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The legal and financial due diligence involved in buying and selling a business

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There are many critical legal and financial issues to consider when buying or selling a business. Attwood Marshall Lawyers Partner Barry Van Heerden explains the complexities involved.

Introduction

Purchasing a business is a significant financial and professional decision. Financially, a business may sell for hundreds of thousands of dollars, if not millions. There are also non-financial qualitative aspects, like transferring staff, maintaining client relationships, honouring a reputation built over years, and post-sale involvement commitments for the vendor that can last anywhere from 6 months to 5 years.

Appropriate legal and accounting advice is necessary before anything is signed. In a business transaction maximising the value of your asset is a focal point. A reputable financial planner/accountant can help secure the best deal tax-wise and an experienced business lawyer can assist both parties to limit legal issues, as far as possible.

A financial advisory firm and a legal firm, with a deep knowledge of the business sector, is invaluable when considering this market. There is a strong demand for businesses in the healthcare sector, specifically dental practices, veterinarian practices and medical practices largely attributed to Australia’s ageing population, rising medical spending per capita and the quality of Australian healthcare services. The transaction itself is often documented with three or four legal contracts.

A Business Sale Agreement          

From a seller’s standpoint, matters regarding the taxation consequences of the sale, transferring of employees and adjustments for employee entitlements and adherence to statutory disclosure obligations that apply, need to be considered. Without proper advice before signing the contract, a seller may end up receiving far less for the business than intended and may remain liable for business obligations post-settlement.

A buyer must ensure full due diligence is conducted on the business. This includes checking business records such as licences, permits and registrations, plans and operations, financials, lease agreements and intellectual property. When buying a business, buyers should also consider the industry’s landscape, competitors, and marketplace dynamics before entering into any contract.

The Contract:

It is a lawyer’s role to review the contract terms to confirm it correctly reflects the deal between the parties and contains clauses at least to deal with the following:

  • the transfer of the business name, premises lease and other vital assets, permits and licences
  • how stock is valued and calculated the fixtures and fittings to be included or excluded
  • the inclusion of appropriate warranties and representations regarding the business sales performance
  • any required security for each party’s compliance with its contractual obligations
  • ‘goodwill’ (an amount that determines the intangible advantages built up by the business, which differentiate the value of an existing business from a new business) and any recuperation or retentions in the event some clients leave the business after-sale
  • an appropriate restriction of trade on the vendor to prevent direct competition within close proximity
  • any necessary training or assistance on running the business from the seller
  • the transfer of existing employees, retention of critical employees and treatment of employee entitlements.


A Premises Lease Contract or Premises Sale Contract

Commercial Lease:

Most businesses are being conducted from commercial premises and in most cases, the lease must be transferred and assigned to the new buyer.

Usually, the lease terms are not negotiable on the transfer and assignment of the lease, and the buyer will take the lease as it.

It is therefore important to be aware of the terms of the lease and specifically in the following:

  • the extent of the lease and right to renew or end the lease
  • the formula for calculating and assessing the rent
  • possibility of sub-letting the premises
  • limitations of local town planning laws regarding types of services or goods that can trade and trading hours
  • landlords’ requirements to maintain the building the premises is in
  • rights to end the lease or a temporary reduction of rent and outgoings if the premises are desecrated or destroyed
  • Limitations to your ability to transfer or re-assign the lease if you choose to sell and the cost involved
  • requirement to pay for rates and taxes and additional outgoings, such as utilities, repairs, and maintenance of the building throughout the lease
  • types of insurance necessary, who will pay for it and who obtains it
  • limitations on the removal of fixtures and fittings
  • requirement on you to redecorate throughout the term and reinstate the premises when the lease expires
  • consequences of failing to pay rent or other breaches of the lease
  • implications of the retail shop leases legislation and whether it applies to your lease – (there is a difference between a commercial lease and a retail lease)
  • payment of a security deposit
  • terms of any personal guarantee and indemnity (usually required for directors of a corporate tenant)
  • impact a lease may have on a franchise agreement.


Commercial Contract:

There are circumstances where an owner of the business is also the owner of the premises that is prepared to sell the premises with the business. The parties will then enter into a commercial contract of sale, and they must be aware of the following (this is not an exclusive list:

Cooling Off Periods
Unlike residential contracts which offer a five-day cooling-off period that allows a buyer to terminate for any reason within the cooling-off period, there is no such cooling-off period for commercial contracts.

Use of Land
As the value of the commercial property is linked to its usage, it is vitally important to ensure the use of the land is permitted by the local government and that all appropriate approvals have been obtained for such use.

Documents
Aside from the physical land and buildings that will be transferred, more documents must be collected and reviewed as part of the completion of a commercial contract.   These can include a Certificate of Classification for the building, plans and sketches relating to construction, documents to enable management of tax (e.g. depreciation) for the buildings.

Financing and Settlement Periods
Typically, a residential contract is conducted within a 30-day timeframe. However, with commercial contracts, the timeframes for settlement are generally extended because of the level of scrutiny required. Consequently, buyers will seek more time to acquire finance and conduct their due diligence, and settlement is more likely to be more than 30 days. In addition, settlement will take place simultaneously with the business settlement and time frames should be in accordance with each other.

GST
Particular attention must be applied to make certain that any purchase price agreed upon has contemplated the application of GST. GST can be applicable in certain situations and may be exempt in others. Either way, prior to signing a contract, advice needs to be acquired to ensure that there is utmost understanding and assurance that the price either includes GST or not. Alternatively, a buyer may need to find an extra 10% of the purchase price, or a seller could get 10% less than expected. In circumstances where the premises is sold as part of the business, it will be a going concern and therefore no GST will be payable.

Due Diligence
A buyer needs to be appropriately advised before signing a contract, to insist a due diligence period during which the buyer can consider all issues in relation to the business.  This period will allow a buyer to terminate the contract without having to provide any reasons. as the reasons for purchasing a commercial property are varied. This ensures scope to conduct investigations or enquiries of the property for its intended use. This can be contained in the contract. The purpose of such investigations is that if a buyer is not satisfied with the results of their inquiries, they can cease the contract and be reimbursed their deposit paid.

A post-sale involvement contract for the vendor

We are progressively acting in transactions where the purchaser requires the vendor, or vendors, to continue to be employed in the business post-settlement. This is to allow for a seamless transfer of the good will of the business to the buyer. The vendor may enter into either a service agreement or a consultancy agreement, which agreements will allow for:

  • Term of involvement.
  • Remuneration;
  • Restriction of trade (during and after trade termination)


However, the transaction documents will also contain restrictive covenants to provide the purchaser additional comfort and protection.  The covenants seek to prohibit the vendors from damaging critical relationships with the business if the vendor does leave the business, either voluntarily by resignation or even if the termination is at the initiative of the new business owner.

The constricting covenants are usually of three forms:

  • a non-compete clause intended to prevent someone from operating in the industry generally for a specified period following the termination of employment or a settlement of a sale of business or sale of shares.
  • A non-solicitation of client’s clause.
  • A non-solicitation of employees’ clause.


A Partnership or Shareholder’s Agreement

Partnership Agreement:

Buyer’s Entity:
It is extremely important from a buyer’s perspective to decide on the entity in which to use prior to entering a contract. There are different entities such as a company, family trust and/or unit trust.

If the buyer has agreed or has decided on which entity to use, it is therefore necessary to consider agreements relevant to the entity. For example, in a company shareholders agreement would be important whilst in a unit trust, a unit holders’ agreement would be applicable.

If a buyer buys a business in its personal name with someone else, it might be necessary to consider a partnership agreement.

The contents of the terms and conditions of these agreements will be discussed in a later blog

Shareholder’s Agreement:
A Shareholder’s Agreement controls the relationship between shareholders and the directors of a company. It provides distinct advantages over the default set of replaceable rules in the Corporations Act 2001 (Cth), or a standard form company constitution.

A Shareholder’s Agreement is more bespoke and specific to your company. In any inconsistency, the Shareholder’s Agreement will override the constitution.

A Shareholder’s Agreement sets out details for:

  • the issuing of new shares
  • the conduct of board meetings
  • the duties of each director; and
  • what happens in the event of a dispute


The agreement enables the company’s smooth operation since shareholders and directors are clear on the obligations they owe to the company.

A Shareholder’s Agreement is not a legal requirement, but it is essential to have one in place if your company has more than one shareholder. Once signed, it will be a binding legal contract between the shareholders and directors.

With all of this at stake, you would think that a buyer or vendor would want to make sure that they get appropriate legal representation and financial advice to ensure they get what has been promised to them and protect themselves from future risk.

Attwood Marshall Lawyers – working with financial professionals to provide a holistic and comprehensive service to business professionals

When buying or selling a business, there is nothing necessarily in a place that regulates the process. As a result, failing to obtain the right financial and legal advice can be a risky venture. 

Our experienced Business and Commercial Lawyers can guide business owners and savvy investors through the complex sales process to ensure they are sufficiently informed and protected against any unfavourable outcomes.

At Attwood Marshall Lawyers, we are compelled to assist business owners, or potential business owners, achieve purchases with minimal stress involved. We have acted on behalf of buyers and sellers in businesses of all sizes across all industries, with extensive experience in assisting clients who are buying or selling businesses.

To obtain professional and trusted advice regarding property and commercial matters, contact us any time on 1800 621 071 or speak to Property and Commercial Department Manager, Jess Kimpton, on direct line 07 5506 8214 or email jkimpton@attwoodmarshall.com.au. We’re here to help!

You can visit our experienced team at our conveniently located offices at Robina Town CentreCoolangattaKingscliffBrisbaneSydney or Melbourne.

Read more:

Welcome change for the new year – new Insolvency Reforms activated to put business owners back in control

Issues to consider when buying a dental practice – Property & Commercial Law

Courts turn up the heat on SMSF inheritance disputes

 
 
 

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