

A school isn’t your typical commercial business; it doesn’t make products or sell a straightforward service which will be perfectly acceptable to its customers as long as they serve their purpose and come with a good warranty. A school is a fluid organism with a variety of stakeholders – from parents, through employees to the local community – tasked with providing its pupils with the foundations for a future. Reflecting this, a school’s operation will be subject to a high level of public and regulatory scrutiny, and its failure will have consequences going beyond simple insolvency.

With that in mind, any seller’s or buyer’s first step onto the transaction ladder must be to undertake some preliminary due diligence to ensure the school is in a position to be sold and, if a buyer has been identified, that the aspirant next proprietor is able to ensure its future. For instance, a seller should ensure that the school is performing solidly and has strategies in place for continued excellence or improvement, while a buyer will want to look at its historic academic performance and ensure that it has the infrastructure in place to support and nurture the school in the future.

To a certain extent a buyer can undertake their initial consideration from a distance but once high level checks have been completed, a buyer will want to engage more actively with the school’s owners.

Proposing a price

Once the buyer is happy the school is a good target and/or fit for its portfolio, it will want to put forward an offer. There are a variety of different pricing structures to consider. For instance, a school performing well will likely be valued using an EBITDA multiple while a school with substantial property that’s performing less well may be valued on an asset basis.

Both the school’s sellers and its prospective new owner should ensure they take professional advice on how the school should be valued and what an appropriate price would be in the current market.

Agreeing the Heads of Terms

Once key sale terms have been agreed, they should be recorded in a set of heads of terms (also known as a memorandum of understanding). While not an essential step – and noting the commercial terms in the document are generally not legally binding – heads allow both parties to set out any red-lines (for instance, whether key management is to be retained) and will offer a party at least the moral high-ground if the other party decides to vary terms as the transaction continues.

Of course, it should be borne in mind that heads of terms are a good place to include obligations of confidentiality and exclusivity (two of the few legally binding terms usually contained in the document).
Due diligence

With heads agreed, the buyer can get down to ‘kicking-the-tyres’ of the school to ensure they don’t fall off. Broadly, a due diligence process is a series of investigations – typically legal, commercial and financial – to ensure the school is in the hoped-for condition. Key areas to look at include the school’s academic performance, accounts (management and annual), real estate title, employment contracts, commercial contracts and any ongoing or anticipated disputes or complaints.

In no small way, the due diligence process is the buyer’s first line of defence. While the final transaction documentation (below) will include a number of warranties from the sellers (effectively contractual promises as to the condition of the school at completion), prevention is always better than cure and it’s far preferable to identify any issues upfront than to have to deal with them later. As such, the buyer should ensure its due diligence process is appropriately thorough to minimise issues down the line.

A buyer’s advisers should be able to help with this exercise.
Transaction documentation
As the due diligence process continues, the buyer’s solicitors (typically) will start preparing the acquisition documentation. Depending on the transaction, this will vary but key documents will include:
- The Purchase Agreement (known as an SPA (share sale) or BPA (business and asset sale)) – the document setting out all terms agreed between the parties, including the price and any post-completion adjustments, any post-completion restrictions on the sellers and a set of warranties.
- Tax Covenant – if the school is run by a company, the sellers will typically covenant with the buyer to meet any tax that has accrued but not been paid up to completion. Of course, the price should have taken into account any accrued but unpaid tax liabilities, meaning the tax covenant is more a protection for unanticipated or undisclosed liabilities.
- IP / Real Estate assignments / transfer – if the school is not run by a company or other type of entity with a distinct legal personality (for instance, an unincorporated partnership), the sellers will transfer the IP and Real Estate using separate documentation.
On receipt of the transaction documents, the sellers will start preparing a disclosure letter (as below).
The disclosure process

If the due diligence process is the buyer’s first line of defence, the disclosure process is the seller’s. As above, the SPA prepared by the buyer’s solicitors will contain a number of warranties asking the buyer to ‘stand behind’ the state of the school at completion. Typical warranties include confirmations that the school’s accounts have been properly prepared, that the school’s property is registered with the appropriate Use Class and that the school has complied with various regulatory duties. If a warranty is not true and the buyer is not formally told that it is not true, the buyer will be able to claim damages for a breach of warranty.

With this in mind, the disclosure process and letter is the seller’s opportunity to formally put the buyer on notice of a breach of warranty. If done correctly (and a seller should take professional advice on how to do so) the buyer will not be able to make a claim for any breach where details of that breach were notified to the buyer in the disclosure letter.
Completion

Once all the documents have been agreed, Completion can take place. Pre-2008 the various parties would meet to sign documents together. These days, Completion is more likely to take place remotely with the parties’ solicitors’ carefully – and in compliance with current legal requirements – co-ordinating signing of the various documents.

Of course the various parties will want to ensure appropriate engagement about the change of ownership with other stakeholders – especially the parents and students. If the sale was completed by means of a company sale, the announcement of the acquisition may be the first external stakeholders hear so the parties will want to be careful to time Completion appropriately (for instance, at the end of a term or year) and likely will want to work together to ensure the transition takes place as smoothly as possible.

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Jonathan Greenwood

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K12 merger and acquisitions – a transaction refresher

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