Avoiding disaster when buying a business

January 29, 2023 Paul Brennan
Avoiding disaster when buying a business
Show Notes Transcript

Basic advice for anyone buying a business

Paul Brennan is the principal of Brennans Solicitors, a law firm located on the Sunshine Coast, Queensland, Australia, where he practices with his wife, Diane in the areas of business law, litigation, property and wills/estates.

Over the years, by working in various countries, he noticed how similar the law can be. He set out to explain the law in a simple and often humorous way.

He has written several books about law and lawyers.

Further details of his profile can be found on Linkedin.

 Long ago judges got sick of people saying that they did not know what they were signing and generally if you sign a contract then you are stuck with it.  Consumers get some leeway but generally not business people.

Nowadays lawyers put essential information like price in easy-to-read schedules.  Many put red stickers on contracts so that clients know exactly where to sign.  This makes it easier for people buying businesses to have a quick look at the schedules, sign up and rely on the contract being fairly reasonable. 

As a buyer of a business what do you need to look for?

Well, first of all expect the Seller to be in poor heath (like ageing South American dictators facing a show trial, many desperate sellers seem to develop these and then cheerfully live on to 90).

The Seller will not want you to have a due diligence condition?  This acts like a cooling off period for say 14 days.  It allows time for your accountant to get a better and closer look at the business.  It also gives time for you to reflect on the deal.

Here are 6 other conditions that need to be considered carefully by a Buyer:  

1.       Hand over

On completion the Seller will want to receive the money, hand over the keys and walk away.  A handover condition would list the various other documents and evidence of ownership that you may need if he is to finance, operate and eventually sell the business.  Hopefully you will be able to piece these items together later on, however at that stage it will not be your client’s problem as he will be long gone.

2.       Warranties

These are promises made by the Seller to say that the business is alright.  There can be quite a few for instance the business has no issues with the authorities.  The Seller promises that he does not know of certain other issues that affect the business.  By giving these promises the seller risks being sued by you if the business does not live up to his promises.

3.       Restrictions on the Seller’s Right to Trade

This limits the Seller’s right to carry on a similar business in a certain area, for a certain period of time after the sale.  This is a difficult condition as the limitation should not be too wide or a court may throw it out.  However if you get it right the Seller will not be able to carry on a competing business for some time.  If this is not specified in the contract the Seller can set up next door.   Of course the Seller would not dream of coming back.  But in the event of a miraculous recovery it gives the Seller this option. 

4.       Finance

This allows you to get out of the contract after say 14 days if no finance can be found but it can be used by some as a way of getting out of the contract generally.  The Seller will want you to find finance however without this clause and a contractual deadline looming you will be even more motivated to ensure that you come up with the money.

5.       Deposit

The standard deposit is often 10%.  It is usually kept by a stakeholder.  However it is increasingly common for sellers to accept less than 10%.  This can cause problems if the deal falls through. If there is a low deposit it gives the Seller very low leverage if a problem should occur.  

Having the deposit kept by a stakeholder on trust can be inconvenient for the Seller.  If the deal falls through the stakeholder will usually insist on a court order or the consent of both parties before releasing the deposit.  It would be far easier for the seller if the deposit was released to him straight away.

6.       Plant and equipment 

Unless it is listed in the contract you can never be sure that what you think is being sold is actually being sold to you.  Anything not nailed down may disappear on settlement unless it is listed in the contract.  Equally you may be left with some large items of machinery that the Seller does not want.  Some items which appear to be business assets may not in fact belong to the Seller such as rights in intellectual property.

Buyers usually require and Sellers normally accept these conditions.  If they are not included in the contract it does not mean that you cannot ask for such concessions later on.  However it would allow the Seller the advantage of being able to refuse.

Buyers should not expect a contract to be “fairly reasonable”. In my experience if you do not check the contract before you sign, then it is the condition that you desperately needed which is missing.  We lawyers call this ‘sod’s law’.

© Paul Brennan 2007. All rights Reserved.

Extract from "The 10 Greatest Legal Mistakes in Business...and how to avoid them"