Traps and Pitfalls to be Aware of when Buying a Business

Buying a business, whether an existing business or a franchise, it is an important decision and there are many things that you need to look out for.

Some of the traps and pitfalls that purchasers need to look out for are:

  • misleading and deceptive statements by the vendor (seller);
  • what comes with the purchase – both assets and liabilities;
  • the structure of your business;
  • properly identifying and valuing all intellectual property; and
  • taxation considerations.

Misleading & deceptive statements

Vendors may make representations to the purchaser about things such as the profitability of the business, customer base, what assets the business has (including intangible assets such as IP), etc.  While most vendors will not try and deceive a purchaser, they may make representations that are not correct and a purchaser may rely upon these.

While there is no guarantees to not becoming a victim of misleading representations, there are some ways this risk can be minimised:

  • Have all material representations in writing.  One way of doing this is to include them as warranties in the purchase agreement.
  • Conduct a thorough due diligence – this means checking (or having your legal and accounting advisors check) as many as the representations as possible.
  • Seek appropriate professional advice about the representations.

What comes with the purchase?

Buying a business will not usually mean buying just the assets, such as stock and equipment.  It will often mean the intellectual property, and sometimes any employees.

It is important to know exactly what you are buying so that it can be properly valued and investigated to ascertain that the vendor actually owns it.  This should be set out clearly in the purchase agreement.

With some of these will come liabilities.  For example, if employees are transferring with the business, how will their entitlements, such as any accrued annual leave or long service leave be treated?  Will the purchase price be adjusted to account for this?  How will any contingent liabilities be treated?

Structure of the business

When taking over an existing business, it is important that you set up the right business structure for you.  The three main business structures are:

  • Sole trade;
  • Partnership; and
  • Proprietary limited company.

Each has its own advantages and disadvantages and what suits you will depend on things such as size, financial arrangements and taxation considerations.  For example, if you are running a family operated business, a partnership may allow you to income split and minimise tax liabilities.

You should obtain professional advice before deciding which structure is right for you.

Intellectual Property

Intellectual property often makes up a large part of what is being purchased, but its importance can be overlooked.

The intellectual property that may come with a business may include:

  • business or company names;
  • domain names;
  • registered and unregistered trade marks;
  • copyright in a whole manner of material such as logos, computer software, core technology, customer lists, policies and procedures, business and marketing plans etc;
  • patents and designs; and
  • confidential information and trade secrets.

It is vital that the purchase agreement sets out exactly what intellectual property is included in the purchase so that a thorough due diligence can be conducted and you can be certain that the purchaser owns the IP and has the right to assign it upon completion.

You will also need to find out if any other parties may have an interest in the IP.  For example, the designer of the business logo may not have properly assigned the copyright in the logo to the vendor, which means that the vendor cannot validly assign it to you once you purchase the business.

The IP that comes with the business needs to be properly valued, or you may end up paying too much for it.

Taxation Considerations

For GST purposes, the sale or ‘supply’ of a business is GST if it is deemed to be a ‘going concern’.  To meet this test:

  • the purchaser must be registered, or required to be registered, for GST;
  • the supply must be for consideration (that is, the purchase must be paying something for it);
  • the vendor must carry of the business until it is sold;
  • the vendor sells to the purchaser all things necessary for the business to continue operations; and
  • both parties must agree in writing that it is a going concern.

Stamp duty may also payable.  While the general rule is that the transferee (i.e. purchaser) is liability for any duty that arises, this may be negotiated into the purchase agreement so that vendor pays, or there may be some adjustment to the purchase price.

Taxation issues may also arise in relation to any IP that is acquired with the business.

Conclusion

While there are many traps and pitfalls to be aware of, owning and operating your own business can be a very rewarding experience.

There are ways to manage and minimise any potential risks, through careful documentation, thorough due diligence and negotiation, which can be provided by an experienced business lawyer.

This information has been prepared by BPC and is general advice only.  This article does not take into account your personal situation.  Before acting you should obtain legal advice in relation to your particular circumstances. The information contained herein is current at the date of publication, the law frequently changes and as a result the information can be updated and no longer correct. This article is for the information of clients of Beilby Poulden Costello and is not intended as an advertisement or promotion.

By Barry Beilby

Publish Date: November 7, 2007