As a business owner, you can appreciate there are several costs associated with running a business. Typical expenses include operation costs, rent, cleaning and maintenance. You will need to pay many of these expenses in advance for the day-to-day running of your business. These types of expenses are ‘outgoings‘. When it comes time to sell your business, these outgoings will impact your business sale agreement and, ultimately, the purchase price. This article will explore various factors that can influence the purchase price of your business, including:
- costs associated with outgoings;
- accumulated employee entitlements; and
- prepayments.
Vendor Due Diligence
When selling, you might find yourself diving straight into negotiating the sale of your business. However, you must first ensure that you have a good understanding of all the costs associated with running your business.
Review your business’ financials and consider:
- what costs your business has paid in advance;
- what services others have already paid for that your business has not yet delivered; and
- your current employees, and any entitlements they currently have.
Performing due diligence on your own business will allow you to better understand its costs. Likewise, you will be in a better position to negotiate a beneficial purchase price when you understand your business and its value well.
The next step is drafting the term sheet to set out the ‘headline purchase price’ for the business. The headline purchase price is the price the purchaser agrees upon to buy the business. It often does not factor in any adjustments that may be required for outgoings.
Term Sheet
When negotiating the sale of your business, you must agree to key terms that set out the intentions of the vendor and the purchaser. One of the most crucial terms of the sale is the purchase price.
Another key term when selling your business to a prospective purchaser is the date that the parties intend to complete the deal. This is the date at which the purchaser effectively buys the business, and you receive the purchase price for it. It is the ‘Completion Date’.
After you and the purchaser agree and set the purchase price and Completion Date, you should consider the business’s outgoings.
Continue reading this article below the formOutgoings
As part of running your business, it is common to pay some outgoings in advance. As such, there may be outgoings your business has already paid for that go beyond the Completion Date.
For example:
Maria owns a business running a florist. She agrees to sell the business to Sam on 31 July 2021.
Previously, Maria had already paid for a supply of roses to the florist until 31 August 2021. Accordingly, there will need to be an adjustment to the purchase price. Since Maria has already paid for the supply of roses past 31 July 2021, Sam will be liable for paying this outgoing cost under the business sale agreement.
Therefore, the agreed purchase price will need to be adjusted so that the purchaser pays for the benefits they will receive.
Adjustment to the Purchase Price
Adjustment for Outgoings
Your purchaser will benefit from outgoings your business already bought before Completion, which relates to the period after the Completion Date. Hence, they will be responsible for paying for them.
The most common mechanism used for this is what is known as an ‘Adjustment to the Purchase Price’. Therefore, if you have paid for any business outgoings that relate to the period after the Completion Date:
- you should adjust the purchase price at Completion so the sale is more favourable to you; and
- the adjustment will consider the amount you have paid to the extent it relates to the period after the Completion Date.
Adjustment for Employees
Similarly, you can also apply this principle the other way around to employees.
In a business sale, employees will often transfer as employees with the business. During their time working for your business, these employees will likely have accumulated employee entitlements. Accordingly, your purchaser does not want to be accountable for these entitlements.
You and the purchaser can agree to adjust the purchase price at Completion, in favour of the buyer, to take into account all employee entitlements of transferring employees accrued before the Completion Date.
Adjustment for Prepayments
A further adjustment to the purchase price is an adjustment for payments made to the business for services that the business has yet to complete or deliver. These are known as ‘prepayments’.
Prepayments are the opposite in many ways to outgoings. They are relevant where your business has received money for services that your business will supply after the Completion Date. In this situation:
- you and the purchaser must agree to adjust the purchase price at Completion in favour of the buyer, and
- the adjustment will consider the amount others have paid your business (prepayments) to the extent it relates to the period after the Completion Date.
For example:
Gordon owns a business as a movie script writing company. He agrees to sell his business to Lily on 31 July 2021.
Gordon has already received payment to write a movie script, which he has not yet completed, due on 31 August 2021. Therefore, there will need to be an adjustment to the purchase price for the prepayment of the movie script already paid to Gordon.
Key Takeaways
When selling your business, it is important to know you are entitled to certain reimbursements in addition to the purchase price. Be sure you understand the costs associated with outgoings, employee entitlements and prepayments. Before preparing the term sheet, assess the costs you are expecting to get back and those that you may have to account to the purchaser. This will impact how parties draft the term sheet and the drafting of the business sale agreement. Outgoings will ultimately impact the total amount you will receive.
If you would like more information about the sale of business process, contact LegalVision’s sale of business lawyers on 1300 544 755 or fill out the form on this page.
Frequently Asked Questions
There are several costs associated with running a business, including operation costs, rent, cleaning and maintenance. These types of expenses are ‘outgoings.’
As a business owner, you will often pay many of your outgoings in advance for the day-to-day running of your business. You might have paid for the supply of products for your business that runs well after the completion date for your sale of business. Accordingly, the agreed purchase price will need to be adjusted so that the purchaser pays for any outgoings from which they will benefit.
The ‘Completion Date’ is the date that the parties intend to complete the deal. This is the date at which the purchaser effectively buys the business, and the vendor receives the purchase price for it.
Due diligence is the process by which buyers can assure themselves that the seller accurately represents their business. Buyers need to be aware of any risks or liabilities when committing to purchasing the business.
The purchase price’s variation based on outgoings will depend on the adjustments for outgoings at the Completion Date and those that benefit the buyer.
We appreciate your feedback – your submission has been successfully received.
