Before you purchase an existing business, it's important to conduct thorough due diligence and be aware of all the liabilities you may be taking on.
Purchasing a business
There are two common ways of purchasing a business: asset sale/purchase and share sale/purchase. You should understand the advantages and disadvantages of each to determine which vehicle is most appropriate:
An asset sale involves purchasing some of or all of the assets owned by the business for sale. The sale of assets is between the business and the buyer. The seller of the assets retains ownership of the business after the sale.
Common examples of assets that are sold include plant and equipment, intellectual property rights (i.e. trade marks), land and statutory licences.
Purchasing a business through an asset purchase means you are able to choose the assets you want, leaving any unwanted assets aside. The benefit of this approach is that you can avoid the unknown encumbrances that may come with a share purchase.
A business may also be bought by purchasing the shares of the company. In this option, the buyer purchases the company and takes on all its assets and liabilities.
During the takeover, the contracting party remains the same. This means that, as the buyer, you can avoid having to renegotiate or novate a large number of contracts and licences.
When reviewing existing contracts, carefully examine the change of control clause. Such a clause in an existing contract may give the other party the right to renegotiate the contract due to the change in ownership.
Conduct due diligence
Regardless of whether a business is purchased or sold through assets or shares, both the seller and purchaser should conduct their own due diligence. Due diligence is a review of the business that you intend on buying. It involves an inspection of the company’s operations, transactions and financial registers.
Generally, it is conducted after you have shown an interest in the business but prior to any agreements being signed. Potential buyers must make sure that they take the process seriously.
As a purchaser, ask questions such as:
- What is included in the purchase price?
- What liabilities am I going to inherit by buying particular assets or the company?
- What makes the business viable?
- Is retaining key employees important for a successful takeover?
Having the correct registrations, licences and permits is important for you to be able to continue to run your business. Check that the business’ licences, permits and approvals are current and transferable. You need to know whether these licences are part of the sale.
You can search for the licensing requirements at a local, state and federal level on the Australian Business Licence and Information Service. You may find that you need to apply for a new licence to run the business.
For example, those running a food shop in Brisbane must apply for a new licence with the Brisbane City Council as these licences cannot be transferred.
Review contracts and liabilities
Make sure you obtain all the necessary legal documents from the sellers and ask a business lawyer to review them. This helps to evaluate the risks associated with the business and also confirm that the seller owns the business.
Documents that you should ask for include:
- Business registration certificates;
- Leasing agreements;
- Employment agreements;
- Supplier and distribution agreements; and
- Client agreements.
These documents help to identify all present and future liabilities within the contract. If you choose to purchase a company through a share takeover, you take on all these liabilities.
Knowing the extent of these liabilities can help you negotiate the price down or obtain indemnities.
The business you are interested in buying may have key staff members that are important to its success. If you take over the company, these employees are likely to stay on, as their employment contracts are still with the company despite the change in ownership.
Talk to the current business owner about current employees and whether they intend to stay with or leave the business.
When buying a business by asset purchase, note that employment contracts cannot be transferred to the buyer from the seller’s business. To retain these employees, you have to enter into a new contract of employment with each employee.
When purchasing a business, understand the risks, the liabilities and the agreed terms of what is included in your purchase by conducting thorough due diligence. This assists in understanding the value of the business, its liabilities and how to approach the sale.
During the due diligence and negotiation stage, make sure you engage a business lawyer to assist you with reviewing the legal agreements.
Anthony Lieu is a lawyer and the head of marketing at LegalVision.
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