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.
For many of us, starting our own business is one thing we dream to do but unfortunately, of the many hundreds of thousands of new startups every year, over 80% wont make it past their first year.
A few articles ago I gave 6 Legal Tips for Small Business – those tips could apply to all small businesses no matter what stage of development the business is at.
This article gives some special tips for startup businesses. To get the best use out of the article, I suggest that you don’t just answer the questions raised with vague comments to yourself – but really ‘get inside’ each issue.
So, here goes, here are some things for start up businesses to consider if you haven’t already thought of them….
If you are starting or operating a small business by following the tips in this article you will have a solid legal framework for your business success.
In the beginning
I am assuming you’ve already done your homework and worked out there is a need for the product or services you are going to provide and that you have the skills to do the job. If you haven’t then bookmark this article and undertake Due Diligence before you commit. “What the....” you say?
“Due diligence” is a fancy legal term for undertaking a detailed assessment of the risks and benefits of setting up your business. It is particularly important if you are looking at buying an existing business, renting premises, or taking on a franchise, because in those cases you will want to look very closely at what you will be getting and who from.
A thorough analysis of pros and cons is always recommended. See a lawyer, see an accountant, take advice wherever you can get it, but ultimately it is your business so you need to know and understand the risks in it.
Don’t commit to anything until you have seriously examined and understand contracts, leases, local authority and government requirements/restrictions, financial records (if you are buying into a business or franchise), product security, upcoming zoning issues.
There is a heap of public information available to help with your research. If you need to see private commercial information from the seller or franchiser there’s a good chance you will need to sign a confidentiality agreement. READ IT before you do. Feel free to message me for more hints on this.
Well, that issue dealt with, back to my tips on operating a successful small business:
No. 1 Get Your Business Structure Right
Starting at the very beginning, you need to make sure you set up the right type of business structure. You have three main choices: sole trader, partnership or company. Each choice has pros and cons. What will work best for you, may not work best for someone else.
A big con for sole trading is, if you personally own assets then operating a business as a sole trader may involve risk of personal financial loss if the business is not successful.
If you intend to operate a business with one or more other people you really, really (can I say 'really' a couple of more times??) need to document your partnership agreement. The Partnership Act does provide protection for partnerships but its a one size fits all approach and we know how that can look! Besides, documenting your agreement helps you to discuss some of the key issues about going into a business together.
Setting up a company can protect individual assets (so long as you are not signing bank guarantees) and can ensure there is a way to work cooperatively with others. If you do choose to set up a company, then there are many other considerations and I strongly recommend you don’t just grab standard documents. Sure, I get that they are much cheaper, but I can tell you from years of commercial litigation experience that its the standard “simple” and “cheap” documents that get people into trouble - (don’t let me get started on home made documents!! What a nightmare!!)
So, decide on business structure as early as possible (and don't forget to talk to your accountant about tax implications!)
No. 2 Comply with the law
Oh I know this sounds obvious, but during the Due Diligence phase you should have identified key licence and permit obligations for your business and one of the first things you need to do as a business is make sure that you hold the correct licences and permits. As soon as you have done that, record the expiry dates in your calendar if applicable - you do not want to find yourself in a position where you realise your food preparation licence is due for immediate renewal and you are booked out solid for the week and have to squeeze in time to attend to it.
No. 3 Put it in writing
Contracts in writing are an absolute must! Whatever terms and conditions you agree to with your customers and suppliers, you need to make sure that these are in writing. It doesn’t mean you have to spend hours in contract negotiations with a suite of lawyers on each team to work through a basic supply agreement, but there needs to be something in writing, it's as plain as that.
A lot of businesses selling or leasing products and services have standard terms and conditions which are attached to their quote. These terms and conditions don’t have to be the size of a book, but there are some basics that need to be included to protect YOU and to give your customer or supplier certainty. So, if you want a ‘for instance’ read on...
How about, what happens if you offer a product by a certain date but you have to get it in from a third party supplier? Or, what happens if you install materials for a builder in a new property and the builder goes into administration? What if you offer a specific service working cooperatively with other service providers - how is your liability dealt with when the ‘you know what’ hits the fan? Its contracts, terms and conditions which will give you a leg to stand on and you need advisers who have been in the trenches to give you the worst case scenario when preparing those documents. Invest in good paperwork. Believe me you will reap rewards in the long run, or at the very least protect yourself from a lot of pain, as a result.
No. 4 Protect your Intellectual Property (IP)
Whats your IP? It’s that logo you spent weeks designing, the catchphrase, the jingle, the recipe/ formula only you use, the marketing strategy unique to your business, the e-book you wrote. Intellectual property is the intangible thing that comes from your creativity, and you absolutely want to protect that, because it forms the very basis for what makes your business unique. There’s no real shortcut. Trying to do this on your own will cost more than time in the end. You will need specialised IP assistance (spoiler alert: Not me!! But I can refer you to someone I trust).
No. 5 Make sure you get paid by having clear and risk minimising payment collection procedures
Small business is more often than not operating at the whim of big business. Payment terms are stipulated by primary contractors, and you just need to go with the flow. But fortunately some of that is changing. One thing you can do is ensure that where you do have control of payment terms you exercise that control.
Insisting on a significant deposit or payment first is very unlikely to be possible in most cases. Payment on delivery of goods and services is obviously the most effective alternative way to ensure payment is received. You should set up everything you can to try to achieve this. Portable EFTPOS, for example, means you have immediate cash flow even though it costs to obtain it.
But COD can be a luxury. If you have to provide goods and services on payment terms, make sure these terms are stipulated in your terms and conditions and on your quote and restated simply on your invoice.
Follow through with debt management when you say you are going to. Make it personal. Don’t leave it to your office assistant to chase up debts. Learn how to chase up debts without upsetting people. (As an aside however, from my experience, the ones who get upset about you chasing up a debt, are in financial trouble, simply don’t treat your payment as a priority or have some problems with the goods or services you supplied. Either way, you need to know.)
The longer a debt is outstanding the more likely it will not be paid. A firm and swift debt collection process is critical to keeping the cash flowing.
No. 6 Apply Employment Laws correctly
If your small business involves employees make sure you get your ducks in a row with employment law. Make sure your employees or contractors have contracts. Have a manual which outlines human resource policies (clear guidelines take time at the beginning but save thousands of dollars along the way). Give your employees what they are entitled to, when they are entitled to it. Make sure that you have poor staff performance issues dealt with promptly and lawfully following the manual you prepare.
Every business adviser will tell you that, if you have employees, they are the backbone of the business so take care of your back!! The costs of recruitment and/or dealing with employee matters including down time are major.
AND ONE GOLDEN RULE
One of the common threads in all of the tips I have given is an overarching rule. Avoid disputes and litigation as reasonably as you can. Sometimes, disputes are unavoidable. Downtime, costs of lawyers and compromised claims cause serious bleeds in your business. By taking preventative steps you can minimise your exposure to these and those preventative steps include the tips above.
I am interested in a dialogue about the subject of business law tips. I look forward to hearing your views.
My legal waiver statement: Seriously, if you are relying on the above tips or anything you find on the internet as legal advice you have big problems already. News and Views is definitely about sharing information and ideas. The only legal advice you can rely on is advice given to you personally after your individual circumstances have been taken into account.
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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