In Short
- Due diligence is the process of investigating a business before buying it to understand its assets, risks, and obligations.
- Key steps include reviewing the business structure, sale agreement, supplier and customer contracts, employee arrangements, and lease terms.
- Conduct relevant searches on ASIC, the PPSR, land titles, IP registers, and litigation databases to identify any issues before proceeding.
Tips for Businesses
Clarify whether you are buying shares or assets, and structure your purchase appropriately. Ensure the sale agreement protects your interests and includes non-compete clauses. Verify intellectual property ownership and check that key contracts can be transferred. Review employee agreements and lease terms carefully to avoid unexpected liabilities. Working with a lawyer will help you manage the process efficiently.
When purchasing a business, you must undertake due diligence. Due diligence refers to investigating the material aspects of the business you are looking to buy. When you complete thorough due diligence, you place yourself in a better position to understand what you are buying and any risks you may take. You will likely conduct due diligence in the period between striking an agreement with the seller and signing the binding sale of business agreement. Generally, you will have agreed on a price subject to due diligence. This article will run through the main items you should consider when conducting due diligence on a prospective business you are purchasing.
Business Structure
Understanding the structure of the business you are purchasing is essential as there can be significant consequences if the business is not structured correctly.
Firstly, you need to be aware of what you are purchasing. Broadly, there are two ways to purchase a business. You can either purchase the shares of the business (share sale) or the business’ assets (asset sale). What you buy will affect the sale process and your legal responsibilities for the business and can also have tax consequences.
Secondly, consider how you will purchase the business. You can buy the business:
- as an individual;
- using a private company; or
- using a trust.
Conduct the Relevant Searches
Conducting relevant searches is a crucial part of the due diligence process. You need to consider:
- who currently owns and runs the business;
- whether there is any ongoing or impending litigation against the business; and
- whether the business has outstanding liabilities such as an unpaid loan.
Generally, the types of searches you should conduct on various registers will include the following.
| Register | Search |
| ASIC Connect. | You will need to conduct a company search on the ASIC organisation register. This will reveal the current directors and shareholders of the company and will indicate who currently owns and runs the business. The ASIC records must match the company’s internal records. You should also ensure that the identities on the ASIC records correspond with the signatories to the sale contract and corporate approvals. |
| Personal Property Security Register (‘PPSR’) | A search on the PPSR will indicate whether there are any secured creditors. For example, suppose a creditor, such as a bank, has registered a security interest against the company’s assets. In that case, the assets might not be as valuable as they seem, and there are likely contractual barriers preventing you from taking ownership of those assets without third-party consent. |
| Land and Title Searches | These are state and territory-based searches you need to conduct on any owned or leased premises in which the company is interested. These searches are where you might discover, for example, that a bank has a mortgage over one of the business’ properties. |
| IP Australia | Ensuring the company correctly owns and holds its intellectual property (IP) in most share or asset sales is crucial. If the business you are purchasing has not registered its IP correctly, this presents a real risk that a third party might use or claim infringement of that IP. Therefore, you must conduct adequate searches on the relevant IP Australia registries. |
| Litigation Searches | You will need to consider whether there is any ongoing or impending legal or regulatory action against the company. Litigation searches can be challenging to conduct and very costly. The easiest way to conduct them is using third-party services such as InfoTrack. |
Sale of Business Agreement
A sale of business agreement is a contract that outlines the terms and conditions of the sale. You must have this contract in place so that both parties know the nature of the sale. Anything not included in the contract will not be included or covered in the sale. As a result, you will want to ensure you have a well-drafted contract providing adequate protection. You will also want to ensure the contract includes everything you want to purchase. Below are a few considerations to take note of.
Critical Commercial Terms
The critical commercial terms should cover the following:
- the assets you are purchasing, such as equipment and motor vehicles;
- the purchase price you have agreed on;
- any liabilities or legal responsibilities you are assuming (if any); and
- the target date for you to take over the business.
Conditions Precedent to the Sale
Be aware of any conditions you need to fulfil before purchasing the business. Being clear on the conditions of the sale gives you the security that you can purchase the business as long as you fulfil the conditions.
Non-Compete Clause
The non-compete clause is essential to maintain the value of the business you are buying. There are a few types of non-compete clauses. For example, the non-compete clause could prevent the seller from:
- poaching existing clients or employees after the sale; or
- competing against you, such as opening a cafe in the exact location or opening the same type of business within a specific time frame after the sale.
Intellectual Property
To maintain the value of the business, you must have a clear picture of the ownership status of the business’ intellectual property and which intellectual property you will have assigned to you. A business’ intellectual property will be its most valuable asset in many cases.
For example, you should ensure the business owns its trade mark so that your brand is protected once you purchase the company. Or, if you are purchasing an app, you want to ensure the business owns the software.
Supplier and Customer Contracts
If the business you are purchasing has critical suppliers or customers, you must ensure they are transferred to you by having the proper contracts. Naturally, this means you will need to know who they are.
Similarly, if you are purchasing a business where customers are on contracts, you should check which customers are under each contract. You should also check their rights and obligations under those contracts. This is particularly relevant in service businesses, such as software providers with subscribers and manufacturing businesses.
When it comes to supplier and customer contracts, you should be aware of:
- what contracts exist;
- the critical periods, such as the commencement and termination dates;
- whether you can have any contracts transferred to you; and
- any sales benchmarks in place.
Employees and Contractors
Keeping existing employees and contractors that understand how the business operates can be invaluable to you. You should confirm with the seller whether you will retain them once you purchase the business. If you are retaining existing employees and contractors, you should be aware of:
- the length of their contracts;
- any non-compete clauses;
- their rights to terminate; and
- their obligations under the contract.
Leases
Understanding the lease is crucial if you want to take over a business with physical premises. This is because you want to ensure that you can use the premises after you have purchased the business.
Typically, you take over the seller’s current lease in a business sale. To affect this, you will need all parties, including the landlord, to sign a deed of assignment. There is typically little room for negotiation when taking over a lease, so you must understand your rights and obligations under the lease. Hence, you should carefully check:
- the term of the lease, which is how long the lease lasts;
- any rent increases; and
- the ‘make-good’ clause, which outlines how you are to leave the premises when you move out.
If the current lease is due to expire, or the landlord is open to negotiating a new lease, you can prepare a new lease. In this situation, you are in a position to negotiate the lease.
Before buying a business, it is important to undertake due diligence, to verify the information supplied by the seller. This guide will walk you through the due diligence process.
Key Takeaways
Conducting due diligence when purchasing a business is critical. Undertaking proper due diligence when purchasing a business ensures you are fully aware of your rights and obligations. This includes:
- examining the business structure;
- examining the sale of business agreements; and
- conducting relevant searches.
If you want assistance purchasing a business, our experienced business purchase lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
A sale of business agreement is a contract that outlines the terms and conditions of the sale. You must have this contract in place so that both parties know the nature of the sale.
Depending on how you construct the clause, a non-compete clause can prevent the seller from poaching existing clients or employees after the sale. Additionally, a non-compete clause can prevent the seller from competing against you once you purchase their business.
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