A client of mine recently came to me to assist in the sale of his business. He had a willing buyer and an agreement in place which provided that the buyer had the opportunity to undertake a due diligence (further enquires) process. 

The client asked me to review the sale contract and to assist in dealing with the due diligence process.

I would like to share with you some observations that arose out of this due diligence process for the sale of his business. I propose to only concentrate on the legal elements of the due diligence. The financial (accounting/taxation) were substantial in their own right and were also extremely important to the ultimate outcome of the due diligence process.

Ownership

The due diligence process usually starts with an analysis of the ownership structure. This is particularly important if the entity that conducts the business is being sold rather than just the assets of the business e.g. sale of share in a company or units in a unit trust. The underlying documents which set up these structures must be viewed together with the history of the ownership and transactions that led to the sellers being the current owners of the business structure.

Employees

Many businesses have key personnel that will stay on with the business after a sale to new owners. Those persons will have employment arrangements and those arrangements must be secure and commercial and reasonable in the particular industry that the business operates in. Leave entitlements must be understood. Above all else, the arrangements should be in writing.

Assets

Key assets of the business must be encumbrance free or at least understood by the buyer to be subject to obligations that the buyer is aware of and can control. 

Contracts

Key contracts with the business, for example, suppliers to the business or off takers or buyers from the business must exist and preferably be in writing. These contracts should be for a reasonable term to enable the buyer to build a relationship with the other party and to keep the arrangements on foot should it desire. If the other party has notice that the business is going to be placed onto the market and his arrangements are secure and not under threat, the sale process will usually be easier. 

Licences intellectual property

Intellectual property of the business needs to be secure. Licences, business names, trademarks, patents, designs should all be in good standing, in place and under the ownership of the correct party. I have been involved in a transaction where a seller of a licensed premise was not the owner of the Liquor Licence. Rectifying this situation was expensive for the seller and cost him valuable time in the sale process.

Premises

The property where the business is conducted should be secured to the business by way of a written lease for a reasonable term. All too often parties reach the end of a lease term and do not get around to renewing the lease. Waiting until the business is on the market to instigate this process can be risky and may be costly if an unscrupulous Landlord smells a situation he can take advantage of.

Taxation

Taxation considerations must be considered. Income tax, capital gains tax, goods and services tax and State based Duty will all be relevant considerations. 

Move quickly

I found during the due diligence process that if the responses of the seller are prompt and well organised, momentum can be gained and the whole process over and done with  such that the goodwill created upon the signing of the contract is maintained. If delays occur as a result of the seller not having answers readily available, the parties’ risk becoming stale, enthusiasm wanes, and the parties end up wanting to find a reason to get out of the transaction.

Lessons learned

In my example, the sale did not proceed past the due diligence phase. It ended through no fault of my client or any reason due to my client’s legal due diligence falling short. But when the sale did not proceed, my client did not feel he had wasted his time and money. Rather, he felt that he was left with a better understanding of how his business operated and what he needed to do to ensure that it remained ready for a prompt sale should the opportunity arise again in the future. 

On reflection, I now liken that due diligence process to a medical check-up for insurance purposes: I go in expecting to merely have items checked off, but come away having discovered that all was not as I had thought and the doctor has given me medications and guidance on how to look out for myself better in the future. 

I strongly suggest that all business owners, whether they are considering a sale in the short term or not, undertake a comprehensive legal due diligence of their own business for it will not only ready the business for an eventual sale, but it will also allow the owner to better understand and operate that business now.