Sales of Businesses

The art of business sales is in the contract drafting: carefully considering all contingencies. The science is in the implementation: stewarding the deal through to successful completion.

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Sale and Purchase of businesses

Sale of a Business by Business Contract

By far the most common way of selling or buying a business is by way of a business contract that transfers the business’s unencumbered  assets.

Under this form of sale which is usually “walk-in walk-out”, all debts of the business remain with the seller as do pre-sale liabilities and tax liabilities. The business assets sold usually include goodwill, plant & equipment, lease of the premises, fixtures and fittings, stock and intellectual property.

The price for the sale reflects the combined value of each of those components.

Staff can transfer to employment by the buyer without detriment to their employment benefits, or their contracts can be terminated by the seller at the date of completion of the sale.

Lease and supply contracts must be assigned (with the approval of the landlord and customer). Business names and related collateral are also transferred.

A carefully drafted restraint-of-trade (“non-compete”) covenant is of course essential so as to preserve the goodwill being acquired by the buyer.

Transfer of shares in the company

The sale of shares in a company that owns a business is another means of selling a business although it occurs far less frequently.

It involves a sale of the company “warts & all” to the buyer, meaning that the buyer acquires all of the company’s assets – including the business – and all of its liabilities.

This method of acquisition requires a buyer to be satisfied that the company is ‘clean’. In particular, the buyer must be satisfied with the following:

  • Any potential for customer or supplier disputes
  • Adverse taxation liability
  • Latent liabilities
  • Incomplete regulatory compliance

Is it better to sell or buy the business or the shares?

The documentation required for the two different methods of asset transfer is different, though the legal costs for a buyer and seller are generally much the same in each case.

Every case should be considered individually – particularly from a taxation perspective – to determine the best means of acquisition or disposal.

Apart from tax considerations, the benefits and detriments of buying the company rather than just its business are as follows:-

Upsides 

  • The buyer gets the benefit of government approvals or licences that are not transferable.
  • Leases and supply contracts don’t require formal assignment (although the buyer will still need approval from the landlord in the case of premises leases).

Downsides –

  • Latent liabilities and customer or supplier disputes are inherited even if they were unforeseen.

Because all of these features are difficult or impossible to independently investigate, many buyers are not prepared to entertain this means of acquisition.

The capital gains tax and income tax payable on a share sale will be different to that payable on the sale of the business by itself.

Hospitality business contracts

The value of the goodwill in a hospitality business – restaurant, café or bar – is usually determined in the first instance by reference to future maintainable earnings having regard to historical revenue and then negotiated according to other features of the business including location, reputation etc.

Fixtures, fittings, plant and equipment and stock also feature prominently in arriving at a sale price.

As with all leasehold businesses, the security offered by the lease – and any options to renew – is also an important feature.

Other special considerations apply to motel and hotel business sales.

Hospitality businesses are often highly leveraged and particular attention needs to be paid to ensuring that all security interests including those under the Personal Property Security Register are released at the time of payment of the purchase price.

It is particularly important that all “representations” as to profitability and takings made by the Seller are recorded in writing and that adequate due diligence is conducted by the buyer’s financial advisers.

Real Estate Agency sales & rent rolls

A Rent Roll can be acquired either with or without the agency business that operates it.

Rent Roll sales contracts must accommodate many eventualities and provide a mechanism for the transfer of property owners’ “appointments to act” in favour of the Rent Roll buyer. The Purchase Price is usually arrived at by applying a goodwill multiple to the gross annual management income derived from each property under management. Thus the actual settlement sum will be dependent upon the final inventory of managed properties at completion date.

The contract must also provide either a reasonable method of allowance to the buyer of a refund in respect of property is a manager with management of which in this within a short time (usually three months) following completion.

Because the transfer of property management to the buyer is dependent upon property owners completing and signing new appointments buyer’s favour, the contract should also provide for second and third settlements to accommodate the late return of such documentation from owners and the sign-up of additional properties over that period by the Seller.

Professional services business sales

Because professional services firms are largely dependent upon recurring client business, a “client schedule” listing those customers, is usually included in the contract documentation.

The sale price is usually comprised of goodwill (calculated by reference to maintainable earnings or  cash generation capacity); plant and equipment; and work in progress.

The method by which work in progress is to be valued must be specified in the contract so that  shortly prior to completion, it can be calculated and paid for on completion by the buyer.

Alternatively, the buyer can collect pre-completion work in progress on behalf of the seller and remit it to the seller as it is billed and collected from customers.

Sales of professional services businesses often contain an “earn out” provision whereby part of the buy price is retained by the seller for 12 or 24 months pending recovery of post-settlement earnings for the business at a specified level.

By way of example, the sale of a business for $1 million might provide for deferred payments of $200k that are contingent upon the business achieving earnings of not less than $300k during each of the two years following completion. The usual provision is that deferred payments are reduced dollar for dollar by whatever about the earnings fell short of the agreed threshold in either year.

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