Creating a solid and profitable Business requires research, planning, hard work, and a short to long term strategy.
If you purchase an existing Business you are foolish if you do not carry out proper and full due diligence. You may not know how to do this but you should engage a law firm that does know how to conduct due diligence.
The engine room of many businesses is its legal documentation and contracts with –
Its customers, its employees, its suppliers and protection of its intellectual property.
The contractual relationships can be complex which must be managed with care. Right from the outset you must be certain of your business structure, the contracts that have been struck with the obligations required to be met. A mistake can be costly and destroy your business.
In general, you are purchasing the assets of the Business. If the operator of the Business is a company, you either purchase the assets from the company itself or the shares from the individual shareholders of the company.
As the purchaser, you should only buy the assets you require and not incur any company liabilities.
In turn, the shareholders of a company wish to sell their shares so they can absolve themselves of any future liability. So you the purchaser when purchasing their shares would obtain warranties and indemnities from the Sellers about future liabilities of the company.
The decision as to whether or not to buy assets or shares is critical and to make such a decision you must appreciate; type of business, the circumstances deal, any unique contracts or licences that exist that the business might have, tax implications, and more.
One of first decisions you must make when you negotiate the purchase with seller is identify the structure of the business you want to purchase because to later alter the structure mid-way through the deal will likely cost you a small fortune in wasted costs.
Also as part of the process to negotiate the purchase there should be various preliminary agreements you would need to consider and in regards to which you should take advice.
A seller of a Business will to keep the sale confidential from clients and staff (and other third parties).
In the event the sale of the Business does not proceed, the seller will not accept that their commercial circumstances are made public.
The essential terms of a transaction would be laid out in a preliminary document such as a Heads of Agreement.
This agreement would include a clause such as; this agreement is “subject to contract”.
The Heads of Agreement does not bind the parties to enter into a binding contract to purchase the Business but it intent would be the seller providing to the purchaser an ‘exclusivity period’ during which the purchase would consider the terms of the purchase and carry out due diligence.
Due diligence that should be thorough and detailed covering every aspect of the Business.
Due diligence is the process of investigating the Business to make sure that the information the seller gives you is accurate and there are no commercial issues of which are adverse and you do not know.
At time, this point your lawyer would use the sellers answers in drafting the purchase agreement and create in the agreement specific clauses to address any risks or problems unearthed during due diligence.
Some of the material issues a purchase agreement may address -
Stock – list out and value all current stock, then do a stock take on or after completion to make final adjustments to the purchase price.
Plant and Machinery - list out all plant and machinery - hopefully the seller will have a full asset register, plus copies of hire purchase or lease agreements.
Goodwill - this is the premium over the book value of the business, which typically represents things like the value of the brand, customer base and IP.
Creditors/debtors - the seller will generally remain liable for creditors until the completion of sale, and retain debtor payments owed to the seller.
Employees - if you’re buying the business as a ‘going concern’ then the employees will usually be transferred automatically. You should get detailed advice on this because the financial consequences can be significant.
Contracts - all contracts and agreements with third parties and the business should have been identified and reviewed during due diligence. You’ll list out those documents and add any specific clauses to protect yourself against potential liabilities found in those contracts.
Warranties – these are a series of contractual statements made by the seller about the business as at the time of completion of the sale. They are particularly important.
Assignment deeds – if you wanted to take over the hire purchase or leasing contracts for plant and equipment, you might need both formal consents and signatures from the hire purchase/leasing company before you can be assigned and take possession of the plant and equipment.
Where business premises are involved in the purchase, you’ll also need:
Transfer document - this is a formal transfer document that will be needed, like in any other conveyance.
Landlord consents - if the business premises is being leased, you’ll need the landlord’s consent (at your expense) to get the lease transferred or assigned to you. This really increases the complexity of the transaction and can take a lot of time or even completely stop a transaction.
Personal Guarantees - the landlord may require you (and your directors if relevant) to give personal guarantees or other security as condition to getting the landlords consent.
Licence for early possession - the seller might give you a temporary licence to occupy the premises, on the understanding that you’ll both will do your best to get the landlord’s consent as soon as possible after completion of the purchase.
If the deal is structured as a purchase of company shares, the main document you’ll negotiate is a share purchase agreement.
YOU are purchasing the underlying company shares and in effect taking on all the assets and liabilities of the company.
These are a long series of clauses that act like statements made by the seller to you as at the time of settlement.
Example - That the seller is the lawful owner of the company assets or that company isn’t about to be sued etc. They’re supposed to be comprehensive, so expect them to run over many pages. A lot of warranties are boilerplate (like the above examples), but where they really add value is when they deal directly with issues discovered during the due diligence process.
The trick will be to balance your need to have a comprehensive set of warranties in place, while being reasonable in terms of both the number and scope of the warranties. These will be heavily negotiated and you’ll rely heavily on having a competent lawyer on board for this negotiation.
The seller will usually also want to include some clauses that limit their liability in terms of both the amount of liability (i.e. a capped amount) and for how long they remain liable for any breach of a warranty.
If your due diligence reveals any potential problems and liabilities, you must obtain an indemnity from the seller for each issue. An indemnity is a specific type of clause that offers a specific remedy than a claim for a breach of a warranty.
You need to consider preventing the seller from competing with you for a set period using a non-compete clause, a type of ‘restrictive covenant’.
In response to the warranties you’re seeking, the seller (and their lawyers) will carry out a ‘disclosure’ exercise. The end result will be a disclosure letter, which records any exceptions or qualifications to the warranties, instead of changing the actual text of the warranties in the share purchase agreement.
To protect yourself against UNFORSEEN tax liabilities, you MUST obtain a separate tax indemnity from the seller. If later YOU DISCOVER find out that there is unpaid or undisclosed tax owing for a period when the seller owned the company.
For a business purchase, you’ll need a checklist of tasks to check and complete – ABN and GST registration, payroll compliance - PAYG, insurance, etc. – a CHECKLIST AGENDA is required..
So clearly purchasing a business is not simple, it requires thorough due diligence and preparation, with an understanding of the proper legal framework and the correct preliminary documents for the business you purchase (whether you’re buying assets or company shares).
In each case the steps taken and documents required will differ depending on the structure of the purchase. The above is far from a complete list of what needs to be considered in purchasing a business.
In purchasing a business there is a lot at stake and potential risk that should be minimised. You need the right legal advisors to minimise your risk and purchase the business with confidence.
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