What is “due diligence” when purchasing a business?
Due diligence is relevant to both vendors and purchasers and is not something that happens overnight. If you are a thinking of selling a business you should take time to review and coordinate your business affairs so you can be sure that the business is compliant, organised and complete. Once you open your business up for investigation by potential purchasers they will be looking for holes and, if they find any, it will be reflected in the purchase price or you could lose a deal altogether.
On the other hand, if you are thinking of purchasing a business, it is normal practice to give yourself adequate time to conduct your due diligence so that you (and generally your financiers) are satisfied that the business you are buying is what the sellers represent it to be, is compliant and is fairly priced.
The scope and extent of due diligence will depend on those matters highlighted above however typically includes:
- A review of corporate structure and governance documents, regulatory licences, permits and approvals, material contracts, employment records, asset condition reports, finance agreements, leases and real property documents, active litigation, insurance documents and conducting public searches of corporate data, intellectual property, courts and government agencies;
- Verifying the financial information furnished by the vendor and obtaining a valuation of the business;
- Speaking with staff and suppliers of the business; and
- Ascertaining who are the customers of the business.
The seller may also require the intending purchaser to sign a confidentiality agreement prior to disclosing information about the business to the intending purchaser.
Due diligence is not something that should be overlooked when buying a business or selling a business.
What happens with the lease for the business premises?
If the business you are intending to buy has a lease relating to the existing premises, it is important that an experienced lawyer reviews the lease to ascertain the process involved for transferring that lease and terms of the lease. Normally, consent will need to be sought from the owner/lessor of the premises for the transfer of the lease.
What is Goodwill?
Goodwill is an intangible though saleable asset almost indestructible except by indiscretion. It is built painstakingly over the years.
Goodwill is a special asset of the business and is the right to have the continuing benefit of existing and prospective customers of the business and the maintenance of turnover and profits. Goodwill arises for a variety of reasons in a business, for example, the quality of products sold by the business, the location of the business, the high quality and performance of staff, the creation and maintenance of durable customer and supplier relationships, and the absence of competition, and so on.
Its value is not recognised in account books but is realised when the business is sold, and is reflected in the business’ sale price by the amount in excess of the business’ net worth.
What is a restraint of trade in respect to a business?
A restraint of trade is a clause that is inserted contracts when selling a business that restricts the seller of a business, or a director or shareholder or key employee of a business from undertaking certain activities for an agreed period of time after the sale has been completed. The restraint of trade clause is to protect the goodwill of the business that has been purchased. There is a range of possible restraints, including:
- restraining the person from being involved in a similar business which is located within a specified area for an agreed period of time;
- restraining certain activities, such as to not sell any products that compete with the products of the business;
- restraint the person from soliciting, enticing or endeavouring to obtain the business of past or existing customers of the business;
- restraining the person to keep secret and confidential, business and financial information regarding the business; and
- restraining the person from interfering with or enticing the employees of the business to leave and work for another business.
Are licences or permits required to run a business?
An important consideration when buying a business is to make sure you have or obtain all the necessary regulatory licences and permits required to legally conduct the business at the premises.
The validity and adequacy of the licences and permits can be checked while conducting the due diligence however you should also check whether such licences and permits can be transferred or whether the purchaser is required to go through a new application process or whether there are additional requirements due to changes in law or policy requiring new licences and permits to be obtained.
The different types of licences required for a business include:
- licences in relation to the use of premises for particular activities and their suitability for such use;
- licences regarding the licensee’s suitability and fitness to conduct the business activity;
- professional or occupational licences held by the business owner as a pre-condition of conducting the business which cannot be transferred to another person.
There is a Business Licence Information Service in New South Wales providing information and forms for many licences and permits. Click here.
For more information, get in touch with Rockliffs today.