How to buy a business

Introduction

For those wanting to go into business on their own, buying an existing business can both ease the learning curve involved and also provide you with some established goodwill – that is, the immediate ability to generate turnover.

This information sheet outlines some of the factors you will need to consider in buying a business.

The sale and purchase agreement

You should thoroughly review the proposed sale and purchase agreement and seek a lawyer's advice as to its effect.

The Real Estate Institute of New Zealand and the Auckland District Law Society have approved a printed form of agreement, and it is common for this form to be used for the sale of small and medium-sized businesses.

The purchase price

Goodwill, plant, fittings and fixtures, and stock together usually make up the purchase price. It is important that the purchase price is broken down into these components, with a value attributed to each one, in the agreement for the sale of the business.

Turnover

Are the seller's turnover figures correct? Can the seller substantiate them? Ask for detailed financial statements of the performance of the business and have them assessed by an accountant.

It is common for sale and purchase agreements to include a warranty by the seller that the turnover details in the agreement correctly state the average weekly turnover (including GST) of the business during a certain period. (If the seller breaches a warranty, you can sue him or her for damages.)

If a turnover figure has been affected by a one-off increase in business activity, it may be misrepresentation if the seller fails to bring this to your attention.

Goodwill

Is the goodwill worth what the seller is asking for it? Are there any patents, trademarks or other intellectual property included in the goodwill, and if so, are they dependent on any licences?

Note that goodwill is generally capital, and therefore is neither deductible nor depreciable for tax purposes.

The premises

Are the premises adequate? Are they properly authorised for the operations of the business or for any changes you intend to make to the business?

It may be advisable to check that the status of the property under the RESOURCE MANAGEMENT ACT 1991 is appropriate for your intended use of it, especially if you plan to modify the business so that the use of the property is different from that of the seller.

If the premises are leased, the lease is part of the goodwill. The consent of the landlord to the lease being assigned to you will need to be obtained, but the landlord cannot unreasonably withhold consent. The sale agreement form approved by the Real Estate Institute and the Auckland Law Society provides that it is the seller's responsibility to seek the landlord's consent.

Plant

What plant is included? "Plant" normally includes all items of machinery, implements, vehicles, furniture, fittings and fixtures

The sale and purchase agreement should list in detail every item of plant that is being bought. This is usually done in a separate schedule to the agreement.

Is the plant owned, leased or under hire purchase? The seller can sell the plant only if the seller owns it at the date of the agreement to sell the business. If the plant to be transferred to you is leased or on hire purchase, the agreement to sell the business may specifically provide for those arrangements to be continued with you the buyer.

If the business premises are leased, it is important to ensure that chattels and fixtures belonging to the landlord are not included in the list of plant items in the sale agreement.

Whereas the buyer will want a high value on plant and equipment for a greater depreciation claim, the seller will want to sell it at no more than its book value to avoid tax on depreciation recovered on the sale.

The stock

Consider the nature, quality and approximate value of the stock. How is it to be valued? Normally, an estimated value is inserted in the agreement and the actual value as at the close of business on the possession date is determined by a physical stocktake.

Is any of the stock already secured and subject to a Romalpa clause? This is a clause preventing title to the stock passing until it's fully paid for: see related article How to be aware of your rights under a "Romalpa" clause ("reservation of title" clause).

Contracts relating to the business

What are the business's existing contracts, such as contracts to buy goods, contracts to supply goods, and service contracts?

You will need to be satisfied that these contracts will pass to you with terms and conditions comparable to those that applied to the seller. It may therefore be advisable for the sale agreement to provide that the seller will introduce you to the business's suppliers and customers, and that the seller will disclose all details of his or her past dealings with them and attempt to ensure that the relationships will continue with you.

You should consider what warranties exist for goods and services supplied to the business.

Liabilities

Are the assets included in the sale being acquired free of encumbrances? This means that the assets are the seller's property, that no money is owed on any assets to third parties, and that the seller is able to pass title in the assets to the buyer. Agreements for sale of a business commonly include a warranty by the seller to this effect.

You should also consider including a warranty by the seller that he or she will pay and discharge all business debts and liabilities by the possession date.

What are the seller's obligations for the supply of goods and services? What indemnities has the seller given or will need to be given by you?

Employees

You will need to see a full list of staff and details of the employment contracts.

It is usual for the seller of a business to warrant to the buyer that the seller will pay all outstanding PAYE tax and any other payments required by the Inland Revenue Department, and that the seller will fully pay every employee up to the settlement date, plus holiday pay, along with any other entitlements owing to them.

When a business is sold, the employees become technically redundant: employment contracts cannot be transferred and so their employment with the seller ends.

Access to business records

It may not be practical for you to be given full access (called "due diligence") to the seller's business records, because of, for example, the seller's confidentiality concerns. Instead, sale agreements commonly provide for an alternative form of access (called "limited due diligence") whereby the seller discloses information to you in a memorandum and the accuracy of this information is warranted by the seller in the sale agreement. In this case, you the buyer will sign a confidentiality agreement.

Access to the business before settlement

Will you need access to the business before settlement to obtain valuations, to make alterations or to be introduced to customers?

Risk and insurance

The sale agreement should specify when the risk in the assets passes from the seller to you. Normally this is on the settlement date.

What types of insurance will you require? Types to consider are public liability insurance, insurance of the plant, and (less commonly) business interruption insurance.

Apportionment of costs

What costs will have to be apportioned between you and the seller at settlement (for example, rates, rent and licence fees)?

Restraint of trade

The purchase price of a business includes goodwill, and therefore the buyer is entitled to restrain the seller from competing against the buyer in a similar type of business for a certain period (usually two years) and within a certain radius from the premises.

However, the courts won't enforce such a restriction if the time period and the geographical area are unreasonable to the seller.

Conditions of the sale

Is the sale subject to finance, consent of the landlord, a satisfactory LIM (Land Information Memorandum), and satisfactory accounts for the business?

Franchises, licences and consents

Are there any franchise or license agreements that need to be assigned?

If the business requires a licence to operate, or some other governmental consent, the agreement should contain a warranty by the seller to the effect that the licence or consent will be kept current up to the possession date and that the seller will facilitate its transfer to the buyer, if transfers are permissible.

Operating the business before and after the sale

It is usual for the agreement to include a warranty that the seller will properly carry on the business as a going concern and maintain its turnover and preserve its goodwill.

It is also common for the agreement to include a requirement that the seller, or some other experienced person that the parties agree on, helps the buyer for a period so that the buyer can get the benefit of the seller's knowledge and experience.

Registering for GST before the sale

It is desirable that the buyer registers for GST so that the transaction can be zero-rated for GST purposes. If this is done, no GST will be payable on the purchase price. (See How to work out whether you must register for GST).

Whether to form a company to be the buyer

You should consider whether it is best to buy the business in your own name or instead to form a limited-liability company to be the entity buying the business (see How to form a company).

Cautionary notes
  • You should consult a lawyer and accountant on all aspects of buying a business. They can help you decide if the purchase is worthwhile, and ensure that it takes place with minimal difficulties.
  • Buying a business is an extremely important decision and means committing your own cash resources or borrowing money from a bank to complete the purchase, or both. Borrowing money for the transaction could mean having to increase your mortgage over your home or other property.


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