Purchasing a business is an exciting opportunity that can lead to reward and satisfaction. However, there are several factors that buyers should consider before signing on the dotted line to avoid potential pitfalls. These include conducting due diligence, understanding the structure of the transaction and the assets you are purchasing and key protections that should be included in the contract.
Below are Coleman Greig’s top tips for purchasing a business.
- Know the structure of the transaction
When considering the purchase of a business, it is important to understand whether it is a purchase of the business, which will comprise a collection of specific assets and associated liabilities, or whether it is a purchase of the entity that owns the business (normally a company or trust).
Relevant considerations include:
- whether you are prepared to accept all the liabilities of the company if you are purchasing the shares in the company, or if you would prefer the certainty of assuming only specific liabilities in purchasing the business;
- taxation consequences;
- stamp duty consequences; and
- employee entitlements that may crystalise.
- Conduct due diligence
Due diligence is a crucial step in the process of purchasing a business.
Undertaking due diligence can help you understand the profitability of the business and is important in confirming the business has complied with relevant laws so that you can reduce your future liability. Items that you should consider before commencing and finalising negotiations include, but are not limited to:
- the proper legal identity of the seller;
- assets of the business and confirmation of the ownership of all assets purporting to be sold;
- whether the assets are encumbered and whether there are any security interests over the assets registered on the Personal Property Security Register that will need to be removed;
- whether any guarantees will be required;
- who will act as covenantors on things such as warranties;
- the business plan;
- the profitability of the business;
- the liabilities of the business;
- how the business is perceived within the marketplace;
- a review of historical and forecasted sales figures;
- the costs of operating the business;
- the employees of the business; and
- key contracts with suppliers and customers.
- Understand the purchase price and whether the business is being sold as a going concern
You should ensure that the method used in valuing the business is reasonable and accurate. Be sure that a method that is relevant to the specific industry or profession is being used.
You should also consider whether you wish to purchase the business on a stock inclusive basis, whether you wish to adjust for stock levels on completion or whether you will pay for stock as an additional sum. Many contracts will also require adjustments to the purchase price, such as amounts for accrued employee entitlements and other variables, which cannot be finalised until completion.
You should also understand whether the business is being sold as a ‘going concern’ for GST purposes. The business is sold as a ‘going concern’ if the sale includes all the assets and other elements required for the continued operation of the business and the business is carried on until it is sold. The supply of a business as a going concern may be GST-free if the following requirements are met:
- the purchaser is registered for GST on or before the date of the supply;
- the supply is for consideration;
- the seller carries on the business until it is sold;
- the seller supplies to the purchaser all of the assets and other elements required for the continued operation of the business; and
- both parties agree in writing that the supply is of a going concern.
However, if the business is not sold as a ‘going concern’, GST may apply and a tax invoice should be issued on completion so that GST can be paid and input credits can be claimed.
- Understand how you will take possession of the premises
If there are premises from which the business is conducted make enquiries as to whether the premises are leased or provided under licence. If there is a lease or a licence, consent from the landlord will generally be required for the transfer of the lease. This takes time and will need to be factored into sale timeframes.
- Carefully review the material contracts
You should carefully review the material contracts with suppliers and customers and the lease (if applicable) and ensure that they are capable of being assigned if there will be a purchase of the business. If there are any change of control clauses in such contracts, the seller will likely need to be obtain consent before the sale to ensure that it is not in breach of these material contracts. Close attention should also be paid to terms of the existing contracts as the purchasing entity will be required to comply with the terms of each contract after completion.
- Identify key personnel and whether such personnel are to be offered employment
If there are employees, the seller should provide you with a table of each employee’s name, position and accrued employee entitlements. The employee entitlements up to completion will be the seller’s responsibility. However, there may be an adjustment for a portion of accrued entitlements as at completion of the sale in your favour. Note however that when you are buying the shares in a seller entity that owns the business, there will be no change in the employer entity of the employees and all entitlements will remain in full.
You should ensure that any non-salary benefits given to employees are documented. The ‘key’ employees whose employment is important to the business should be identified and you may wish to negotiate a term that acceptance of employment with you by the key employees is a condition precedent to the transaction being completed.
- Ensure there are adequate protections in the contract
The inclusion of certain terms in the relevant sale document will be crucial in protecting you from the risks that may arise during and after the purchase of the business.
Protections you can include in the contract include, but are not limited to:
- comprehensive warranties and representations about the business;
- restraints of trade for the seller and their key personnel, which are critical for a purchaser to prevent a key person from setting up a business in competition after the sale has completed;
- provisions in relation to the intellectual property including warranties in relation to the seller’s right, title and interest to such intellectual property;
- an indemnity from the seller and any covenantors as to the warranties and debts or liabilities of the business; and
- provisions in relation to training from the seller prior to and / or after completion.
It is also important that the contract contains clear terms and arrangements for the payment and delivery of possession, unencumbered title and security of tenure of what you buy.
- Have key advisors
Having key advisors in your corner is crucial. You should consult your lawyer and accountant to advise you on the transaction, including whether the purchase of the business is being sold as a ‘going concern’, the tax implications of the purchase and any duty that may be payable. Your lawyer and accountant can also assist you with the due diligence process. Consulting your lawyer will be crucial during the negotiation stage as they can review the relevant documents and negotiate terms of the contract. Your lawyer can also assist you with settlement of the purchase of the business.
Key Takeaways
Managing the key factors that we have identified are essential to successfully undertaking the purchase of a business. It is important to understand what you will be purchasing, to protect yourself and ensure that all matters relating to the purchase are attended to.
If you have a query relating to any of the information in this piece, or you would like to speak with a lawyer in Coleman Greig’s Commercial Advice team with regard to the purchase of a business, please don’t hesitate to get in touch today.
This material is provided by Coleman Greig Lawyers as general information only in summary form on legal topics current at the time of first publication. The contents do not constitute legal advice and should not be relied upon as such. Formal legal advice should be sought in particular matters.
