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Buying a Business: Initial Legal Considerations

11 July 2016

Buying a business can be an easier option for first time business owners, rather than starting a new business from scratch. An existing business will usually have an established name, customer base, reputation and cash flow.

For discussions sake, let’s say that Kate is looking to buy a café. She has had a look around and found one that she is interested in buying, which is known as the Flowerpot Café. It is owned by Smith Holdings Limited (Vendor). We have set out a few of the main points that Kate should consider prior to having an offer being prepared, or when reviewing an offer that has been prepared by the Vendor.

  1.    Kate needs to consider whether it is better to purchase the assets that make up the Flowerpot Café, or the shares of the Vendor. A share purchase will generally allow for a more seamless transition, however, will also mean that Kate will inherit the history of the company, warts and all. This will include any debts and liability that the Vendor owes to others. The alternative approach is to purchase the assets of the business. In this case, a list of all of the assets that make up the Flowerpot Café is prepared and attached to the agreement. The sale of assets usually prevents any unwanted debt or other liabilities transferring to the purchaser. However, the change of ownership of those assets can have some follow-on effect, for example, the Flowerpot Café lease and any supply contracts would need to be assigned to Kate
  2.     Kate should obtain advice about the value of what she intends to purchase, whether assets or shares. Specialist valuation advice should be sought from an accountant or valuer. Usually the accountant or valuer will need to see a copy of the accounts in order to provide this advice, especially if a share purchase is being considered. Once Kate has the advice she will be able to consider what price she is prepared to pay. This may be more or less than the valuation, depending on the specific situation. Kate also needs to consider whether she is prepared to pay a deposit, and when it will be paid.
  3.     Kate needs to consider what things she needs in order to run the business from the settlement date. These could include finance, the lease assignment, any food preparation certificates, alcohol licences and key staff. If Kate isn’t sure whether she will have these things prior to signing the agreement, she may want to make the agreement conditional on her obtaining them. This will give Kate a period of time to get these things sorted out before she is committed to buying the Flowerpot Café. Alternatively, Kate could make sure there is enough time between signing the agreement and the settlement date to make sure they are sorted out.
  4.     Kate should also have a detailed look at the Flowerpot Café’s accounts and records to ensure she understands what she is buying, and that the business is going to be successful in the long term. She will also want to get a feel for the specific location, and make sure there isn’t anything that may affect the Flowerpot Café that she is unaware of, for example, that a motorway won’t be built next door or similar. Kate intends to have her professional advisors help her with this process. This is known as a due diligence condition, and if required is added as a condition of the agreement. Due diligence normally takes place after the agreement is signed, as the Vendor doesn’t want every prospective purchaser ‘investigating’ the Flowerpot Café until they have agreed to purchase it. Of course, if there is an issue with what Kate finds during due diligence, she can cancel the agreement and get her deposit back, or attempt to renegotiate the purchase price.
  5.    Kate may need some help to learn the ropes of the Flowerpot Café once she takes over. This is known as a vendor assistance period. Kate will need to think about how long after settlement she will need this help for.
  6.    Kate doesn’t want the Vendor setting up a café next door once she takes over, as the customers may start going there instead. To prevent this Kate should consider requesting a restraint of trade be put on the Vendor and the beneficial owners of the Vendor. The restraint is usually expressed in terms of a duration and geographical area, and must be reasonable in the circumstances.

Once Kate has considered all of these things, she will be in a position to meet with her lawyer, discuss her plans and the matters set out above. The lawyer will then be able to draft a sale and purchase agreement which takes into account Kate’s specific requirements, or provide advice in relation to the appropriateness of the agreement that has been prepared by the Vendor. Getting advice prior to signing will make sure that Kate’s interests are looked after.

The above points are just some of the considerations to take into account when buying a business. If you have any questions on the above points, or are looking to buy a business and would like some advice, please don’t hesitate to contact us.

 

Chris Steenstra is an Associate in the Commercial Corporate team at Norris Ward McKinnon, specialising in IT and Commercial Corporate law.  Email Chris at:  chris.steenstra@nwm.co.nz

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