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If you’re looking to buy a business with a storefront owned and operated by the landlord, you may come in contact with key-money, an extra payment included with a lease to take over the business with the lease. This article sets out key considerations for buyers whose landlords offer key-money and explains why it’s important to have a sale of business agreement in these situations.

What is Key-Money?

Suppose you’re purchasing a warehouse space. There’s goodwill tied up in the business, a number of valuable assets and it’s profitable. You’re looking to make an offer. An agent prepares a lease. It states that you’ll pay a single, lump-sum payment for these assets and to take over the business. This extra payment is key-money.

Key-money is illegal for leases regulated by various retail leasing laws in Australia. However, for commercial premises, it’s a grey area and key-money arrangements can be legal in certain circumstances.

Buyers asked to pay key-money often feel like they’re getting a good deal. They naturally place a level of trust in the agent and landlord that the documents they are preparing are what they need. However, a lease in this situation does not protect either party in respect of purchasing the business. Rather, it only relates to the use of the premises. Relying on a lease will only get both sides in trouble.

Why Do You Need a Sale of Business Agreement?

It is a red flag for you, as a buyer, if a landlord is offering you a lease and key-money as a substitute for a formal sale of business agreement.

A sale of business agreement is essential for both parties to sell a business properly. Just as you wouldn’t buy a house without a sale of land contract, you need a sale of business contract to clearly transfer the interest in the business to the buyer free from encumbrances (third party interests). A sale of business agreement is a unique contract. It is not a lease.

What Does a Lease Do?

A lease:

  • deals with the right to exclusively occupy a space owned by someone else;
  • creates a property interest;
  • sets out protections for the person paying rent for exclusive use of the premises; and
  • doesn’t, on its own, transfer a business.

The business is separate to the use of the space and, as a result, you should always have a sale contract to purchase an existing business even if the landlord is the business owner, because it is that contract that transfers the business to you.

What Does a Sale of Business Agreement Do?

A sale of business agreement isn’t just a formality either. It sets out a number of clear protections for both parties. Commonly, a sale of business agreement will include:

  • the transfer of intellectual property (IP) and key assets for the business;
  • promises (known as warranties) that both sides offer to each other about the sale. For example, that the seller supplied accurate information about the business and its assets and that the buyer has inspected the business records;
  • sections that protect both sides if either the seller or buyer breaches a warranty and there is subsequent loss;
  • conditions for payment and the completion of the contract;
  • restrictions, to protect a buyer, that do not allow the seller to set up a new rival business next door;
  • confidentiality provisions to protect the release of key information; and
  • bespoke clauses around things like deferred payment, security and employees.

If a seller or their agent refuses to provide a contract, and insists on a key-money arrangement, even on a commercial lease, you should question that purchase. If a seller considers a sale contract unnecessary, the protections above are the reasons why you, as the buyer, can argue there should be one.

Key Takeaways

As a buyer, it’s important to be on the lookout for arrangements that include key-money. Remember that if the premises are retail, it’s likely illegal for the landlord to offer you key-money with the grant of lease. However, if the premises are commercial, seek to negotiate for the inclusion of a tailored sale of business agreement. Not only will it protect your interests, but, if something goes wrong, you’ll have a contract in place to preserve your legal rights. If you need assistance, 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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