When buying a business, it is usual practice for buyer’s to undertake formal due diligence investigations on the business either before or after a contract of sale is signed. When undertaking this due diligence, as well as checking the business’s financials and reporting systems, there are a number of other important things to consider which may not automatically spring to mind.
In this article, we set out some of the less obvious matters to cover off on when preparing to buy a business.
If the business operates from a leased premises, the parties will need to agree on whether the existing lease will be assigned to the buyer or if the buyer requires a fresh lease from the Landlord. The standard REIQ Business Sale contract provides for both of these eventualities.
While reviewing the Lease terms is contemplated by the standard contract, the Buyer should also turn their mind to the following additional considerations which are not quite as obvious.
Unless the business is a retail business, the assignee of a lease is not automatically provided with a detailed breakdown of the outgoings payable under the Lease. Depending on the type and location of the Premises, outgoings costs can form a significant part of the business’ monthly expenses. It is always prudent when taking a new or existing lease to ascertain the likely outgoings costs. These can be obtained from either the seller or the Landlord.
Another relevant enquiry to make of the seller is their history with the Landlord. While a Landlord is not likely to agree to the buyer as a new tenant until the seller is compliant with their lease, the reverse is not necessarily true.
Particularly in circumstances where the Premises location is important to the business’ success, or where the existing lease has a large amount of time to run, it is prudent to obtain an idea of the Landlord’s history from the seller. For example, has the Landlord been difficult to deal with, slow to respond to any issues or carry out repair work? If so, have these instances been a result of something the seller has done specifically, or is it likely that the buyer may be in for a turbulent Landlord-Tenant relationship?
Consider whether the business’ employees are integral to its current success. This will be particularly relevant in a service based business.
The standard contract contemplates which party is responsible for payment of employee entitlements. As well as this however, consider what impact it will have on the business if the existing star employee/s of the business decide not to continue their employment once the buyer is the new business owner.
Is it likely that this will have a significant impact on the business’ customer base?
If this is identified as a particular issue, you should also carefully review the terms of the key employee’s employment contract. Do they have a restraint of trade obligation towards the business which will prevent them from setting up or working in competition with the business for a certain time after they leave? If not, is it likely that this may occur?
How relevant the employees will be ultimately depends on the facts and circumstances of the particular business and how it operates.
3. MAJOR CONTRACTS
Consider how the business makes most of its money. Does it have a few major customers or clients that generate most of the business’s revenue, or are the business’s customers mostly one-off? Do the customers of the business rely on the particular expertise of the business owner, or do they engage the business because it is convenient?
If the business heavily relies on a few major contracts for its annual turnover, as the buyer you should review the content of these contracts carefully.
Consider whether the contracts are ongoing or for a set period. If they are for a set period, how long does the contract have left to run before it expires? If the business appointed as the exclusive service provider to that customer or client, or are they free to take their business elsewhere?
Importantly, even if the contract is for a set term with the business, it may be necessary to obtain the customer’s consent to the change in ownership of the business for the particular contract to continue.
4. RETENTION MONEY?
Withholding “retention money” is a common practice in the sale of real estate rent rolls. The idea being that if the current clients of the real estate agent opt not to sign up for a new engagement with the agent who has bought the roll, the value of the rent roll decreases and the purchase price does also.
Not just for rent roll sales, negotiating retention money can be an important part of buying other businesses. If, as discussed above, it is likely that major contracts or other clients of the business may take their business elsewhere after the change in ownership, retaining part of the purchase price for a certain time after settlement is a useful tool to deal with any possible loss in turnover of the business.
If retention money may be relevant as a buyer, it should be negotiated prior to signing the contract.
If particular licences or permits are required to operate the business, consider how these are obtained.
Are the licences attached to the business itself or to the particular seller? Can they be assigned, or will it be necessary for the Buyer to apply for a new licence in their own name?
An important consideration for this issue is not just whether the buyer will be eligible to hold the licence, but also how long an assignment or grant of a new licence is likely to take. When dealing with government departments, these processes are not always carried out smoothly or in a timely fashion.
The buyer will not wish to part with the purchase money until satisfied that they will be entitled to operate the business. As a result, working out an appropriate length of time for the sale contract and satisfaction of any special conditions is an important part of the due diligence process.