Buying or selling a business can be the culmination of dreams of financial independence or lifestyle change. In this situation it can be easy to make emotional, rather than reasoned decisions. Leaving things to chance, or not being fully aware of the legal issues involved in a transaction of this kind can lead to these dreams quickly turning into financial and legal nightmares. In sale of business agreements knowledge is paramount, it is important that you go into an agreement armed with knowledge of the legal and financial issues involved. This article will set out some of the preliminary questions and issues you should be aware of when contemplating the risky venture of buying or selling a business.
What is being bought and sold?
“What am I buying” and “what am I selling” may seem to be easy questions but properly answering them is the first crucial step in successfully buying or selling a business. Simply put, when you buy or sell a business you are transferring ownership of a bundle of rights, responsibilities and assets that are used together to create profit for their owner. It is essential that you understand and can identify what each of these assets and components are so they can be effectively transferred from seller to buyer. Knowing what each of these components is and what they are worth is what is called exercising ‘due diligence’.
Components of a business will include: business names, business goodwill, business premises (lease or ownership), equipment and fixed assets, stock, current orders, supply agreements, patents and trademarks, and business licenses. The seller must be able to guarantee the transfer of the ownership of all components to the buyer.
Who is buying and selling?
It is extremely important to properly identify the status of both buyer and seller. Again, it may seem obvious, but it is vital that as a buyer you know exactly who owns the business and has the right to sell it to you. If different parties own the business then it is important to know who owns which components. The results of buying from the wrong person or not buying all components of the business that are needed can be disastrous.
Just as the buyer who buys from the wrong seller will face negative consequences, so too a seller who has sold something they do not own. Costly litigation (initiated by the buyer and actual owner) and tax penalties will undoubtedly make this a costly mistake. It is also important that the seller is satisfied that the buyer has the financial resources to complete the sale.
What is included in the sale value?
When negotiating a price for a business the following component categories are considered:
Fixed Assets and Equipment
The seller must complete a full inventory of assets and equipment of the business; the price the buyer pays for these assets will be what is called the ‘book value’. The ‘book value’ is the price at which the asset was originally valued. It is important to remember that this price cannot rise, it can only depreciate from this value. If these assets are sold above the depreciated value this will become taxable income for the seller.
The business premises will be the most contentious of these assets. If the premises is not owned but leased then the buyer must be sure that they can obtain the rights to the use of the premises either through a transfer of the lease, a new lease or through the purchase of the building.
This will give the business a value above that of the assets alone. Whilst it may seem to be a vague commodity, ‘goodwill’ can be bought and sold. In a tangible sense, ‘goodwill’ will involve business names, names of products and services, and telephone numbers. To increase the value of the business for the seller, the components of goodwill should be registered so as to become saleable commodities. Meanwhile, the buyer should exercise diligence in determining what these components of goodwill are worth and whether they are already registered. These may be amongst the most valuable items of a business and crucial to future business success.
Stock in Trade
This consists of all commodities used in the production of saleable goods, goods being produced and finished goods. Whilst the value of this stock will be originally based on an estimate, it is important for the buyer that this stock be accurately valued just before settlement of the sale and is within 10% of the original estimate.
Not included in the value of the business will be any ‘encumbrances’. Any mortgages, charges, or bills of sale over any stock or assets must be settled by the seller before the sale. If any stock or assets are the subject of a lease or hire purchase then the seller must be sure they can be transferred to the buyer or that the seller can pay them out. It is important that searches through ASIC (if the seller is a company), and the Registrar General’s office are made to ensure that all these obligations have been settled and the seller is not a bankrupt.
Conclusion: Do I really need a Lawyer?
Buying or selling a business is, by its very nature, a ‘risky business’. What, at first sight, can appear to be a simple transaction can often end in financial and legal hardship. Surprisingly, many don’t think they need, or can afford, legal advice; the question should not be whether you can afford to get legal advice but whether you can afford not to. When completing a sale of business agreement your lawyer will become one of the most important figures in your life. Legal fees are insignificant when compared to the amount of time and money that can be lost if the deal is not handled correctly. Having a lawyer act on your behalf to guide you through this risky process virtually hands you a guarantee that this important transaction will be handled correctly the first time to your benefit.
For specific advice on preparing a sale of business agreement contact our Maitland business purchase and sale lawyers.