If you are purchasing a business, conducting due diligence is a step that should not be missed in the buying process. Due diligence is the process of investigating the business that you are looking to buy. Completing thorough due diligence ensures that you understand what you are buying and any risks that you may be taking on.
You will usually conduct due diligence after you and the seller have agreed on a deal, but before signing the binding sale of business agreement. You may have agreed on a price, subject to due diligence. Below, we run through a checklist to consider when conducting due diligence when purchasing a business.
Understanding the structure of the business you are purchasing is important as there can be significant consequences if you do not get it right.
Firstly, be aware of what you are purchasing. There are two ways to purchase a business. You can either purchase the shares of the business or purchase the assets of the business. What you are buying will affect the sale process and your legal responsibilities for the business. It may also have tax consequences.
Secondly, consider how you will purchase the business. You can buy the business as:
- an individual;
- a private company; or
- a trust.
It is a good idea to get business structuring and tax advice on how best to structure the sale.
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?
- Is there impending litigation?
- Does the business have outstanding liabilities such as an unpaid loan?
Sale of Business Agreement
The sale of business agreement is a contract that outlines the terms and conditions of the sale. It is vital you have this contract in place so that both parties are clear on the nature of the sale. Anything not included in the contract will not be included or covered in the sale. As a result, you want to ensure that the contract is well drafted and adequately protects you. You will also want to ensure the contract includes everything you want to purchase. Below are a few considerations to take note of.
Key Commercial Terms
The key commercial terms should cover the:
- assets you are purchasing (for example, equipment and motor vehicles);
- purchase price you have agreed on;
- liabilities or legal responsibilities you are assuming (if any); and
- target date for you to take over the business.
Conditions Precedent to the Sale
Be aware of any conditions you need to fulfil before you are able to purchase 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.
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 e.g. opening a cafe in the same location or opening the same type of business within a certain time frame after the sale.
Understanding what intellectual property the business owns and will be assigning to you will help you maintain the value of the business. In many cases, a business’ intellectual property will be its most valuable asset.
Supplier and Customer Contracts
If the business you are purchasing has key suppliers or customers, it is crucial that you have contracts in place to ensure they are transferred to you. 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.
You should be aware of:
- what contracts exist;
- whether they can be transferred to you; and
- the period of the contract and any sales benchmarks under the contract.
Employees and Contractors
Keeping existing employees and contractors that understand how the business operates can be very valuable to you. You should confirm with the seller whether you will be retaining 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.
If you are looking to take over a business with physical premises, understanding the lease is very important. You want to ensure that you are able to use the premises after you have purchased the business.
Typically in a business sale, you take over the seller’s current lease. The lease is usually transferred to you through a deed of assignment. When taking over a lease, there is typically little room for negotiation, so it is critical that you understand your rights and obligations under the lease. You should carefully check:
- the term of the lease (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 expiring or the landlord is open to negotiating a new lease, a new lease may be prepared. This puts you in a position to negotiate the lease.
When purchasing a business, it is essential that you understand exactly what you are buying. 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 agreement; and
- conducting the relevant searches.
If you have questions about the due diligence process when purchasing a business, get in touch with LegalVision’s business purchase lawyers on 1300 544 755, or fill out the form on this page.
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