Buying a small business

1. What is a “due diligence” inquiry?

The principal causes of businesses failing include location, inexperienced or incompetent management, lack of capital, excessive overheads, and problems relating to stock. A viable business can be ruined with poor management, but even someone with superior management skills would find it very hard to resuscitate a potentially non-viable business. Hence the need to thoroughly evaluate the financial viability and the cost of a business before entering into a binding contractual commitment to purchase it. In addition, the business should suit the interests, abilities, need, and financial capacity of the intending purchaser. These investigations are called “due diligence” inquiries.

Due diligence enquiries include:

1. obtaining a valuation of the business;
2. reviewing the business’s contracts;
3. speaking with the business’s suppliers and staff;
4. verifying the financial information provided by the seller; and
5. ascertaining who the business ‘s customers are.

The seller may require the purchaser to sign a confidentiality agreement before disclosing confidential business information to them.

2. What is goodwill?

Goodwill 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 from the quality of the products the business sells, the location of its premises, the absence of competition, the performance of the staff etc. It is generally reflected in earning power of the business but can be destroyed quickly by factors beyond the business owner’s control.

Elements comprising goodwill are different for different businesses. Things a purchaser should consider to help protect the goodwill include:

1. introductions to customers and lists/records of customers;
2. obtaining transfers of the business’s designs, patents trade marks, and logos;
3. the seller training the purchaser;
4. securing continued employment of key employees;
5. obtaining a transfer of the business name; and
6. restraints of trade by the business seller, directors or shareholders.

3. Do I need licences to run the business?

Licences and permits may be essential for the continuing operation of a business. Many licences are principally concerned with the suitability of the premises for particular uses and activities but some are concerned with the licensee’s suitability and fitness to conduct the activity. Some licences can be obtained from a public authority at a moderate annual fee, whilst others have a substantial value and may form a substantial portion of the value of a business.

Some professional or occupational licences need to be held by the business owner as a pre-condition to conducting the business and cannot be transferred to someone else. Other licences require the holder to provide evidence of substantial assets.

The Australian Business Licence Information Service provides information and forms for licences, permits, approvals, regulations and codes of practice.

4. What is a restraint of trade in the context of a business?

A restraint of trade is a restriction placed on a business seller, director, key employee or shareholder preventing that person from undertaking certain activities for an agreed period after completion of the sale of business. The purchaser requires the restraint to protect the business’s goodwill.

5. How does the purchase of a business affect staff entitlements?

When a business is sold, the purchaser usually has a right to select which employees they want to retain.

The seller must pay out the entitlements of any employee not re-employed by the purchaser. Sellers may become liable to make severance or redundancy payments to employees not re-employed by the purchaser.

For most employees re-employed by the purchaser, the employee’s entitlements to long service leave and holiday leave carry over and are maintained. The purchaser can be liable to pay employees for untaken holiday and long service leave accrued before the purchaser became the business owner. Provision for these obligations should be clearly settled with the seller in negotiations before the sale.

Under most awards or industrial agreements, a business purchaser does not acquire any retrospective liability in respect of employees’ untaken sick leave for the period before they purchased the business.

Purchasers may be required to make severance or redundancy payments those employees they re-employ and subsequently discharge .

Purchasers should also be aware of the effect of fringe benefits tax on benefits given to valuable employees to induce them to stay on.

6. Is stamp duty payable on the sale and purchase of a business?

There is no stamp duty on the transfer of ‘business assets’. A ‘business asset’ includes goodwill, intellectual property, stock in trade, registered motor vehicles and a statutory licence such as a gaming machine entitlement.

However, stamp duty is payable on any land, or an interest in land (e.g. a transfer of lease) included in the sale of a business and on ‘dutiable goods’ (e.g. plant and equipment) also involved in that transaction.

7. Does GST apply to the sale and purchase of a business?

GST may be payable on the sale of a business if it is a taxable supply for the purpose of the GST legislation.

The contract for sale of the business will usually contain provisions relating to whether the price is inclusive of GST and whether the purchaser or the vendor is liable to pay the GST.

The sale of a business may be GST free if the sale constituted the supply of a “going concern” (i.e. where the seller supplies to the purchaser everything necessary for the continued operation of the enterprise and carries on the enterprise until the day of supply [usually the completion day]).

If a business purchaser is to obtain an input tax credit (i.e. claim back GST) or if a business sale is to be GST free under the sale of a going concern concessions, the purchaser must be (or be required to be) GST registered at the time of the supply and acquisition.

The supply of a business as a going concern is GST-free if:-

1. The supply is for consideration;
2. Everything required for continued operation of the business is supplied;
3. The purchaser is registered or required to be registered for GST;
4. The supplier carries on the business until it is sold; and
5. Both parties agree in writing that the supply is of a going concern.