Top 5 legal tips when buying a business

Tip 1:  Know what you are buying – shares or assets

Most people operate their business through a company.  This means that a buyer can either buy:

• the shares held by the shareholders in the company; or
• the assets used by the company to operate the business.

However, if the business is operated by a sole proprietor or through a trust, then the buyer may be limited to buying just the assets.

The difference between a share purchase transaction and an asset purchase transaction is that:

• a share purchase transaction involves the buyer purchasing all of the shares in the company that operates the business.  When the buyer purchases all of those shares, the buyer becomes the shareholder or owner of the company - including everything that the company owns (i.e. plant and equipment, land and buildings, goodwill, intellectual property and rights and benefits under customer contracts).  Importantly, owning the company also typically means that you inherit any debts or liabilities of the company (which is factored into the purchase price).
• an asset purchase transaction involves buying some or all of the assets that the company uses to operates its business.  These assets may include contracts, plant and equipment, land and buildings, goodwill and intellectual property.  In an asset purchase transaction, the buyer may prefer to purchase just some of the assets that are used to operate the relevant business and leave behind other assets and any of the debts or liabilities with the company.

The decision on whether to buy shares or assets may become clearer after undertaking due diligence on the target business. There may also be tax reasons why a buyer may to prefer to purchase shares over assets or vice versa, and a buyer should speak to its accountant about this at the outset.

Tip 2:  Negotiate an exclusivity period with the seller

If possible, a buyer should try to negotiate for an exclusivity period during which the buyer has the sole right to conduct due diligence on the target company and business.  This is intended to prevent the seller from trying to solicit other offers from (or negotiate with) other prospective buyers during the exclusivity period.

Tip 3:  Understand your funding options

Before starting the acquisition process, a buyer should consider how it will fund the proposed acquisition (cash, debt finance from a financial institution, or possibly vendor finance).

If a buyer needs to get a loan to fund the acquisition, the lender may wish to take security over the shares or assets of the target business and review the due diligence on the target business.

Tip 4:  Undertake due diligence

Due diligence is essentially an investigation into (and an appraisal of) the target business/company, to assess its assets, liabilities and commercial potential.

From a legal perspective, this would include things like reviewing the business’ material contracts, funding and borrowing arrangements, any current litigation, records of any employees and their entitlements, and conducting searches on any land or buildings owned or occupied by the target business.

A buyer will usually also want to do financial, commercial and possibly tax due diligence on the target company or business (and should speak to their accountant about this).

Due diligence is important because:

• a buyer should ensure that it knows what it is buying so that it can better manage its risk associated with the purchase of the target business; and
• it will assist a buyer to negotiate the terms of the purchase.  For example, legal due diligence may reveal that there are certain risks in the target business which the buyer may then want to protect against.

The level of due diligence on the target business will depend on a number of factors including the value of the acquisition and the buyer’s experience in the relevant industry.  Please see our recent article for top tips when conducting due diligence.

Tip 5:  Understand what protections you may need in the documents as a result of due diligence

If the buyer still wants to proceed with the purchase after conducting initial due diligence, the next step is to prepare, negotiate and enter into definitive transaction documents to formalise the proposed sale and purchase of the target.  Sometimes a term sheet or heads of agreement is entered into first for the parties to agree on the key terms that will appear in the definitive transaction documents.

A buyer will need to understand any material issues arising from due diligence to translate those issues into protections sought by the buyer in the sale and purchase agreement.  Examples of buyer protections that are often included in a sale and purchase agreement include:

• having certain conditions precedent that must be satisfied before settlement or completion of the transaction;
• including provisions that require part of the purchase price to be held back or retained until a specified action or result is achieved; and
• including indemnities or warranties from the seller to address specific risks.

If you have any questions on buying a business, undertaking legal due diligence or would like assistance with conducting legal due diligence on a target business, please do not hesitate to get in touch with one of the Sierra Legal team.