Here are 6 legal tips for buyers who are considering buying a business.
1. Due Diligence
A buyer should undertake due diligence of a business to assess commercial viability and risk before committing to a purchase.
While a buyer will sensibly conduct its due diligence prior to signing a contract of sale, we would still recommend that buyers include a due diligence clause in the contract that allows the buyer to conduct detailed due diligence investigations even after the contract is signed to give an extra opportunity to make sure the business is right for them. The buyer might be given anywhere from 7 days to up to 30 days or longer (depending on the scope of the due diligence) to conduct its investigations.
A due diligence investigation clause might require the seller to disclose:
- copies of the lease, sub-lease, licence or other agreement in relation to the business premises
- copies of all business contracts, including those that may require consent from a third party
- details of all assets (including plant and equipment)
- details of any litigation or court action
- details of the liabilities of the business
- details and copies of any licences required to operate the business
- copies of employment records and other material documents or contracts relating to the business operations.
Where a buyer is not satisfied with its due diligence investigations on reasonable grounds, it will usually have a right to terminate the contract.
The Land and Business (Sale and Conveyancing) Act 1994 also gives a buyer of a “small business” (being a business where the total purchase price of the business is $300,000.00 or less) a right of disclosure of certain information about the business. This information is set out in a Form 2 – Vendor’s Statement and includes:
- a summary of the financial performance of the business;
- trading statements for the last 3 financial years; and
- other particulars, including the period of time the seller has been carrying on the business and the trading from the business premises, the lease terms, workplace and employees.
We recommend that a buyer of a business that does not fall within the category of a “small business” should insist on this information from the seller.
A buyer should consider its funding arrangements for the purchase of a business. For example, cash, third party finance, or vendor finance (or any combination thereof).
If a buyer will require finance for the purchase, then the sale contract should contain a subject to finance clause as a condition of the contract on agreed terms, such as timeframe for finance approval and minimum loan amount or required loan terms.
Usually where finance is provided by a lender, the lender will register a security interest against the property of the business and sometimes the shares of the company.
3. Commercial Lease
A properly drafted contract of sale should contain a clause that requires the contract and settlement to be subject to the assignment (or transfer) of the lease for the premises to the buyer (called an assignee) with the landlord’s consent. Most commercial leases between the landlord and seller will contain a clause that deals with the landlord’s consent to an assignment of a lease to an assignee including any restrictions that may apply to it. Under the Retail and Commercial Leases Act 1995, a landlord is entitled to withhold its consent to an assignment of lease:
- if the proposed assignee proposes to change the use to which the shop is put; or
- if the proposed assignee is unlikely to be able to meet the financial obligations of the tenant under the lease; or
- if the propose assignee’s retailing skills are inferior to those of the assignor; or
- if the tenant has not complied with the procedural requirements for obtaining the landlord’s consent under the Act.
Where the landlord withholds its consent to the assignment of the lease to the buyer, the buyer should have the right to terminate the contract with the deposit refundable.
If the contract of sale does not contain an assignment of lease clause and the landlord withholds its consent to the assignment, the buyer might be liable to complete settlement and pay the purchase price but not have any premises to trade from.
4. Business Structure
Before committing to buy a business, a buyer should consider the appropriate business structure for the purchase of the business, whether it is as a sole trader, partnership, company or trust.
Where there is a company involved, a buyer can purchase a business either through buying the assets of the business used in its operation (e.g. plant and equipment, intellectual property, goodwill, stock) or the shares of the company:
- Where shares are purchased, the buyer will become the shareholder of the company and will be in control of the business.
- Where a buyer purchases the assets, it will purchase of either all or some of the assets used by the business in its operation. The buyer may choose not to incur the liabilities and debts of the company.
When buying a business, it is always recommended that a buyer should obtain appropriate accounting and taxation advice as to the appropriate legal structure. Purchasing shares can be risky to a purchaser as a purchaser does not know what liabilities or contracts the company might be involved in. Similarly for a seller there can be capital gains tax issues that would need to be carefully considered.
5. Restraint of Trade
A buyer can consider a restraint of trade clause. This clause can help protect a buyer by restraining the seller from opening up a competing business, trading off the goodwill of the business sold, or soliciting customers or clients of the business sold or soliciting employees of the business.
A restraint of trade clause will usually express the restraint by geographical location (e.g. 100km from the business premises) and period of time (e.g. 12 months or 2 years). It is very important to think carefully about what restraints would be reasonable, taking into account the type of business and its location. A clause which is too strict can be set aside. Often we would advise a buyer to include a “staged” restraint term which provides options for the level of restraint.
6. Professional Advice when buying a business
Lastly, it is essential that a buyer obtains professional advice, including accounting, legal and/or financial advice before it commits to buy a business.