Are you considering purchasing a business? Before you commit, it is essential to have a thorough understanding of the company’s commercial viability. You should check that its operations, financial information, contracts and legals are sound. This process is called due diligence. This article will outline the commercial considerations you should make before purchasing a business.

When Should I Do My Due Diligence?

Generally, you should do your due diligence after you and the seller have agreed to the deal, but before a binding sale of business agreement is signed. You may have decided on a price and other key commercial details, such as when the business will be handed over, but this should all be subject to due diligence. Understanding the business’ operations, the industry and the seller’s reasons for selling should all form part of your decision to go ahead with the purchase.

Business Operations

It is also important to consider whether the type and size of the business is compatible with your interests, experience, personality and capital.

You also need to understand any restrictions on the business. You should consider whether the business:

  • is part of a franchise (if it is part of a franchise, you will need to follow the franchisor’s operations manual and franchise agreement);
  • has to comply with any regulations (for example, if the business is a bar, does it have a liquor licence and can this be transferred to you?); and
  • has the required permissions to perform the business functions (for example, if you are looking to purchase a pizza restaurant, make sure that this business activity is permitted under the lease).

The Seller

Understanding the seller’s motivations for selling the business and their role within it should also inform your decision. You should consider:

  • why the seller is selling the business (for example, an elderly couple selling because they want to retire is very different to the owner selling because the business is not doing well);
  • what the seller’s role is in the business (if the current owner’s role is critical to the business, you should consider whether you have the skills and experience to take on their role); and
  • whether the seller is likely to become your competition. Many purchasers prohibit the seller from setting up a competing business or poaching clients for a set time after the sale. You should address this concern in the sale of business agreement.

Before committing to the purchase, you can ask to observe how the current owner manages the business. This trial period could give you a better idea of how the business runs. You could also ask the seller to stay on and provide training after they sell the business. This request can form part of the sale of business agreement.

Industry and Competition

Understanding the state of the industry you are entering into is critical for the longevity of the business. Find out whether it is expanding or declining.

For example, it would be pointless to buy a video store now that most people use Netflix or another online provider to watch movies at home.

You should consider:

  • how strong any competition is (for example, a major competing franchise next door compared to a run-down coffee shop);
  • whether you will face online competition; and
  • whether the business has an edge (for example, a unique product or location).

For example, if the business you want to buy is the most expensive cafe on a street with two other cafes nearby, it may not be a wise investment.

The type of industry the business operates in, and your experience in that industry, are also factors you should consider when deciding if the business is right for you and your goals.

Suppliers

Continuing to use existing suppliers will give you some quality guarantee and continuity within the business. You should carefully review whether any supplier contracts can be transferred to you, or whether the supplier requires you to enter into a new arrangement. It is also important that you understand:

  • the length of any contracts;
  • any fees involved;
  • whether there are any minimum purchase requirements; and
  • how you can deal with incorrect or unsuitable stock.

You should also find out if the business has any unwritten agreements with suppliers that you would like recorded in writing and transferred to you.

Location

You should consider the location of the business before you purchase. Find out if it is a quiet area or if there is consistent foot traffic. An unhelpful location may the reason the business is for sale. You should also see if there are any impending:

  • developments;
  • town planning changes;
  • road developments;
  • rezoning plans; or
  • public works.

These could affect the ongoing success of the business.

Staff

If you plan to take on the existing staff, you should investigate their current arrangements. You should consider whether staff members:

  • have valid contracts;
  • are qualified for their job;
  • have a visa and, if so, have work rights;
  • are being paid the correct wage and entitlements according to the relevant modern awards; and
  • have accrued entitlements to annual leave, long service leave, holiday pay, sick leave, superannuation and other employee benefits.

You can check the Australian Business Licence and Information Service (ABLIS) website to see what licences business operators and workers must have in different industries.

Lease

If the business currently operates out of physical premises, ensure you can take over the lease. The sale of business agreement may have a clause stating that the sale is subject to either the transfer of an existing lease or a new lease being entered into.

You should review the lease to make sure you are happy with its terms. It is essential to understand:

  • what the rent and outgoings are;
  • how the rent increases each year;
  • what the insurance and security deposit or bank guarantee requirements are; and
  • what your obligations are in maintaining the premises during the lease and when it ends.

Leases are often lengthy documents that span years, so understanding your rights and obligations should be a priority at this early stage.

Key Takeaways

Before you decide to purchase a business, you should do everything you can to make sure that the business checks out. This due diligence involves a thorough investigation of the business and its operations to understand:

  • how it works;
  • why it is being sold; and
  • its commercial viability going forward.

If you have any questions about purchasing a business, you can contact LegalVision’s business purchase lawyers on 1300 544 755 or fill out the form on this page.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

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