When you are selling a business, you are transferring ownership of a bundle of rights, responsibilities and assets that are used together to create profit for their owner. These rights, responsibilities and assets need to be clearly identified so they can be effectively transferred from seller to buyer.
The components of a business can include:
- the registered business name
- business goodwill
- business premises (lease or ownership)
- fixed assets
- current orders
- supply agreements
- patents and trademarks
- business licences
Other considerations include:
- should the prospective purchaser sign a confidentiality agreement?
- will any unpaid accounts (debt) remain with the previous owner, or will the right to recover the debt be transferred to the new owner?
- what are the taxation implications?
- have all representations made to the prospective purchaser been accurate?
- what consents and approvals are required for the sale to proceed?
What is included in the sale value?
When negotiating a price for a business the following component categories are considered:
- Fixed Assets and Equipment
The seller must complete a full inventory of assets and equipment of the business; the price the buyer pays for these assets will be what is called the “book value”. The “book value” is the price at which the asset was originally valued. The seller also needs to determine whether there is a mortgage or bill of sale over the assets, which must be paid out at settlement.
The business premises will be the most contentious of these assets. If the premises are not owned but leased then the buyer must be sure that they can obtain the rights to the use of the premises either through a transfer of the lease, a new lease or through the purchase of the building.
- Business Goodwill
This will give the business a value above that of the assets alone. It is an intangible property right. It is generally represented by the value in the reputation of the business, good location, market penetration and good relations with its customers, suppliers and employees. In a tangible sense, “goodwill” will involve business names, the business location, telephone numbers, names of products and services, customer lists, people, efficiencies, systems, processes, techniques etc.
If the combination of these components of goodwill does not produce a profit (or cashflow) in excess of a reasonable return for the assets employed in the business, then goodwill has no value.
To increase the value of the business for the seller, the components of goodwill should be registered so as to become saleable commodities (e.g. registering the business name and/or logo as a trademark). Meanwhile, the buyer should exercise diligence in determining what these components of goodwill are worth and whether they are already registered. These may be amongst the most valuable items of a business and crucial to future business success.
- Stock in Trade
This consists of all commodities used in the production of saleable goods, goods being produced and finished goods. Whilst the value of this stock will be originally based on an estimate, it is important for the buyer that this stock be accurately valued just before settlement of the sale and is within 10% of the original estimate.
Not included in the value of the business will be any ‘encumbrances’. Any mortgages, charges, or bills of sale over any stock or assets must be settled by the seller before the sale. If any stock or assets are the subject of a lease or hire purchase then the seller must be sure they can be transferred to the buyer or that the seller can pay them out. It is important that searches through ASIC (if the seller is a company), and the Registrar General’s office are made to ensure that all these obligations have been settled and the seller is not a bankrupt.
What are the steps in a sale of business?
- Preliminary negotiations, pre-exchange searches (“due diligence”), negotiation of special conditions, agreements signed.
- Exchange of contracts takes place at the offices of the vendor’s solicitors, where a deposit of 10% of the purchase price is usually paid. Contracts are now legally binding.
- The purchaser’s solicitor sends to the vendor’s solicitor “requisitions on title”, which are a list of questions sent to the vendor’s solicitor. If the answers turn out to be false or misleading, these will provide protection to the purchaser.
- After exchange, the vendor will generally have a number of obligations to fulfil, as stated in the contract for sale. These include: executing the necessary documents to transfer title, discharging a mortgage and acquiring a lessor’s consent to a transfer of lease.
- The contract for sale will state a completion date, when settlement will occur. Settlement generally occurs at a place nominated by the vendor. The solicitors for the buyer and the seller must have all the relevant documents signed and the appropriate cheques.
Please contact Shire Legal if you have any questions about selling or buying a business.