Buying A Business Tips Traps & Tactics

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Information about Buying A Business Tips Traps & Tactics
Business & Mgmt

Published on July 21, 2009

Author: EtienneLawyers



A presentation to assist people preparing a business for sale or purchasers in purchasing a business

Tips, Traps & Tactics Of Buying a Business Presenter: Steve Brown B.Ec, LL.B (Syd), M.App.Fin (Mac), A.Bus, FAICD

Topics  Taking Instructions  Issues to Consider  Pre-contractual representations  Drafting Refresher  Specific Contractual Terms & Conditions  Negotiation of Contract  Due Diligence an overview

Taking Instructions  Find out what it is that the client wants. It is trite just to say a vendor wants a sale and a purchaser to purchase a business  Lawyers role is to facilitate the successful achievement of our clients goals in other words to ensure performance but of what!  Of what is the aim of taking instructions.

Taking Instructions  Checklists are a useful tool to obtaining proper instructions  Checklists minimise a lawyers exposure to professional negligence claims  Only every act for one party  Work with clients accountant regarding tax structure issues on sales and purchases

Issues to Consider - Vendors 1. Identify what is being sold assets, shares, units in unit trust – Examine accounts 2. Identify who actually owns the assets – eg sole director shareholder who is an inventor may have patent in own name not their company 3. CGT issues – Eg Division 152 ITAA 1997

Issues to Consider - Vendors  Should the vendor obtain a guarantee for performance of a corporate purchaser(Swept-Up Marketing Pty Ltd v Voltrant No. 282 Ltd (NSW) Supreme Court, 26 April 1989, )

Issues to consider - Purchaser 1. Does the purchaser have the finance 2. Does the purchaser have the capacity to run the business 3. Determine the legal structure for the purchaser by considering:

 the simplicity of the vehicle and its cost of establishment;  the nature and size of the business;  the potential for the growth of the business and the need for additional capital for growth;  the taxation consequences of each vehicle;  the manner in which the business is to be managed and the degree of owner involvement;  the cost and complexity of terminating the vehicle on the owner exiting the business or passing it on to their family;  the structure of the purchaser’s family; and  the potential for the business to fail and the implications if it does fail.

Type of Nature Governing Legal Status Features Method of Liability Summary of Summary of Entity Law Control Advantages Disadvantag es Sole Trader •Simple but •Dependent •No separate •Tax •Sole control •Unlimited •Simple, •Unlimited relatively upon nature legal entity advantages by trader personal inexpensive personal inflexible of business disadvantage liability •Absolute liability s control •Finance raising •No continuity Partnership •Simple and •State •No separate •Partners •Unlimited •Income- •Transferring flexible Partnership legal entity own and personal splitting tax interests Acts (except under control the liability advantages •Limited size •Common certain Acts) business •Shared Law profits •Partnership agreement Trust •Usually •State •Equitable •Rights •Trustee •Trustee •Tax •Complex complex Trustee Acts not legal enforced in (subject to personally advantages and technical •Common recognition equity not law fiduciary liable (but •Simple sale •No continuity law •Rights non- obligation) usually right of assets of existence •Equity contractual of indemnity •Flexibility at law exists) Company •Complex •Corp Act •Separate •Various •Board of •Members: •Limited •Expense and common law continuing company directors or usually liability •Statutory expensive •Constitution/ entity structures sole director limited to the •Separate, reporting Replaceable amount continuing requirements rules unpaid and/or entity •Directors’ •Other guaranteed •Member duties statutes on shares rights (statute and •Officers: •Company common law) statutory and tax rates •Capital common law raising possible

Negotiation Issues – Pre- contractual representations  Negotiating What to Look Out For…Statutory Impact on Contract Law  Misleading or deceptive conduct  Trade practices act (Cth) ss 52 & 53  Fair trading act (NSW) s. 42  Unconscionable conduct  Trade practices act (Cth) pt IVA  Fair trading act s. 43  Contracts Review Act (NSW only)

Misleading or Deceptive Conduct  Strict liability  Silence  Actual deception  Ambiguity  Overall  Erroneous impression assumption  Product puff  Half truths

Misleading conduct - s 52 Example Four principles were established in the case of Taco Co of Australia v Taco Bell Pty Ltd (1982) ATPR 40-303 as assisting to determine whether conduct is misleading or deceptive. 1. The relevant section of the public must be identified. 2. All people within that section must be considered including the intelligent and not so intelligent, the educated and uneducated. 3. Evidence that someone was misled is helpful, but is neither conclusive nor essential. 5. When a misconception has arisen it is important to determine why, in order to see if it was the business' conduct that caused it.

Misleading conduct - s 52  A SECOND PRINCIPLE: It's the overall impression on the target audience that counts  silence can be misleading - if there is a duty to speak  a prediction can be misleading - if there's no reasonable ground to make it

Drafting Refresher

The Difference Between Agreements and Contracts? Agreements are not as a general rule: Legally enforceable Courts will not involve themselves.

The Difference Between Agreements and Contracts? Contracts are ALWAYS: Legally enforceable Courts will enforce as the law dictates

Non Enforceable Agreement If you wash my car I’ll give you $10

Non Enforceable Agreement I’ll pick you up for dinner at 8 o’clock

Contracts & Agreements – what are they? Practical Answer – they are both Risk Minimization tools that operate as Checklists or Rule Books by applying Performance standards

Contracts & Agreements – How Are They Risk Tools  Agreement to meet and discuss a form of long term supply arrangement  Contract to supply an apple  Contract or agreement to sell a toll manufacturing business

Contracts & Agreement - As Checklists or Rule Books  Who is to do what – who is to sell; Who is purchase (whatever it is that is being sold).  When are the servicesgoods to be supplied by vendor– when are they to be paid for by purchaser.  How are the servicesgoods to be supplied.  Consequences of good or poor performance.

Why have a Contract instead of an Agreement Risk Formality & Legality least formal to most formal form form of Agreement oral contract of written contract

Contracts as risk tools are used to minimise the inherent risks of the contract Risks with a contract to Risks with a sale of supply an APPLE business contract HIGH RISK LOW RISK

How courts interpret contracts  Courts use rules of construction as pointers to discover the presumed intention of the parties to a contract.  The rules are not slavishly applied.  The rules are used to produce as reasonable and just result as possible.

Rules of Contract Construction  The object of construing a contract is to ascertain what the mutual intentions of the parties were as to who is to do what, how and when from the words they used to express the obligations each assumed by entering into the contract.  The intention of the parties is the meaning of the words they have used. There is at common law no intention independent of that meaning.  The intention of the parties must be ascertained from the words used, in light of the surrounding circumstances and the object of the contract, in so far as the object has been agreed or proved.  Courts construe the objective intention of the parties not the parties actual intention.

Rules of Contract Construction  Business common sense is sometimes used in addition to the words chosen by the parties. Here the courts look at the purpose of the contract, whether the form of the contract was a standard form or negotiated by the parties, and the commercial experience of the judge who is to construe the meaning of the words used.  Where the words used are clear, the court must give effect to them even if they have no discernible commercial purpose.  Although not overtly recognised, courts sometime manipulate the construction of a contract to achieve a fair result on the facts as ascertained by the court.  In construing a contract clauses must not be considered in isolation, but must be considered in the context of the whole of the contract.

Rules of Contract Construction  The words of a contract should be construed in their grammatical and ordinary sense, except to the extent that some modification is necessary to avoid absurdity, inconsistency or repugnancy.  The ordinary meaning of a word is its meaning in its plain, ordinary and popular sense, although that sense may be a sense among a particular group of persons.  Where a contract contains technical terms the court may discover the meaning of those terms using a dictionary, or where the technical terms are in dispute the court may only proceed upon calling expert evidence as to what the terms mean.

Rules of Contract Construction Implied terms Special situations  Courts may imply terms where a contract is silent  Standard form contracts upon a point but only if all of Any special conditions are the next 5 conditions are able given greater weight to the to be satisfied: standard conditions in the  it is reasonable ; case of conflict  it is necessary to give business efficacy to the contract;  it is so obvious a term it goes without saying;  it is able to be expressed clearly;  it is not contrary to an express term.

Drafting the Contract  Use standard form or not eg Law Society or own  The need to ensure that what the parties are seeking to achieve will be achieved the contract being a checklist to achieve this  Performance is the key

Specific Contractual Terms & Conditions  Goodwill  Lease issues  Employees  Reduced Deposit Clauses  Exclusion Clauses  Early Access

Goodwill  is incorporeal personal property The Commissioners of Inland Revenue v Muller & C’s Margarine Ltd (1901) AC 217  has no value independent of the business to which it attaches In Commissioner of Taxation v Murray (1998) 72 ALJR 1065,  Therefore is its crucial to identify the bundle of assets and source of goodwill to capture it for a purchaser:

Goodwill examples  A company which operates a business distributing high value medical equipment in Australia has developed important commercial and personal relationships with the German manufacturer of the equipment. The purchaser will need to ensure that it takes an assignment of the exclusive distribution agreements and to work on the relationship with the German manufacturer. It would be prudent for the purchaser to meet the management of the supplier in Germany and perhaps to retain the vendor as a consultant for a period of time to massage the transfer.

Goodwill examples  The vendor is selling a well known convenience store which is located in a particularly busy area, with lots of passing traffic and good parking. The residual term of the lease is relatively short. The purchaser will have to ensure that it renegotiates the lease term to ensure that its rights to the premises are secured.

Goodwill  If there is a risk of customers  The other ways of protecting walking after the vendor from a loss of goodwill is to leaves, it may be necessary to require the vendor to grant a maintain a retention fund from restraint of trade. the sale proceeds from which  Besides penalties for loss money can be repaid to you as purchasers negotiation earnout purchaser if customers are lost provisions which increase the through no fault of the payment for the sale to a purchaser. vendor upon successfully  Retention funds are often maintaining profitability coupled with clawback provisions of various levels of sophistication.

Goodwill example  An electrical contractor servicing domestic customers has had considerable success from advertisements placed in the Yellow Pages over a number of years. The company also has easy to remember telephone numbers. The company name contains the name of the vendor that the vendor wishes to retain.

Lease of Premises  New lease or assignment  If a real property lease is being assigned remember to advise vendors that he assignment does not extinguish their liability under the lease: Only a new lease will do this  Is term of existing lease sufficient to secure value of business for purchaser.

Employee Issues  Both vendor and purchaser need to be aware of employee issues.  Four types of employees  Key employees who must be retained if goodwill is to be secured  Those offered employment  Those not offered employment  Those offered employment but decline to be employed

Terms & Conditions – Reduced Deposit Clauses Iannello & Anor v Sharpe [2007] NSWCA 61  5% paid on exchange 14. Reduced Deposit Notwithstanding anything else herein  No Completion contained, the Vendor shall accept, on exchange of this Agreement, payment  Need to consider if of $225,000.00 being part of the deposit. The parties expressly agree balance of unpaid that if the Purchaser defaults in the observance or performance of any money penalty obligation hereunder which is or has become essential the balance of the  In this case held to be deposit, namely $225,000.00, shall become immediately due and payable a penalty and the Purchaser shall forfeit the whole of the sum of $450,000.00 pursuant to Clause 9 hereof to the Vendor.”

Reduced Deposit Clauses  To minimise penalty issue never reduce deposit  But how to negotiate this with purchaser  Be firm  Be innovative take balance by promissory note or bill of exchange or bank guarantee

Exclusion Clauses & S 52  You cannot contract out of s 52. In entering into this agreement the purchaser acknowledges that it has not relied on any statement, representation or warranty by or on behalf of the vendor whether express or implied as to ...  Clarke equipment Australia ltd v Covcat Pty ltd felling machine, exclusion clause in contract no effect.  Collins Marrickville Pty Ltd v Henjo investments Pty ltd.

Tenders & S 52  Representations that a project will take a stated period of time and it does not or the start is delayed beyond the time it is represented to commence may amount to misleading and deceptive conduct.  Section 51A shifts onus of proof for predictions. A representations as to future action must be made upon reasonable grounds.

Tenders & s 52  A RFT that does not indicate that strict compliance with the terms of the tender is essential gives to a tenderer not shortlisted a right to injunct the tender process (MacMillan’s case)  A tender that is not evaluated in accordance with how tenders were represented to be evaluated may be misleading (Hughes Aircraft v Airservices Australia)

Early access  To premises  To executed documents that can facilitate completion  To staff, key personnel or clients/customers

Early Access  Do not permit early access  Do not have documents held in escrow  Rather than early access provide supervised training  Rather than early access allow due diligence

Overview  What is due diligence?  What is the purpose behind due diligence?  Who Conducts due diligence?  What is the due diligence process?  Where is information obtained?  Lessons from the cases.

Negotiation of the Sales Contract

Why negotiate?  To get a better deal?  Because risk is inherent in all commercial transactions And……..

Because In an ideal world the risk pendulum would lie perfectly balanced between the interests of vendor and purchaser. However in reality the position depends upon the bargaining position of the vendor and purchaser.

Contracts as risk Acquisitions minimisation tools? Risk 5 year HDPE Supply contract More Formality & Legality Less risk as level of risk increases least formal to most formal form form of Agreement oral contract of written contract

AS 4360 - Risk Evaluation Evaluated list of legal requirements compared to business units functions Risk Yes acceptable Accept Identify Unacceptable No residual risk treatment Reduce Reduce Transfer in Avoid options Likelihood Consequence full or in part cl 4.5.1 Assess treatment Consider feasibility, costs and benefits, and levels of risk options cl 4.5.2 Recommend Treatment Strategy Choose treatment strategy cl 4.5.3 Prepare systems to embed plans to reduce, transfer, avoid risk Implement Reduce Reduce Transfer in Avoid treatment Likelihood Consequence full or in part plans Yes Cl 4.6 cl 4.5.4 Risk acceptable ? Retain

LEGAL RISK MANAGEMENT 1. Understand the legal aspects. 2. Identify potential risks. 3. Take practical steps to eliminate/minimise those risks.  By taking actions that:  Reduce the likelihood of an event;  Reduce the consequences of an event;  Transfer in full or in part the consequences of an event (Negotiate a price to accept the risk); and/or  Avoid the event.

Reduce the likelihood of an event  Due Diligence

Reduce the consequences of an event  Warranties  Liquidated Damages  Restraints of Trade  Post employment of key personnel  Exclusion clauses

Transfer in full or in part the consequences of an event Firm A price which is not variable for any reason Price Fixed A price, the final value of which is fixed by Price reference to some variable parameter such as inflation, currency exchange rate, or maintainable profits of the businesses Earnout/ A price based on the post acquisition profits of Workout the business so that the seller shares in the on Price going growth of the businesses

Avoid the event  Don’t proceed with the purchase or sale

What is due diligence? Due Diligence is: Detective work; Doing your homework; Over coming unforeseen and unwanted issues after acquiring a business

Purpose behind due diligence?  To minimise risk  The more informed a purchaser is the more chance the purchaser has to not loose money

Purpose behind due diligence?  Confirm what the  Investigate the state of business is; management of the business;  Confirm that the soundness of any  Confirm the status of company to find pending lawsuits; and contingent liabilities;  Identify the extent and  Avoid quantum of contingent misunderstandings as liabilities to the type and condition of the business being bought;

Purpose behind due diligence?  Essentiallygain information that will be useful for  valuing assets,  defining representations and warranties, and/or  negotiating price concessions;

Who conducts due diligence?  Due Diligence Committee  Comprised of purchaser  Purchasers lawyer  Purchasers accountant  Purchasers financier  Others that are need as required by the transaction

What is the due diligence process? Preliminary Form DDC Investigation DD Undertakes of C’ttee Detective Target work Use Results to negotiate Due Diligence Purchase Obtain Process terms Target to acquire Acquire Target knowing all that is to be known Given the time and money the Purchaser has/wants To spent

Where is information obtained?  From the target, data room, employees on-site investigations  From the purchaser’s own knowledge  From industry bodies  From trade magazines  From consultants  From customers, clients and suppliers

Lessons from the cases….  Have a due diligence agreement Plessey Components Pty Ltd v Cant  Determine what is proper due diligence objective or subjective test SDS Corporation Ltd v Pasdonnay Pty Ltd & Anor  Minimise disruptions to target SDS Corporation Ltd v Pasdonnay Pty Ltd & Anor  Get a clear understanding between the parties Hayle Holdings Pty Ltd v Australian Technology Group Ltd [2000] FCA 1242


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