The 4 stages of buying a small business
Are you buying a small business and unsure what to expect? One of the most common enquiries we receive here at LegalVision surrounds purchasing a small business. Below, we break down the process of buying a small business into its four main stages, so you know what to expect.
1. Offer and Acceptance
The very first stage of buying a small business involves making an offer to purchase the business. Offers can take the form of a written letter, or it can be a simple verbal offer.
We recommend that you always make an offer formally and in writing. This way, the terms are set out clearly and minimises any potential for confusion. Written offers also help cut down the time and cost spent on any further negotiations. Once the offer is accepted, you should, in turn, obtain this acceptance in writing.
Some of the terms you may want to agree to at this point include:
- The price;
- What assets the sale will include, taking into account not just equipment but also intangible assets such as client lists, goodwill and business names;
- Whether the sale will include the transfer of employees;
- Whether the sale is to be subject to any conditions such as financing and/or due diligence;
- Whether the owner will provide any training with the sale; and
- Whether you intend to restrain the seller from competing against you once they sell the business.
It is important to note that there is no requirement for you put down a deposit at this point of the business sale. However, it is common for the seller to insist on one. If this is the case, then ensure you pay the deposit to a third party such as a lawyer or business broker rather than to the seller directly.
2. Contract Review
Once you and the seller have agreed to the general terms of the purchase, the next stage is for the seller or their lawyer to prepare a contract. Again, having a formal written offer and acceptance will help speed up this process. A written agreement will ensure most of the details of the sale are readily available.
In the time that it takes the seller or their lawyer to draft the contract, it is prudent that you also engage a suitable lawyer. A lawyer will speed up the business sale process. It ensures that all correspondence between the seller is done through them, meaning the lawyer will have the opportunity to review the draft contracts on your behalf. Trying to find a lawyer once the seller has provided the draft contract will only slow down the process.
It is important that you review the draft contract with your lawyer. The contract will likely contain many clauses that are very favourable to the seller and which you will need to renegotiate. A common example of an unfavourable clause is a “no warranties” or “entire contract” clause. These provisions effectively act to prevent you from being able to rely on any warranties or representations (i.e. promise) about the business unless the contract expressly includes them.
For example, this might include promises about the state of any equipment or promises about the number of customers and revenue. These types of promises are usually passing comments made by the parties during the initial negotiations and most of the time don’t make it into the contract.
The review will also allow you to ensure that the contract properly reflects the terms that you have agreed on. Again, the formal offer and acceptance will come in handy at this stage.
3. Negotiations and Exchange
Once you and your lawyer have conducted the review, the next step of buying a small business will be to engage in formal negotiations. Typically, the lawyers from each side will correspond with each other to finalise the contract, ready for execution.
The contract review you have completed with your lawyer will assist with identifying and isolating what points and clauses the parties need to negotiate. When the parties finally reach and agreement, it’s time to sign (execute) and formally exchange the contract. In all states aside from Queensland, an exchange is where the parties swap copies of the contract. It is at this point that you will need to pay the deposit. The seller will also need to commence the process of conducting due diligence and transferring the business’ assets.
During exchange and settlement, you should complete your due diligence so as to confirm that the promises the seller made are accurate. You should also ensure that the following are ready to be transferred for use on and from the settlement date:
- Client lists
- Business name.
You should also calculate any final adjustments to the price, for example:
- Any rent paid for the month;
- Wages accrued by employees; or
- Stock that has already been ordered and paid for.
Once everything is ready, then the very final stage is about organising actual settlement, attendance and cheques. If you’ve followed the instructions above, you’ll simply need to hand over the cheque and get the keys
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