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Purchasing a business can be an exciting time, however, before entering into a contract it is vital that a prospective purchaser gathers as much information about the material aspects of the business as possible in order to evaluate the transaction. This process is often referred to as “due diligence”.
Failure to conduct necessary due diligence can be extremely costly and result in unexpected consequences.
Types of Due Diligence
Due diligence can be broadly classified into three categories which often overlap:
- Financial;
- Commercial; and
- Legal.
Financial and Commercial Due Diligence
Financial and commercial due diligence will commonly involve, amongst other things:
- Reviewing the business’ various financial records;
- Understanding the accrued entitlements of employees;
- Inspecting the business premises and ensuring the plant and equipment are in good working condition;
- Considering the nature of the business, the goods and/or services offered and why the vendor is selling; and
- Investigating the industry, competition and locality of the business.
Legal Due Diligence
Legal due diligence allows a purchaser to assess the legal risks associated with a business in order to make an informed decision as to whether to proceed with the purchase. Consequently, this will assist the purchaser in understanding what terms are necessary to adequately protect them.
While the legal due diligence process varies depending on the nature of the transaction and the particular business being purchased, we have highlighted five key areas of investigation below:
Material Contracts
It is important to examine contracts that have been entered into by the vendor which are material to the operation of the business. Issues to consider when reviewing these contracts include:
- Can the contract be assigned to the purchaser and, if so, whether the consent of the other contracting party is required?
- What are the respective rights and obligations of each party?
- If the contract is for a fixed term, when does the contract expire?
- How easily can one party terminate the contract?
Lease
If the business is operated at a premises subject to a lease, it is crucial that the lease is transferred to the purchaser. In reviewing the lease, a purchaser should consider:
- Whether the lease can be assigned and if so, whether landlord consent is required?
- When the lease expires and whether there are any options to renew? If the lease expires shortly after the purchase, it may be preferable to surrender (end) the existing lease and enter a new lease with the landlord or vary the existing lease to extend the term or add further options to renew.
- The obligations of the lessee, particularly make good obligations at the end of the lease.
PPSR Search
It is in the purchaser’s interest that all business assets are transferred free from any encumbrances. A search of the Personal Property Securities Register (PPSR) should be conducted to determine if there are any security interests registered over the business assets. If there is, the security interest should be discharged or the business assets released from the security interest on or before completion.
Intellectual Property
Often the key asset of a business is its name and a search should be undertaken to find out whether it has been registered. A registered business name (as opposed to unregistered) is valuable as it prevents someone else from registering that same name.
Depending on the type of business, trademarks and patents may be other intellectual property assets essential to the operation of the business.
Licences/Approvals
It is vital that the business has the correct licences and approvals to operate and that these are up to date. One area of investigation that is often overlooked is confirming that the type of business falls within the uses that have been approved for the premises by the consent authority, such as the local council. This is of particular importance when the purchaser wishes to change the nature of the business. If this change has not already been approved, the purchaser will need to consider whether the proposed change in use will constitute exempt or complying development or whether development approval will be required.
Further, there may be specific licences or approvals needed for the type of business being purchased. For example:
- liquor licences;
- motor dealers licences;
- food business licences; and
- service approvals for childcare centres.
Where a particular licence is required, the purchaser should consider whether the licence can be transferred or if a new application for that licence is necessary. In both instances, it is helpful to understand the process and cost as the transfer or application could potentially be complex and time-consuming which may delay settlement of the business purchase.
Looking for assistance with a business purchase?
Our business and commercial lawyers are highly experienced in sale and purchase of business transactions. Our lawyers can assist you throughout the entire process from pre-contract due diligence and drafting and negotiating contract terms through to completion of the transaction. If you are considering buying or selling a business, contact us on (02) 4288 0150 or at [email protected] today to discuss your individualised needs.
For more information, visit pdclaw.au and the Business Government website.
Sarah has practical experience and knowledge from working with the legal team across a range of areas of law, particularly in the areas of business sales and purchases and conveyancing transactions.
