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Purchasing a business can be a rollercoaster of competing interests, with exciting possibilities on one hand and potential challenges on the other. Some transactions may not even make it through to the end of the ride.
Unfortunately, it’s impossible to know at the onset which way a business transaction will go. For this reason, a buyer should protect themselves from buying a debt or taking on an unnecessary risk. To do this, it's essential to add special clauses into a contract of sale, allowing the buyer to assess the business while providing flexibility during the transaction to renegotiate with the seller or walk away if needed.
Although each provision should be carefully considered and tailored to your specific situation, here are some commonly used clauses in most business contracts that may be useful for you as a potential buyer.
1. Due Diligence
Each business is different, so you and your advisors need to be able to investigate the business fully, not just what has been advertised to you or what you have seen at face value.
You should have an accountant, lawyer and business advisor help you with financial, legal and commercial due diligence.
To provide your advisors the platform they need, a due diligence clause is required which must include:
A reasonable time frame to give your advisors the opportunity to fully investigate the business;
The ability for you or your advisors to seek further information from the seller or the seller’s advisors;
A time requirement on the seller to respond with the requested information to you, ensuring they don't unnecessarily delay the process;
A mechanism that allows you to cancel the contract should you have any concerns.
Although your advisors will assist you in recommending questions, reviewing information received and provide recommendations to you, it is you who will ultimately be running the business. So, ensure your advisors fully explain the business and guide you on the key considerations moving forward.
2. Lease:
If the business is operating from premises, you'll need either an existing lease assigned to you or a new lease to be granted in your name. Both scenarios will require the landlord's involvement and approval.
The lease terms will significantly govern your business operations, especially if the location is crucial in maintaining goodwill or operational efficiency.
Therefore, your contract should be conditional on obtaining a lease with terms that best suit your needs.
You should consider:
Rental;
Outgoings;
Insurances;
Term of the lease;
Options remaining;
When those options must be exercised and in the case of an assignment, has the seller as lessee exercised the options correctly;
Security required (sometimes three to six months equivalent of rent);
Make good provisions at the end of your occupancy.
These elements of a lease are standard for commercial tenancies, and if not respected can cripple a business. For example, the rent and outgoings are unreasonable, or the time frame of the term provides insufficient time for you to recover your expenses from the purchase and still make a profit.
The value of your business would improve with a lease that has a lengthy term and favourable conditions, which is important if you plan to sell the business in the future.
As you can see, there is substantial work involved just with the lease alone. You will need to ensure that your condition grants you the right to choose between a new lease or an assignment (depending on the landlord’s preferences), as well as sufficient time to negotiate the terms.
3. Finance:
Even if you can afford to purchase the business without outside funding, it's ideal to discuss the business with a financial advisor, and if necessary, with a finance broker to discuss your financial options.
Keep in mind your expenses do not end at the purchase price and you will need additional funds for:
Stamp duty;
Legal, accounting and business professional fees;
Additional money for cashflow.
Consider also your business plans. Do you wish to run it the same as the seller has done before or do you wish to improve it and add your own personal touch to it which may require additional investment?
You should identify what your borrowing powers are. Ensure your business contract is conditional on you being satisfied that your finances are sufficient, not only for the purchase but for your future business plans.
4. Interpretation
Although an extremely boring and legally mind-numbing provision, it is important to have a clear provision that determines which part should take priorities should there be any inconsistencies (a.k.a. standard conditions).
Although lawyers will always attempt to avoid inconsistencies by deleting standard conditions by way of special conditions, it is preferable to have one special condition that directs the parties on which conflicting provision or clause takes priority and to what extent.
5. The Possible 5th Clause
There are numerous other clauses that could be crucial depending on the type of business you are purchasing. Here's a brief overview of other possible clauses that may apply:
(a) Franchise
If you are purchasing a franchise business, you will need to ensure that the contract is conditional on you being satisfied with the terms and conditions of the franchise agreement.
Franchise Agreements come with considerable costs, so it is critical that you are given the opportunity through well drafted special conditions to ensure the business’s goodwill is strong enough to support such costs.
Sometimes the Franchisors will dictate the terms of the contract of sale, in which event you should always have your lawyer review and advise on those terms to ensure that you understand what you are entering into before signing the contract.
(b) Livestock
If you are purchasing a business involving livestock, then you need to ensure that a condition is drafted to allow you the right to investigate the health and number of the stock to your own personal satisfaction. Failing to do so could impact your your ability to trade after the purchase.
(c) Critical Suppliers
In the event you are not purchasing a franchise, but one of the business’ suppliers is key to its operations then you will require a special condition in which the contract is subject to you entering into a supply or service agreement with that supplier.
(d) Crucial Employee
This is always a difficult issue, as an employee is not bound to remain with you, even if the employee stays on in the business initially after takeover.
For that reason, ask yourself as a buyer:
· Can you learn from that employee what's needed to run the business, and how long it might take?
· If the employee's skills make the role critical, would it be possible to replace them?
· If there is no solution, would the employee be willing to engage in partnership with you sharing the costs and profits of the business?
Depending on the situation, you may need to add a condition that addresses the future of key employees. Whatever pathway forward you see, you must ensure the appropriate condition is drafted to take on both the interests of the parties and complies with workplace and employment laws.
(e) Seller’s Name
Sometimes it is all about the name, and although you are entitled to any business name connected with the business on settlement, this does not necessarily grant you the right to the name of the seller’s company which might be one and the same as the business name.
In this case, you will need a condition that requires the seller to arrange a name change of the company, allowing you unfettered access to the name of the seller or business upon settlement.
(f) Forward Payments and Deposits
It is common for customers to pay deposits before the seller for the service or goods. As a buyer, you should always ensure that the contract, or at least the settlement of the contract, is conditional on confirming and identifying all down payments from the customers.
Also, your condition must not only provide you the right for this discovery but must also ensure that such payments are reflected as adjustment to the total purchase price in your favour on settlement.
This way you are not left with what the seller has already been paid for, nor will you be out of pocket for any disbursements which the customer has already covered the seller for.
Each business and operator are different to the next, and so it is critical that you engage with professional advisors before commencing with negotiations to purchase. If you need assistance and guidance with your transaction including determining and drafting the appropriate clauses for what you need, please contact our commercial, property and business team.
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