Preparing your Business for Sale

Two areas where a commercial lawyer can help you in preparing your business for sale:

  • Pre-marketing preparation, and
  • The sale itself.

Pre-marketing preparation essentially means a health check on your business. Is it all in order for a sale? What is your structure and how do you best transition out of the business. Usually, with a sole trader or partnership it will be a straight sale arrangement – with a company it can be a share sale or a straight sale – where there’s land involved with different ownership there might be two simultaneous sales or inter-dependent sales, and where there’s a lease there will almost always be a lease assignment.

A key part of the health check is making sure that the correct entity owns each of the assets – it’s common for a lease or business name to be owned by the wrong entity.

It helps to fix these problems before you market so that potential buyers don’t get confused when doing their due diligence, and scared off.

And we look at your business contracts – supply contracts, contractor contracts, customer contracts – can they each be assigned to your buyer? This can be crucial – we mentioned last week a business that had a contract with Australia Post that is worth a lot to the current business owner, but you have to check whether it contains a clause that allows you to assign it – or are you forced to give back to Australia Post to select next contractor for a nominal sum? Or there may be a rigorous consent process for an assignment, such that you need to aim your advertising to sell your business to a particular market and not waste time on certain enquiries.

Then, of course we recommend that you need a lawyer to assist you with the sale itself – as a rule it is the vendor’s task to prepare the sale contract, which is an important document and you have to get it right. We can create the contract to fit your sale situation, and after 15 years of this I can safely say that every sale is unique and should have a tailored contract. Your sale contract should not be a one-size-fits-all. With your accountants, we look at what has to go in there, apportionment of price for what you are selling, and also advise on structure of the sale for tax – sale of shares, sale of business, sale of parts of business, sale of land/lease, and whether your sale is a “going concern”

What is a going concern? An artificial creation by the tax office – if you sell all components of a trading enterprise that is a going concern, no GST is payable.

Sounds great, no GST – often business people get caught up in the effort of making their sale a going concern and forget that it is a tax neutral outcome if GST does in fact apply. Vendor collects 10% on top and pays to the taxman, purchaser pays 10% on top and gets back from the tax man. Each end up in the same position PROVIDED you correctly negotiate the price as GST exclusive in the first place. Always negotiate your price as GST EXCLUSIVE so that everyone knows where they stand – and if GST is payable, you still get your agreed price. You can also guess why it is important to be clear in your price and your negotiations that you are GST exclusive. A deal may be struck only to fall apart when GST is brought in to play because price was not clearly agreed as INCL or EXCL. I’ve even seen litigation spring out of this when a vendor has forgotten GST altogether and the vendor has then gone knocking on the purchaser’s door for an extra 10% after the tax man knocked on the vendor’s door. The law says that if contract doesn’t mention GST, it is INCL, which will always be bad for a vendor.

For a purchaser the real detriment of GST if you can’t bring it under the going concern umbrella is that it can be a killer in terms of cash-flow – if you’re a purchaser, and you’re REGISTERED, and you have to PAY GST, you will get it back from the tax man the next quarter, but you may not have that additional 10% lying around or financed (buying a business is expensive enough).

If it’s important for the buyer to have it GST free, to avoid coming up with the extra 10%, then there’s things the lawyers need to do and check to ensure that your transaction qualifies as a going concern.

Firstly, your sale contract must record in writing that it is the sale as a going concern. If you leave this out, you won’t qualify.

Secondly, the vendor must sell all of the things that are necessary for the continued operation of your business. This is where a lot of these arrangements fall over as going concerns. If a vendor wants to keep some assets of the business such as a delivery motor vehicle or machinery – then it’s not a going concern because you’re not selling everything. Usually a going concern is brought undone by a failure to supply the premises. Part of giving them everything they need is giving them the premises to operate out of – it’s not enough to sell them everything and say they now need to go and source their own premises. You must give them yours (unless it is a business that doesn’t require a location to trade from, it is mobile or run from a home office but strict rules apply here). If you are leasing your business premises, there must be an assignment of lease OR surrender of an existing lease and the landlord entering into a new lease with your buyer. In certain situations you can even supply an alternative premises (again, you need to look closely at ATO rules on this). If you do not have a lease agreement and you pay no rent (because you or a related entity own the premises), you can’t supply a right to occupy the premises and this will not be a going concern. If you have an unwritten lease agreement but pay market rent, then in theory this is a tenancy-at-will you can assign. But the waters are murky, so often (particularly in the pre-marketing preparation) we will recommend that you put a written lease in place if you lease from a related entity, so that you have a “right of occupation” to sell, and so that you can qualify under the going concern exemption.

Sell all of the things – you will also come undone where your ownership is hotch-potch, you the seller must supply all of the things, can’t do this if your company owns the machinery, but the lease is in your name (there are exceptions but again, strict ATO rules). Another common mistake is the business name is often in the wrong  name, or not owned at all, we make sure your register this ownership, as well as checking the ownership of any intellectual property that I have mentioned in previous lectures (trademarks, patents).

Another requirement is that the seller must trade up until the day of supply. You can’t schedule business closure for one week in the lead up to the sale where you will do painting or renovating – this will nullify going concern.

Both vendor and purchaser must be registered for GST.

Protection? With going concerns you must always tread carefully, there is always a possibility that something we regard one way, the mystical tax man will regard another way, and the going concern exemption may be out the window. Our going concern clause will always state that if this happens – where tax man holding his hand out to you the seller for a 10% cut – you can ask the purchaser to pay this. Remember outcome is neutral, they will claim it back, it will be a cashflow problem for them, but need the contract to say that you can demand it from them so that you don’t have to pay it, as they are the ones who can claim it back.

Just to clarify why your lease or tenure arrangements are important – a big part of the value of your business will often be the location from where it trades, and it will be a deterrent to a purchaser if your lease is about to run out (or has already run out!) and there is no assurance that the landlord will allow you to stay. You can be pro-active in the marketing stage and at point of sale, in dealing with your landlord, warming him or her up about entry into a new lease for a reasonable term that gives your potential buyer comfort that about where they will be running the business for the next 5 years. OR, if in talking to your landlord, you are wholly convinced that your landlord wants to continue the lease arrangement and it is just a matter of the terms, then you can offer to prospective purchasers that they can negotiate a fresh lease with the landlord. I’m not going to recommend either way, different approaches will suit different circumstances. Most important thing is to lock for your buyer the tenure that they want. I’ve mentioned also that sometimes you, your trading entity or you personally or another investment entity, are the landlord and in this case if you haven’t already put a lease in place as we and your accountant will have advised, then you will negotiate a lease, or even a land sale. In all these situation, the purchaser will request that the position be reflected in the sale contract as a condition. This will also be framed to allow the going concern exemption to apply.

I’m just going to briefly highlight the other things that must go into your sale contract, or at least be considered in the context of preparing your contract:

  • What are the ASSETS that you are selling – what is included in the sale, what is excluded?
  • We look at the apportionment of the agreed price over those assets – this should be in the contract and always in consultation with your accountants.
  • Stock will often be excluded from the price and valued in a separate stock take – specify when it is to take place, who is present, that it is landed cost, that any out-of-date perishables or damaged goods are not included, and there’s a mechanism for resolving any dispute that don’t hold up the sale process. Any disputed money should go into a solicitor’s trust account to be resolved quickly and sensibly.
  • When settlement and handover will take place and how – usually a cheque handed over in exchange for control of the business – keys, records, signed business name and vehicle registration papers.
  • Training agreements can be two things – pre-settlement, purchaser can attend at business for set period and receive training, or post-settlement the vendor must attend at the business to assist and make introductions. Often both, but must be covered in the contract.
  • Employees – often framed as a requirement that the vendor terminate all employees as at settlement other than TRANSFERRING EMPLOYEES who are identified in the contract or in writing before settlement after buyer has conducted interviews and decided who they would like. Then there are rules in the contract about employee entitlements transferring to the buyer. More often, the vendor terminates all employees, and the buyer may then offer to employ anew the ones that they want, and the vendor is then paying the employee out as at the date of settlement, no residual entitlements to adjust other than long service. Either way, this must be done properly, and with indemnities/warranties
  • INDEMNITIES AND WARRANTIES – this is often a process of negotiation. Usually a vendor will want to walk away without anything ever coming back to bite them. A buyer will want to be sure that any claims or liabilities hidden away in the business that pre-date ownership will be dealt with by the vendor. It’s usually our job to finesse a middle ground.
  • Finally, that important topic of price, usually a deposit at the time the contract is entered into, this is always recommended, but you might also be agreeing to vendor finance to tie up a sale. The contract should always be clear on the terms of your vendor finance – what you are advancing and what interest is payable, when it is repayable and what to do in the event of a default – not uncommon to have a separate loan agreement, separately enforceable so that the sale terms and conditions aren’t re-visited when it comes time to sue on the loan agreement. Don’t think it won’t happen. Better off thinking that it will happen and preparing for it, better than being left high and dry. The best preparation for default of a vendor finance arrangement is security/protection. Mortgage over real property can be the most effective security, but if they are borrowing from you, likely they are already mortgaged to a bank and therefore you will be getting in line. Retention of ownership – is tricky because of the new PPS regime. A retention of Title clause is likely to be unenforceable UNLESS you subscribe to the new regime. Better to use the new PPS regime using the business assets as security – and you will take priority over later registrations IF YOU DO THIS PROPERLY. There are strict time limits on registration in purchase situations like this – if you do it right you will have the right to re-claim the business assets before the bank or liquidator steps in if they go under, full protection. If you don’t do this right, under PPS, you get nothing – a bank who has subsequently registered a General Security Agreement (new lingo for their fixed and floating charge) will defeat any claim you would have on business assets to pay you back for the vendor finance you have advanced. EVEN IF the sale agreement purports to record that you still OWN the business assets until you are fully paid, this is not enough.

If you are doing vendor finance, do it right, and give yourself the power to reclaim the assets in default. Might even be things we can do to ensure they don’t run the business into the ground before default. Without protection, it can all go horribly wrong.

For more information or to make and appointment contact our Business Services team:

p: 02 6206 1300 | e:  info@elringtons.com.au