Buying a business entails as much risk as it does opportunities for success and profitability. Therefore, you must do your due diligence after reaching an agreement with the seller and before signing the contract.
Due diligence is finding out everything about the business in order to understand what risks are involved. There are some things to consider when doing due diligence which are important to learn if you want to reach the right decision.
Businesses are categorised according to their structure or type of ownership. The type of structure will affect your possible business and tax responsibilities. It will also determine the sales process that needs to be completed.
You might only be purchasing half of a partnership instead of an entire business. It’s also possible that what you’re buying are shares of a corporation or part-ownership of a Limited Liability Company (LLC). It’s important to know what exact type of business you are buying so you know what to expect.
Another due diligence when buying a business is to know its history. How long has the business been in existence? How many owners has it had, and who is the current one? More importantly, find out if the business has outstanding liabilities and is impending litigation. You might end up inheriting both if you are not too careful, so make sure to do your research.
Ask the seller for copies of income statements, accounts payable and receivable, as well as profit and loss records. Don’t forget to enquire about the utility accounts, existing business loans, and other lines of credit.
Sale of Business Agreement
Perhaps the most important due diligence when buying a business is to scrutinise the sale of business agreement. It is the contract where the terms and conditions are stipulated. Before signing it, you need to ensure that everything is clear and what you expect to purchase is included. Below are the things that must be presented in the contract:
1. Key Commercial Terms – This includes the assets you are purchasing, the agreed purchase price, liabilities you’re assuming, and the exact date of business handover.
2. Non-compete Clause – An essential part of the agreement that will protect your new business. It will keep the seller from stealing the employees and clients when the sale is complete. The non-compete clause will also prevent the seller from forming the same type of business and compete against you.
3. Sale Conditions – These are the things that need to be fulfilled to purchase the business. It can entail getting a business loan from your part, or transferring the right licenses from the seller’s end. All conditions should be clear to both parties.
4. Intellectual Property – This includes all patents, trademarks, and copyright that the business owns. These should be passed on to your ownership after the sale is completed.
Companies have existing contracts and it’s your due diligence to know if they will be transferred over to you or not. These can be contracts with clients, suppliers, or contractors. All of these will be your responsibility as soon as the sale is done. So, make sure that all of them are known to you before signing the sale of business agreement.
In particular, check the rights of the client and your obligations to them. Remember that the profit from existing clients will keep the business running.
Business operations must still run smoothly after the company is transferred to your ownership. That’s why you need to get confirmation from the seller if the employees will be retained by the company. Also, ask about the rights and obligations that are stipulated in their contracts.
This will come in handy should you decide to do a business reorganisation and eliminate employee redundancy, or simply lessen the number of staff.
Lastly, it’s your due diligence when buying a business with physical premises to know about the current leases. Leases are usually transferred through a deed of assignment and it’s important to know the lease terms of the office, building, or warehouse after the business is sold to you.
Existing leases typically don’t allow any term changes even when the business transfers ownership. So, make sure to review the existing leases and only if you find them satisfactory should you proceed with the sale.
Some Warning Signs
Now that you know the things to consider when conducting due diligence, you can evaluate thoroughly the merits and risks of buying a particular business. It will take time and patience, but reviewing carefully will lead you to the right decision.
Nevertheless, some warning signs will tell you immediately if a business is not worth buying. Be wary if the seller is:
- Not disclosing the reason for selling the business
- Not providing copies of financial statements, business permit and license, and existing contracts
- Not giving information about the suppliers, contractors, and estate agent
- Involved in court proceedings
- Has a bad credit history
- Persuading you to close the sale right away
Due Diligence Checklist
Aside from these considerations and warning signs, the Queensland Government is also recommending to complete a due diligence checklist when buying a business. Some of the things on the checklist include legal and tax (government requirements, stamp duty, and assets valuation) and finance and sales (bank statements, sales records, and balance sheets).
The list also includes business operations and industry (procedure manuals, training from the seller, and industry deregulation) and business assets (stock, equipment, and cash). You can see the full due diligence checklist at the Business Queensland website.
Get Legal Advice from Adams Wilson Lawyers
You must do your due diligence when buying a business to ensure that you are making the right decision. If you want to make sure that everything is in order from a legal perspective before proceeding with the sale, then consult Adams Wilson Lawyers.