So you have found a business and you have your heart set on buying it. Or maybe you work for a business that looks like it is being sold. Congratulations, that’s great news! However, before you rush off to hand over the purchase price or greet the new owner of the business, you need to be aware of some important steps to consider.
Decide if this is the right business for you and then, if the answer is a resounding “YES”, proceed carefully and with your eyes wide open about the potential pitfalls that buying a business can involve.
Above all, it is essential that you investigate whether all the claims the vendor is making about the business are true. This process is commonly referred to as due diligence.
What is due diligence when buying a business?
Due diligence involves investigating the business before you commit to the purchase. The purpose is to understand what you are actually buying, identify potential risks and check whether the information provided by the seller supports the proposed purchase price and terms.
The Australian Government recommends reviewing financial records, business operations and legal documents as part of the due diligence process when buying an existing business.
Due diligence varies depending on the type of business involved, but a general guide may include checking:
- whether the income from the business is as high as the vendor claims it is;
- the value and condition of equipment and any stock that comes with the business;
- the business’s contracts and ongoing obligations;
- any licences or approvals required to operate the business;
- the premises from which the business operates and the terms of any lease;
- employee entitlements and employment obligations;
- outstanding debts, liabilities or other financial obligations; and
- the overall risks involved in running the business.
Conducting these checks before signing the contract or paying the purchase price can help you make a more informed decision about whether the business is right for you and whether the proposed purchase terms adequately protect your interests.
What should you check when buying a business?
There is unlikely to be a single due diligence checklist that applies to every business purchase. The investigations you need to undertake will depend on the type of business, its structure, its assets, its employees, its premises and the terms of the proposed sale.
Financial records and profitability
One of the most important issues is whether the financial performance of the business matches the vendor’s claims.
Instruct someone with appropriate expertise and qualifications to carefully review the accounts and financial records kept by the firm, especially if the current owner is making promises that the business is more profitable than it looks on paper.
Financial due diligence may involve reviewing financial statements, tax records, sales information, expenses and other records relevant to the business’s financial position. An accountant or other appropriately qualified professional can assist with assessing the financial information.
Equipment, stock and other business assets
You should also investigate the value and condition of the equipment, plant, fixtures and stock included in the sale.
Consider what assets are actually being purchased, whether they are in good working order and whether there are any issues affecting ownership or use of those assets.
It is important that the sale agreement clearly identifies what is included in the purchase so that there is less scope for disputes about what the buyer is actually acquiring.
Business premises and the lease
Another issue to investigate is whether the premises where the business is located are leased or owned outright.
If the premises are leased, you need to obtain a copy of the lease to be sure that you will be able to continue to run the business from the same premises and to find out how long is left on the lease.
You should also check the terms of the lease and whether the landlord’s consent is required before the lease can be transferred to the purchaser. The lease may also contain conditions that need to be satisfied before an assignment can occur.
The premises can be critical to the value and ongoing operation of a business, so the lease should be reviewed carefully before you commit to the purchase.
Contracts, licences and business obligations
It is also important to identify the contracts and other obligations that are relevant to the business.
Depending on the business, this may include contracts with suppliers, customers, service providers or other third parties. You should determine which contracts will continue after completion and whether consent is required to transfer or assign them.
You should also check that the business has the licences, registrations and approvals required to operate and determine whether they can be transferred to the purchaser or whether new applications are required.
Employee entitlements
What you don’t want to do is unwittingly buy a business without properly understanding its employee obligations and accrued entitlements.
When a business changes owners, the treatment of employee entitlements can depend on the circumstances of the transfer and the relationship between the old and new employers. Some employee entitlements may transfer to the new employer, while others may be treated differently.
Before completing the purchase, the buyer should identify outstanding employee entitlements and ensure that the sale agreement clearly addresses responsibility for those obligations. Depending on the circumstances, the parties may agree that certain obligations are settled before completion or that the cost is properly accounted for in the purchase price.
The Fair Work Ombudsman’s guidance on employee entitlements when a business changes owners explains how different entitlements can be treated following a transfer of business.
What if the business is a franchise?
If the business you are purchasing is part of a franchise chain, then additional due diligence may be needed.
A franchise purchase can involve additional contractual obligations, fees, operating requirements and restrictions imposed by the franchisor. You should carefully review the franchise agreement and the information provided by the franchisor before committing to the purchase.
The Franchising Code of Conduct contains specific rules that apply to franchising participants in Australia. The ACCC recommends that prospective franchisees conduct their own research and obtain independent professional advice before signing or paying money.
Franchise due diligence should therefore be considered separately from the general due diligence you undertake when purchasing an independent business.
Review the contract before signing
It is unlikely that you will be able to think of every possible potential pitfall when buying a business. This is why the time to ask for advice is before you sign a contract and hand over the money.
The proposed contract should be reviewed carefully to ensure that it accurately reflects what you have agreed to purchase and deals appropriately with the risks identified during due diligence.
Depending on the transaction, this may include reviewing:
- the assets and stock included in the sale;
- the purchase price and payment arrangements;
- the business premises and lease arrangements;
- employee obligations and accrued entitlements;
- existing contracts and liabilities;
- conditions that must be satisfied before completion;
- restraints and other obligations imposed on the seller; and
- the settlement or completion process.
If you seek legal advice early, it could save you not just money but also a great deal of stress.
What if you are an employee and the business is being sold?
Similarly, if you are concerned that your business is being sold and you may be adversely affected, it is far better to obtain professional advice than to adopt a “wait and see” approach.
A change in business ownership can affect employees and their entitlements. The legal position will depend on the circumstances of the transfer and the applicable employment laws.
You should seek advice if you are concerned about your employment, accrued entitlements or what may happen after the business is sold. The Fair Work Ombudsman’s guidance on what happens when businesses change owners provides information about transfers of business and employee entitlements.
Buying a business requires careful due diligence
Buying an established business can be an exciting opportunity, but it is important to understand exactly what you are purchasing before committing to the transaction.
Financial records, assets, stock, premises, leases, contracts, licences, employee entitlements and franchise arrangements can all affect the value and risks associated with a business purchase.
The Australian Government’s guidance on buying an existing business also recommends conducting due diligence before signing the contract and considering the business’s financial records, operations and legal documents.
Why legal advice can help
Due diligence is an important part of buying a business, but it is only one part of the transaction. The findings from your investigations should be considered alongside the proposed contract and the structure of the purchase.
A lawyer can help you identify legal risks, review the business sale agreement, consider lease and contract issues and help ensure the transaction documents properly reflect the agreement reached with the seller.
How Revolance Legal Can Help
Understanding the complexities of business purchases is critical. Revolance Legal provides legal advice to individuals and businesses involved in buying and selling businesses in Sydney.
Our business purchase lawyers in Sydney can assist with due diligence, contracts, business structures, lease terms and other legal issues that may arise during a business acquisition.
Revolance Legal can also assist with reviewing and negotiating the legal documentation involved in a business purchase so that you can make an informed decision before proceeding.
Contact us on 02 9266 0688 or email [email protected] to discuss your business purchase.
Frequently Asked Questions About Buying a Business
What is due diligence when buying a business?
Due diligence is the process of investigating a business before purchasing it. It can include reviewing financial records, assets, contracts, leases, licences, employee obligations and other information to identify potential risks and assess whether the proposed purchase is appropriate.
What should I check before buying an existing business?
You should consider the business’s financial records, assets, stock, contracts, premises and lease, licences, employee obligations, liabilities and any franchise arrangements. The exact investigations required will depend on the type and structure of the business.
Should I get legal advice before buying a business?
It is generally advisable to obtain legal advice before signing the contract or paying the purchase price. Early legal advice can help identify issues with the proposed transaction and ensure the contract properly reflects the terms agreed between the buyer and seller.
What happens to employee entitlements when a business is sold?
The treatment of employee entitlements depends on the circumstances of the transfer and the applicable employment laws. Some entitlements may transfer to the new employer, while others may be treated differently. Buyers should investigate employee entitlements before completion and ensure the sale agreement appropriately addresses responsibility for those obligations.
What should I check if I am buying a franchise?
In addition to general business due diligence, you should carefully investigate the franchise agreement, fees, operating requirements, restrictions and information provided by the franchisor. The Franchising Code of Conduct also imposes specific obligations on franchising participants.
What happens to the lease when a business is sold?
If the business operates from leased premises, the lease does not necessarily transfer automatically to the purchaser. You should review the lease to determine whether it can be assigned, whether the landlord’s consent is required and how long remains on the lease.