Purchasing a business is an exciting and often daunting experience. Regardless of the size of the business, there are many complex legal areas that the purchase of business touches upon such as contract law, employment law, company law and property law.
The legalities around these transactions create vulnerabilities that Purchasers need to be aware of and it is essential to engage legal representation before entering into legally binding Contracts.
A Purchaser needs to be aware of the main issues and ruses in purchasing a business. At a minimum, make sure you are informed of the following matters prior to making an offer:
Section 52 Statement
The Vendors Accountant needs to complete and provide a Section 52 Statement if the purchase price is under $350,000. This Statement provides details of the business for the last two operating years including the lease and financial and accounting records. If you are not familiar with this documentation it is highly recommended to seek legal and accounting advice.
Heads of Agreement
Once you are satisfied with the operation of the business and have negotiated and agreed upon a price with the Vendor, you may be required to sign a Heads of Agreement (HOA). Once this document is signed it is binding and legally enforceable. Any verbal agreement is not applicable, unless it is specified in the HOA.
It is highly recommended that you seek legal advice prior to the execution of this document as the HOA determines the manner in which the business is purchased and establishes the main conditions of the Contact of Sale. The Purchaser needs to understand and be aware on matters such as restraint of trade, trial period, assistance period and health inspections as these particulars are addressed in the HOA.
By having a lawyer review the HOA prior to execution, any potential issues can be identified and resolved at an early stage. This will not only save legal fees but will speed up the process to settlement.
The Lease document is the most important aspect to review and understand when purchasing a business. Many Purchasers do not adequately budget for the implications of the Lease. There is the monthly rental, the outgoings, the security deposit, rent increases and insurance. These unbudgeted expenses can put a strain on a new business owner. Therefore the Purchaser must be completely familiar with the terms of the Lease and understand that the Purchaser, who becomes the New Tenant, takes the Lease as it is. Particularly look out for the following:
Many Purchasers do not account for the payment of the security deposit to the Landlord.
Under the Retail Leases Act, the Landlord is permitted to take a bond for the performance of the Tenant’s obligations under the Lease. The amount of the security deposit varies, however it is usually in the sum of three months rental, which can be a substantial cashflow issue when commencing the business. The security deposit as specified by the Lease MUST be paid prior to settlement.
Keep in mind that the Landlord also has the discretion to increase the amount of the security deposit if they are not satisfied that the Purchaser has the requisite business experience or financial resources.
I’m sure you are wondering what the Purchaser’s financial and business experience has to do with the Landlord, but what many Purchasers do not understand is that the whole transaction is contingent upon the Landlord. Once the Contract is signed between the Vendor and the Purchaser, the next process is to gain the Landlord’s consent to transfer the Lease to the Purchaser.
The Contract of Sale of Business is conditional upon the Landlord of the business premises approving the Purchaser as the new Tenant.
Under the Retail Leases Act, the Landlord has the right to ask for the prospective Tenant’s financial resources and business references. The Landlord needs to be satisfied that the proposed Tenant has the assets to pay the rental. Many transactions will fall down at this point, so it is suggested that you prepare a Statement of Asset and Liabilities and seek advice as to a business plan and cash flow estimate to ascertain if you will be eligible to take over the Lease.
Be warned that the most common delay in settlement is gaining the Landlord’s consent.
The Landlord is the third party to the transaction and are customarily inconvenienced by the sale of the business. The law allows the Landlord 28 days to consent to or refuse the proposed new Tenant.
As the transfer of Lease is a legal transaction the Landlord is required to engage their own Lawyer. Note that all fees in association with the Landlord are paid for by the Vendor and Purchaser. As the fees will not be provided until a day or so before settlement it is hard to estimate the amount the Purchaser should budget for. The Landlord’s fees with association to the transfer of Lease can be anywhere from $700.00 to $5,000.00. It is recommended that the Contract is reflected to show how the Landlord fees will be born between the Vendor and the Purchaser.
As the Landlord has up until 28 days to consent, the settlement date specified in the Contract is generally never accurate. Settlement largely occurs within three days of the Landlord providing consent. There have been many situations where people have resigned from their jobs in anticipation of settlement and settlement has not occurred for quite some time. Be mindful of this and gauge an idea from your Lawyer as to the expected settlement date.
Ascertain the current annual rental. This seems obvious, however, the Lease does not state the current rent; it states the rental as at the commencement of the Lease. Many Purchasers make this mistake and a costly mistake this can be.
Also be aware that the rent will increase every year. Make sure you are aware of the manner in how it increases. Is it by CPI increase? Is it by fixed increased? How will this affect your cash flow in the following years?
Outgoings are the Landlord’s costs and expenses in relation to the premises that the Tenant is obliged to pay for under a Lease. Generally outgoings are comprised of council rates, water rates, the Landlord’s building insurance, maintenance, Owners Corporation fees (if applicable). Outgoings are usually a further $3,000.00 to $6,000.00 per annum in addition to the rental. A Disclosure Statement will be provided to the Tenant specifying the estimated costs of outgoings per annum.
Every business is different. In addition to the points detailed above be aware that the type of business you are purchasing may carry further legalities.
For example, if you are purchasing a food business it is prudent to have the purchase conditional upon a health inspection. Also, make sure you have the adequate food qualification and in some instances a food plan. If you are buying a business with a liquor licence make sure the business is conditional upon the successful transfer of the liquor license. If you are purchasing a beauty salon ensure the essential equipment is included in the purchase price.
Every type of business has different aspects to be aware of!
Buying a business
is not something that one does every day. No matter the size or type of business seeking legal advice will assist you to navigate through the minefield of legal issues. We have extensive experience acting for purchasers in transactions
including beauty salons, food and hospitality businesses, gymnasiums, post offices, financial service businesses, real estate agencies and trade service businesses.