A large portion of issues that arise for new business owners are related to incomplete due diligence.
A large portion of issues that arise for new business owners are related to incomplete due diligence.
LET'S TALK LAW
Let's say you are the type of person who is brave enough to buy and run your own business.
It's likely you are also a "can do" person who doesn't necessarily want to sit around and listen to a lawyer wax lyrical about clause 27.5 of a lease*.
However, thecareful and detailed evaluation of the business you are considering is essential to ensure you understand what you are buying.
This evaluation is what we call "due diligence". A large portion of issues that arise for new business owners are related to incomplete due diligence.
Due diligence should be finalised before the purchase is completed. That way, issues can be managed with the seller up front - it is always easier to not pay money than to try and recover it through legal means.
If you want to sign a purchase agreement before your due diligence is completed, you should strongly consider making it conditional on you being satisfied with your investigations within a certain time period.
For small businesses, this is typically two to four weeks.
Sometimes, a seller may not wish to provide all detailed information relating to their business.
If this is because they consider it too confidential, a confidentiality agreement between you and the purchaser requiring you to keep that information secret may be sufficient to make this issue go away.
If the seller still will not provide all information under a confidentiality agreement, or if they do not have it, then the associated risks needs to be managed in the purchase contract.
The matters that should be investigated will vary widely depending on the business and its industry, but should include consideration of:
1. Financial and tax records – These should be reviewed with an appropriate expert, typically your accountant. Together, your accountant and lawyer can also assist you to decide the best structure for the purchase.
2. The assets being sold – Particular attention should be paid to check these are all the assets required to run the business as you envisage. It should also be checked that they do actually belong to the seller.
3. Contracts – All material contracts relating to the business should be reviewed and understood. Key supplier and customer contracts will likely be of particular importance and how they will be managed and transferred to you should be clear. If the business revenue relies on a few large supply contracts, you would not want these customers to be able to walk away because of a change in ownership.
4. Leases or property – Do the sold assets include land or leased premises? If so, the condition of the land should be investigated. Any leases should be reviewed and understood, as well as the condition of the leased property. If the location of the business is important, then the remaining term of the lease will need to be considered.
5. Employees – Where a business has employees, an understanding of these employees and the terms on which they are employed is important.
6. Licenses – If there are any regulatory licenses or consents that are required to operate the business then these will need to be transferred. If they cannot be transferred, then the process for you obtaining them should be understood.
7. Intellectual Property – The intellectual property ("IP") that is necessary or desirable to run the business should be transferred. This might include names, websites, social media accounts, trade marks, patents and trade secrets.
Detailed evaluation of the business you are considering is essential to ensure you understand what you are buying.
Provided you have not committed yourself to the purchase, where you are not satisfied with the outcome of your investigations the information you have gathered can be leveraged to reduce the purchase price, require the seller to fix the issues in question, or you can just walk away.
As always, the recommendation is that you should have a commercial lawyer assist in the legal aspects of the due diligence process. Your lawyer should also review the purchase agreement.
Although small businesses purchases are typically completed using the Auckland District Law Society standard form, most of the time they need to be tailored to fit your particular circumstances and the outcome of the due diligence.
*Clause 27.5 of the ADLS standard form lease for commercial premises allows for cessation or abatement of rent payments when you are unable to access the premises, such as during the Covid-19 lockdown.
• John Eley is a law column writer for Treadwell Gordon
