This is Chapter 5 of Your Complete Guide to Selling Your Business. Check out our Introduction to the Guide go back to the beginning.
The Road to Settlement
There are six steps to settlement:
- Initial review: A buyer contacts you to inspect the business’ premises, financials and lease (if applicable).
- Enter into a non-disclosure agreement (if applicable): If you intend to provide confidential information to a buyer before entering into the sale contract, enter into a non-disclosure agreement to protect your interests if the sale falls through.
- Negotiate terms: You and the buyer negotiate the key terms of the sale. You may choose to enter into a heads of agreement to set out these key terms.
- Prepare the contract: Your lawyer will prepare the sale of business contract.
- Negotiate the contract: You and the buyer negotiate the sale of business contract, sign and exchange the contract, and start preparing for settlement.
- Settlement: The assets of the business are transferred to the buyer and the buyer pays you the balance of the purchase price.
Cheatsheet for Negotiating Terms
Once a buyer is satisfied with their initial review of your business, the next stage is negotiating the terms of the sale. Depending on your business, some terms may not apply, and some may apply specifically to businesses in your industry. During negotiations, a lawyer can help you determine what terms you should consider.
Price is one of the main terms parties will negotiate, and it’s important for the seller to be realistic. The seller will likely require the purchaser to pay a deposit, as part payment of the purchase price. The standard amount for a deposit is 10% of the purchase price. It is a good idea to talk to your accountant about tax implications of the sale, such as capital gains tax for the goodwill of the business.
Paying deposits: The buyer usually only pays the deposit after parties have signed and exchanged the contracts.
The settlement date is the date when ownership ‘passes’ from you to the buyer. This differs from the contract date which is the date when you and the buyer formally sign the sale contract.
Be flexible: Preparing to transfer the business at settlement can take as little as one week or as long as several months. It’s important that you and the buyer agree on a date that you can work towards, but that you are both flexible in case of a delay.
A restraint is an agreement to not compete against the business for a period of time within a certain distance after you sell the business.
Define restraints: You should agree on the exact time (months or years), distance (in kilometres) and who the restraint will apply to. If you intend to carry on a business after the sale, you and the buyer should include this in the restraint. A restraint can take the form of a ‘cascading’ clause which provides the buyer with different fallback options (e.g. 3 years, 2 years or 1 year) in case the matter goes to court and the court rules the first restraint is too broad or unfair to be enforceable.
The buyer may require training on the business’ operations before and after settlement.
Offer training: Negotiate the length of training and additional support you are willing to provide the buyer. If there is specialised equipment or training that the business requires, ensure you set clear guidelines and expectations.
Determine whether you will include stock in the purchase price. If not, then you’ll need to sell the stock to the buyer seperate to the business purchase price. The amount the buyer must pay for the stock is generally calculated via stocktake. You and the buyer will typically conduct a stocktake the day before settlement.
Buyers will commonly also seek to set a ‘maximum stock amount’. The purpose of the maximum stock amount is to allow the buyer to plan their finances — they need to know the amount of funding to allocate for purchasing stock.
The buyer will have an obligation to buy your stock at settlement. However, they are required to only buy stock to the value set as the “maximum stock amount”. Note that the buyer can usually pick and choose what stock to buy to the maximum stock amount.
Determine stock value: You should specify in the contract exactly how the stock value will be determined to avoid disputes arising about the value of the stock, for example, by the original invoiced price you paid. You should include a provision in the contract requiring an appointed stocktaker to determine the value of the stock if you cannot come to an agreement with the buyer.
If your business operates from a ‘fixed premises’ (i.e. a shop front), you will need to determine whether you will transfer your existing lease to the buyer or if the landlord will grant a new lease. The sale of business agreement should also set out the key terms of the lease to avoid disagreements down the track, for example, around rent or the term left on the lease.
Landlord’s leasing costs: It’s important to agree on who pays the landlord’s costs for assigning (i.e. transferring) or granting a new lease. Although most commercial leases will require the current lessee (i.e. the seller) to pay the landlord’s costs to transfer the lease, you can negotiate with the buyer who actually pays the cost of the transfer. Retail leases have different rules for payment of landlord’s costs, which are State-specific.
Conditions of Sale
Depending on the buyer and the business, there may be specific things that need to occur before settlement can take place, for instance:
- the buyer obtaining finance to purchase the business;
- the seller transferring a liquor licence, supplier contracts or specialised equipment;
- the landlord (and the landlord’s mortgagee if required) consenting to transferring the lease or granting a new lease; or
- the franchisor consenting to transfer the franchise agreement or granting a new franchise agreement to the buyer.
You and the buyer should reach an agreement on what conditions must be met for the sale to go through. We have set out an example below where a buyer requires finance.
If you decide to provide vendor finance as a seller, you should ensure you have a loan agreement and security agreement that sets out:
- how much the payment(s) should be;
- when the payment(s) should be made;
- whether interest is payable and, if so, when and at what interest rate;
- what happens if the buyer defaults in making a payment; and
- what security interests and/or guarantees the buyer will provide you in case there is a default. A security interest provides you with a right of recovery against certain assets if the buyer cannot repay the loan. This ensures that you will not be out-of-pocket in the long run.
Providing vendor finance is risky. You should try to mitigate this risk by undertaking due diligence on the buyer. In particular, you need to check:
Vendor Finance Checklist
- What assets they have that you can take security over: For example, office furniture, kitchen equipment, computers, cash and/or business vehicles.
- What is the value of those assets (this needs to be at least equal to the value of the loan): If you lend the buyer $30,000, make sure you have security over the assets with a value of at least $30,000. If the buyer does not repay the loan, you can sell the assets to settle the outstanding amount.
- Whether the assets already subject to security interests would take priority over yours: For example, you lend the buyer $30,000 and take security over a coffee roaster worth $40,000, but a bank has security over this asset for a loan of $40,000 that ranks ahead of yours. If the buyer becomes insolvent, and its assets are sold (including the coffee roaster), the bank will be paid first from the proceeds and receive $40,000 under its loan. This will mean that there are no funds left to pay you.
Depending on the loan amount, you may want to try and obtain security against not just the business’ assets (which will belong to the buyer after the sale) but also any personal assets the buyer may own, such as a house. If you want to take security over a house, you will need a mortgage from the buyer and the mortgage must be registered on the appropriate state’s land titles registry.
Registering a Security Interest
You must also make sure that you register all security interests on the Personal Property Securities Register (PPSR). The PPSR is a register that tells you how your interest ranks in relation to others. Or, what slice of the pie you will get if a business becomes insolvent.
Registration is a way to perfect your security interest. If your security interest is not perfected, and the buyer becomes insolvent, you will be treated as an unsecured creditor and you may not get back the full amount of your loan.
What is the PPSR? The PPSR is a register that tells you how your interest ranks in relation to others. Or, what slice of the pie you will get if a business becomes insolvent.
Vendor Finance: Vendor finance is an alternative to borrowing from a bank, which can be difficult for small businesses.
Vendor finance enables the buyer to pay the seller all or (more commonly) part of the purchase price after the sale is completed. This is generally made either as a lump sum payment on an agreed future date or by regular installments over a set period of time.
There are two main approaches to dealing with employees
in a business sale. For a business that employs mostly casuals, the usual process is to simply terminate all of those employees and to have the buyer rehire them. This is because there are, except in limited circumstances, no employee entitlements that need to be paid out to casual employees on termination.
For a business that predominantly engages non-casual permanent employees and where these employees have accrued significant entitlements, it may be a better idea to have the employees transferred rather than terminated.
The buyer can elect not to take on any employees and an employee may choose not to continue with the buyer. In these cases, the employee’s employment will be considered to have been terminated and you will need to pay out all accrued entitlements.
When terminating an employee, you must comply with your obligations including providing a notice period and paying out any leave entitlements.
Employee entitlements: Paying out employee entitlements can be substantial. Obtain a rough estimate of how much it will cost to terminate your employees and pay out their entitlements before finalising any deal – this will give you an opportunity to negotiate responsibility for paying out these employee entitlements.
A warranty is a promise that the seller gives to the buyer about the business. For example, you may “promise” the buyer that all the business’ equipment is in working order, or that there is no current litigation or disputes against your business.
Limiting warranties: As the seller, you will want to give as few warranties as possible and to limit the scope of any warranties you provide. Note that a buyer will generally insist on the provision of certain warranties so they may be unavoidable. In cases where you may be concerned about providing a warranty, then seek to limit the operation of the warranty by disclosing information about the warranty or limit your potential liability to a capped monetary amount.
You now have your cheatsheet for negotiating terms and you know what to look out for when discussing the sale with your buyer. Read on to find out how to prepare and negotiate your contract whether you’re a sole trader or a company. If you have any questions before you continue reading, you can contact LegalVision’s sale of business lawyers by calling 1300 544 755 or filling out the form on this page.
This chapter was an extract from LegalVision’s Sell Your Business Manual. Download the free 36-page manual featuring the sale process, preparation checklists, and your cheatsheet for negotiating terms.
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