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Tips, Traps & Tactics Of Buying a Business

Presenter: Steve BrownB.Ec, LL.B (Syd), M.App.Fin (Mac), A.Bus, FAICD

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Topics

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

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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.

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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

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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

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Issues to Consider - Vendors

4. 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, )

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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:

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i. the simplicity of the vehicle and its cost of establishment;

ii. the nature and size of the business;iii. the potential for the growth of the business and

the need for additional capital for growth;iv. the taxation consequences of each vehicle;v. the manner in which the business is to be

managed and the degree of owner involvement;vi. the cost and complexity of terminating the vehicle

on the owner exiting the business or passing it on to their family;

vii.the structure of the purchaser’s family; andviii.the potential for the business to fail and the

implications if it does fail.

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Type of Entity

Nature Governing Law

Legal Status Features Method of Control

Liability Summary of Advantages

Summary of Disadvantag

es

Sole Trader Simple but relatively inflexible

Dependent upon nature of business

No separate legal entity

Tax advantages disadvantages

Sole control by trader

Unlimited personal liability

Simple, inexpensiveAbsolute control

Unlimited personal liabilityFinance raisingNo continuity

Partnership Simple and flexible

State Partnership ActsCommon LawPartnershipagreement

No separate legal entity (except under certain Acts)

Partners own and control the business

Unlimited personal liability

Income-splitting tax advantagesShared profits

Transferring interestsLimited size

Trust Usually complex

State Trustee ActsCommon lawEquity

Equitable not legal recognition

Rights enforced in equity not lawRights non-contractual

Trustee (subject to fiduciary obligation)

Trustee personally liable (but usually right of indemnity exists)

Tax advantagesSimple sale of assetsFlexibility

Complex and technicalNo continuity of existence at law

Company Complex and expensive

Corp Act common lawConstitution/Replaceable rulesOther statutes

Separate continuing entity

Various company structures

Board of directors or sole director

Members: usually limited to the amount unpaid and/or guaranteed on sharesOfficers:statutory and common law

Limited liabilitySeparate, continuing entityMember rightsCompany tax rates

ExpenseStatutory reporting requirementsDirectors’ duties (statute and common law)Capital raising possible

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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)

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Misleading or Deceptive Misleading or Deceptive ConductConductMisleading or Deceptive Misleading or Deceptive ConductConduct Strict liability Actual deception Overall

impression Product puff

Silence Ambiguity Erroneous

assumption Half truths

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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.

4. 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 Example

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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

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

Misleading conduct - s 52Misleading conduct - s 52

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Drafting Refresher

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The Difference Between The Difference Between Agreements and Contracts?Agreements and Contracts?

Agreements are not as a general rule:

Legally enforceable

Courts will not involve themselves.

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The Difference Between The Difference Between Agreements and Contracts?Agreements and Contracts?

Contracts are ALWAYS:

Legally enforceable

Courts will enforce as the law dictates

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Non Enforceable AgreementNon Enforceable AgreementIf you wash my carI’ll give you $10

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Non Enforceable AgreementNon Enforceable Agreement

I’ll pick you up fordinner at 8 o’clock

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Contracts & Agreements – what are they?Contracts & Agreements – what are they?

Practical Answer – they are bothRisk Minimization tools that operate

as Checklists or Rule Books by applying Performance standards

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Contracts & Agreements – How Contracts & Agreements – How Are They Are They Risk ToolsRisk ToolsContracts & Agreements – How Contracts & Agreements – How Are They Are They Risk ToolsRisk Tools

Contract or agreement to sell a toll manufacturing business

Agreement to meet and discuss a form of long term supply arrangement Contract to supply an apple

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Contracts & Agreement - As Contracts & Agreement - As Checklists or Rule BooksChecklists or Rule BooksContracts & Agreement - As Contracts & Agreement - As Checklists or Rule BooksChecklists 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 services\goods to be supplied by vendor– when are they to be paid for by purchaser.

How are the services\goods to be supplied.

Consequences of good or poor performance.

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Why have a Contract instead of Why have a Contract instead of an Agreement an Agreement Why have a Contract instead of Why have a Contract instead of an Agreement an Agreement

least formal to most formal form form of Agreement oral contract of written

contract

RiskRisk

Formality &Formality &LegalityLegality

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Contracts as risk tools are used to minimise the inherent risks of the contractContracts as risk tools are used to minimise the inherent risks of the contract

Risks with a contract to supply an APPLE

LOW RISK

Risks with a sale of business contract

HIGH RISK

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How courts interpret contractsHow 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.

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Rules of Contract ConstructionRules 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.

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Rules of Contract ConstructionRules 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.

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Rules of Contract ConstructionRules 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.

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Rules of Contract ConstructionRules of Contract ConstructionImplied terms Courts may imply terms where a

contract is silent upon a point but only if all of the next 5 conditions are able to be satisfied:

it is reasonable ; 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.

Special situations

Standard form contracts

Any special conditions are given greater weight to the standard conditions in the case of conflict

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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

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Specific Contractual Terms & Conditions

Goodwill Lease issues Employees Reduced Deposit Clauses Exclusion Clauses Early Access

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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:

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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.

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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.

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Goodwill

If there is a risk of customers walking after the vendor leaves, it may be necessary to maintain a retention fund from the sale proceeds from which money can be repaid to you as purchaser if customers are lost through no fault of the purchaser.

Retention funds are often coupled with clawback provisions of various levels of sophistication.

The other ways of protecting from a loss of goodwill is to require the vendor to grant a restraint of trade.

Besides penalties for loss purchasers negotiation earnout provisions which increase the payment for the sale to a vendor upon successfully maintaining profitability

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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.

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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.

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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

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Terms & Conditions – Reduced Deposit Clauses Iannello & Anor v

Sharpe [2007] NSWCA 61

5% paid on exchange No Completion Need to consider if

balance of unpaid money penalty

In this case held to be a penalty

14. Reduced Deposit Notwithstanding anything else herein

contained, the Vendor shall accept, on exchange of this Agreement, payment of $225,000.00 being part of the deposit. The parties expressly agree that if the Purchaser defaults in the observance or performance of any obligation hereunder which is or has become essential the balance of the deposit, namely $225,000.00, shall become immediately due and payable and the Purchaser shall forfeit the whole of the sum of $450,000.00 pursuant to Clause 9 hereof to the Vendor.”

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Reduced Deposit Clauses

To minimise penalty issue never reduce deposit

But how to negotiate this with purchaserBe firmBe innovative take balance by promissory

note or bill of exchange or bank guarantee

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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.

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Tenders & S 52Tenders & 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.

O’Connor & sons Pty ltd v Entact clough Pty ltd.

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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)

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Early access

To premises To executed documents that can facilitate

completion To staff, key personnel or

clients/customers

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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

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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.

Overview

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Negotiation of the Sales Contract

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Why negotiate?Why negotiate?

To get a better deal?

Because risk is inherent in all commercial transactions

And……..

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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.

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Contracts as risk minimisation tools?Contracts as risk minimisation tools?

Less riskLess risk as level of risk increasesas level of risk increasesleast formal to most formal form form of Agreement oral contract of written

contract

RiskRisk

MoreMoreFormality &Formality &LegalityLegality

Acquisitions

5 year HDPESupply contract

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Evaluated list of legal requirements compared to business units functions

Cl 4.6

AS 4360 - Risk Evaluation

Riskacceptable Accept

Yes

No

ReduceLikelihood

ReduceConsequence

Transfer infull or in part

Avoid

Consider feasibility, costs and benefits, and levels of risk

Recommend Treatment Strategy

Choose treatment strategy

ReduceLikelihood

ReduceConsequence

Transfer infull or in part

Avoid

Riskacceptable ?

RetainYes

Unacceptableresidual risk

Prepare systems to embed plans to reduce, transfer, avoid risk

Implementtreatmentplans cl 4.5.4

cl 4.5.3

Assesstreatmentoptionscl 4.5.2

Identifytreatmentoptionscl 4.5.1

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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.

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Reduce the likelihood of an event Due Diligence

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

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Transfer in full or in part the consequences of an event Firm Price

A price which is not variable for any reason

Fixed Price

A price, the final value of which is fixed by reference to some variable parameter such as inflation, currency exchange rate, or maintainable profits of the businesses

Earnout/

Workout Price

A price based on the post acquisition profits of the business so that the seller shares in the on going growth of the businesses

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Avoid the event

Don’t proceed with the purchase or sale

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What is due diligence?What is due diligence?

Due Diligence is:

Detective work;

Doing your homework;

Over coming unforeseen and unwanted issues after acquiring a business

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Purpose behind due diligence?Purpose behind due diligence?

To minimise riskThe more informed a purchaser is

the more chance the purchaser has to not loose money

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Purpose behind due diligence? Confirm what the business

is;

Confirm that the soundness of any company to find contingent liabilities;

Avoid misunderstandings as to the type and condition of the business being bought;

Investigate the state of management of the business;

Confirm the status of pending lawsuits; and

Identify the extent and quantum of contingent liabilities

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Purpose behind due diligence?Purpose behind due diligence?

Essentially gain information that will be useful for valuing assets, defining representations and

warranties, and/or negotiating price concessions;

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Who conducts due diligence?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

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Acquire Target knowing all that is to be known

Given the time and money the Purchaser has/wants

To spent

Use Results tonegotiatePurchase

terms

DDC UndertakesDetective

work

Form DD

C’ttee

Obtain Target toacquire

PreliminaryInvestigation

ofTarget

What is the due diligence process?What is the due diligence process?

Due DiligenceProcess

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Where is information obtained?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

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Lessons from the cases….Lessons from the cases….

Have a due diligence agreementPlessey 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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Questions?Questions?