Whether you are just starting out in business or have been in business for 30+ years, it is important to understand the difference between the business that you operate compared to the entity that owns the business.
What is the difference?
In Australia, a large number of businesses are owned and operated by private companies.
A company is recognised as a separate legal entity by the law. A business, however, is not a separate legal entity, and it must be operated by either a private company, a person or a trust.
The business is generally all of the parts that are required to operate the business, including the intellectual property, the plant and equipment, the supplier lists and all other aspects of the business.
Why does this matter?
This distinction is important because when you are selling your business, you are generally not selling the company or entity that owns the business.
There are a number of reasons for this, but the main reason is liability.
The best way to illustrate this point is with an example. If Smiths Holdings Pty Ltd has been operating Smiths Fast Food for 10 years, then Smiths Holdings Pty Ltd, as a separate legal entity, is responsible for everything that has happened in that 10 years. If there is a past employee that wants to make a claim or a liability to a supplier in that 10 years, the liability for that injury sits with the private company, Smith Holdings Pty Ltd.
However, a person buying Smiths Fast Food does not want to take on that liability. They were not operating the business at the time, and should not be responsible for those claims. The company Smiths Holdings Pty Ltd should be, and is, responsible.
What does this mean for the sale process?
While it is preferable to only buy a business and not a company, it is possible to buy the company that operates a business.
This is done where you buy the shares in the company that operates the business. If you choose to buy the shares in a company, there are a number of ways that you can protect yourself:
- Engage your accountant and lawyer to undertake an extensive review of the company’s history to try to ensure that you identify any skeletons in the closet.
- Have the former owner provide you with ‘warranties’. A warranty is a promise that someone makes to you that they have disclosed an aspect of the company to you. For instance, you might seek a warranty that there a no injury claims by any employee of the company. If it turns out that an employee was injured six weeks before you bought the company and they make a claim for compensation, then you can seek your loss against the seller.
- One of the weaknesses of a warranty is that if you suffer a loss, you have to claim that against the seller. If you put some money aside as a ‘retention’ for a set period of time, generally you can access those funds more efficiently.
When you are ready to sell your business, ensure that you have everything set out so that the sale process goes through as smoothly as possible.
Understanding the fundamental difference between a business and the company that owns the business is key to making sure that you can sell your business for the best possible price.
Jeremy Streten is a lawyer and the author of The Business Legal Lifecycle.