So you have found a business you would like to buy. It’s just what you have always wanted to do, and there’s a real market for it. If this sounds like you, then read on.
Before you sign a sale and purchase agreement (contract), you really should take a close look at the existing business - identify the business’ major strengths and weaknesses so that you can identify any concerns you might have. These concerns might be addressed by adjusting the price you are prepared to pay or detailing what you want in the contract. Find out why the business is being sold.
You also need to ask yourself some key questions, including:
1. Who will be the purchaser?
You have to decide on an ownership structure to suit your needs. You could own and operate the business as a sole trader, in partnership with one or many other owners, or through a company or trust. Alternatively, you could divide the ownership and operation of the business and use one entity to own the assets of the business and another entity to operate the business.
2. What will you purchase?
Most business purchases involve purchasing the business assets (including intellectual property), stock and contract rights (such as leases). However, if the business is owned by a company it is possible to purchase the shares in that company, rather than the business itself. This can be a trickier option, so you should seek legal advice because if you take on shares in a company, you will take on the company’s trading history including its liabilities, existing agreements, any tax due and holiday pay liabilities.
3. What is your offer?
You may only be able to get limited financial information prior to making your offer so your offer should be subject to an investigation of the business (generally called a “due diligence condition”). This will give you an opportunity to adjust your valuation if your offer turns out to be too high after you receive more information. However, you need to remember that your first offer will create an expectation for the vendor and it may be hard to renegotiate the purchase price after the contract is signed so you still need to take your first offer seriously.
You need to consider how the purchase price should be allocated between fixed assets, trading stock and goodwill and work out your options for payment of the purchase price. A fixed price payable on settlement date is easier and cleaner but you could put in place a buy out or partnership plan with the vendor.
HINT: Involve your accountant in this process as there are many ways of valuing a business (and if you don’t have an accountant, then you should get one).
4. What do you know about the business?
As discussed above, a due diligence condition gives you an opportunity to complete a more thorough review of the business before you are committed to the purchase. It gives you time to collect information to verify the business’ performance. You should involve your lawyer, accountant and other advisers in this due diligence process.
During the due diligence period, take the time to look beyond the financials and obtain other information regarding the business’ reputation. Research the market to determine whether demand for the product or service is increasing or decreasing. Research the competition: are they growing? Ask whether it is a business that is easy to replicate and whether there is any point of difference for the business. Talk with as many people as you can within the industry including the business’ clients and suppliers, other professionals within the industry and even the competition.
You may decide that you do not want to purchase the business after you have completed your investigation.
HINT: A good due diligence clause will allow you to cancel your purchase if that occurs or to renegotiate the terms (including the purchase price) if required.
5. Is there a lease?
Many businesses operate from leased premises. You need to ensure there is a lease in place if required and if so get a copy of it to review the lease terms. You need to be comfortable with the length of the remaining lease term and the obligations you will take on under the lease as the new business owner and tenant. You may want to negotiate new terms with the Landlord directly to make the lease a more useful asset however, this may not be an option. Having Landlord consent where necessary is a must-do condition of your contract.
6. What warranties should you include in the contract?
Warranties are promises that the vendor makes to you about the performance and quality of their business. You can sue the vendor after settlement if the warranties turn out to be incorrect. Warranties therefore reduce some of the risks you face when purchasing a business. However, a vendor warranty is only as good as the financial backing of the vendor after the sale because a breach of warranty alone does not mean you can get out of the contract and get your money back. Although warranties are useful you should make sure you are happy to purchase the business without the warranties.
A standard contract contains the following warranties from the vendor:
HINT: To make the warranties more useful where the vendor is a company, it is a good idea to have the contract personally guaranteed by the directors of the vendor company.
7. Are there any key staff?
It is important to identify staffing requirements and key employees for the business as quickly as possible. Employees are often an essential and very valuable asset of the business. If you are purchasing a business (rather than shares in a company which operates a business) your purchase contract will need to address the responsibilities of the vendor to the staff at settlement and ensure that any existing staff entitlements rights are met by the vendor to commence a fresh contract on your terms with the staff members.
HINT: If any staff members are particularly important, you may want to make it clear that you will only purchase the business if those key staff members accept your employment terms (Don't forget you will need new employment contracts and there is likely to be an extra legal cost involved).
8. Remember IT and Social Media
Business trade marks, trade secrets, processes, information and product names are very important and can be significant assets for many businesses. Don’t forget about the social media and internet presence of the business. You need to ensure these items are identified and included in your purchase contract.
9. What stock is included in the purchase?
Are there supply agreements in place and what conditions need to be met to transfer those agreements to you? If the business is a franchise, the ongoing purchase of stock may be tied up with the franchise arrangements.
Also consider what trading stock is actually included in the purchase and make sure the estimated value of that stock is specified in the contract. Under a standard contract the final value of trading stock is determined by way of a joint stock take. You will need to purchase stock up to the estimated stock value as specified in the contract plus a maximum percentage adjustment. You need to make provision for potential stock adjustments in your finance arrangements. Should the final stock exceed the maximum allowance then you can elect what stock to take and the vendor can be required to take the excess stock.
Your contract might also need to ensure that you are not purchasing any redundant stock that is unsaleable.
Purchasing a Franchise requires a thorough review of the Franchise agreement by you and your lawyer before entering into the purchase contract. You need to be fully aware of your potential liabilities and responsibilities under the contract. You will probably be required to pay a Franchise fee and you need to know what support and advantage that fee will give you.
For an existing business the Franchise agreement will need to be assigned to you and you will therefore need to satisfy the head franchisor’s requirements and work with them in order to take over the business.
11. What is the state of the assets?
The vendor should provide you with a thorough list of all business assets. You need to review the condition of those assets and consider:
12. Can this business exist without the vendor?
Review the vendor’s role in the business to ensure that the business can continue without them. Some businesses are so tied up with the vendor’s reputation, skill and undocumented business knowledge that without the vendor there is effectively no business?
13. Can you afford the business?
A close analysis of the financial information you obtain for the business during the due diligence period is very important. You need to plan beyond payment of the purchase price and consider your financial ability to meet the business’ ongoing financial commitments such as its working capital and cashflow requirements.
HINT: Most banks give you access to on-line business planning tools. Its worth downloading one of those to set up a business plan and cash flow projections.
14. Does this business fit you?
Is the business in an industry that you know anything about or will you be starting from scratch? What is your level of responsibility and ongoing role going to be in this business and are you capable in regards to time, skill and experience to give the business everything that it needs?
When buying a business it is easy to get excited about its future. However, you can’t ignore the business’s past. To do so creates significant risks for you. Before you sign any business purchase contract it’s important to consider the types of issues raised in this article and discuss your plans with your advisers. They can help you to manage the risks involved. The aim of reviewing the business history and having conditions in your business purchase contract to enable more review opportunity is to identify the risks involved. If you know the risks, you are more able to make clear-headed decisions about buying and successfully driving the business into the future.
Note from the Author
I get plenty of time to think about legal matters while I am on the road.
This blog shares those thoughts and also answers some of the many questions people ask me. Hopefully there is something of interest to you. If there is a subject you would like covered then let me know!
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