Buying or selling a business in Victoria

When negotiating the sale of a business, the parties naturally focus on the purchase price. An equally important question, though, is what exactly is being bought and sold.

A purchaser may acquire the assets that make up the business, including its goodwill, equipment, stock and intellectual property. Alternatively, the purchaser may acquire the shares in the company (or units in the trust) that owns and operates the business.

The commercial result may appear similar: the purchaser takes control of the business and the seller receives the sale proceeds. Legally, however, the two transactions can be very different.

The structure of the sale can affect:

• which assets and liabilities pass to the purchaser;
• whether contracts, leases and licences need to be transferred;
• how employees and their entitlements are dealt with;
• the tax treatment of the transaction;
• the warranties and indemnities required from the seller; and
• the extent of the purchaser's due diligence.

For a purchaser, the wrong structure may result in unexpected liabilities or the failure to acquire an essential asset. For a seller, inadequate preparation can delay the transaction, reduce the purchase price or leave the seller exposed to claims after completion.

What is a business or asset sale?

Buying the assets of the business

A business sale is often another term for an asset sale. In an asset sale, the purchaser acquires specified assets from the person, company or trust that operates the business.

Depending on the nature of the business, the assets being sold may include:

• goodwill and the business name;
• plant, machinery and equipment;
• stock and work in progress;
• intellectual property;
• websites, domain names and social-media accounts;
• customer and supplier contracts;
• telephone numbers and email addresses;
• licences and permits;
• the benefit of the business premises lease; and
• business records and customer information.

The sale agreement should clearly identify which assets are included and which are excluded.

Why might a purchaser prefer an asset sale?

An asset sale may allow the purchaser to select what it wishes to acquire and limit the liabilities it agrees to assume.

For example, the purchaser may agree to acquire the business assets without taking responsibility for the seller's existing bank debts, tax liabilities, historical disputes or unrelated business activities.

However, an asset sale does not automatically protect the purchaser from every historical liability. Employment laws, tax legislation, consumer claims, privacy obligations and the particular terms of the sale agreement may still create exposure.

The purchaser must also ensure that every important asset is properly transferred. A business may depend on a valuable customer contract, regulatory licence or lease that cannot be transferred without third-party consent. Equipment used by the business may be leased or financed rather than owned outright. Intellectual property may be registered in the name of a director, former employee or related company rather than the seller.

The fact that an asset is used by the business does not necessarily mean that the seller owns it or has the right to transfer it.

What does an asset sale mean for the seller?

After an asset sale, the selling company or trust will usually continue to exist. The seller may therefore retain:

• debts and liabilities that were not assumed by the purchaser;
• tax obligations arising from the transaction;
• excluded assets;
• employee obligations;
• contractual liabilities;
• litigation or regulatory exposure; and
• responsibility for winding up or restructuring the selling entity.

A seller should not assume that selling the operating assets provides a complete exit from the business.

What is an entity sale?

Buying the company or trust that operates the business

Instead of transferring the individual business assets, the parties may agree to transfer ownership or control of the entity that operates the business. This commonly occurs through:

• a sale of shares in a company;
• a sale of units in a unit trust;
• a transfer of shares in the corporate trustee; or
• a combination of unit, share and control changes.

In a share sale, the company generally continues to own the same assets, employ the same people and remain a party to the same contracts. The purchaser acquires the shares and takes control of the company.

This can make the transition appear more straightforward. However, the purchaser is also acquiring the economic consequences of the company's history.

The purchaser acquires more than the business assets

Historical risks within the entity may include:

• unpaid tax, superannuation or employee entitlements;
• underpayment claims;
• existing or threatened litigation;
• breaches of customer or supplier contracts;
• defective products or services supplied before completion;
• privacy or data-security breaches;
• regulatory non-compliance;
• related-party loans or undocumented transactions;
• guarantees and security interests;
• environmental liabilities; and
• contingent or undisclosed liabilities.

These liabilities remain with the company even after its ownership changes.

For this reason, due diligence for an entity sale is usually broader than due diligence for an asset sale. The purchaser will commonly investigate the entity's corporate, financial, taxation, employment, contractual and regulatory history.

Following a transfer of shares, a proprietary company must generally notify ASIC of the transfer or change in beneficial ownership within 28 days.

Why might a seller prefer an entity sale?

A seller may prefer an entity sale because it can provide a more complete exit from the investment. Instead of selling the operating assets and retaining the original company or trust, the seller transfers its ownership interest in the entity itself.

An entity sale may also reduce the need to assign individual contracts or assets. However, the parties must still review change-of-control provisions. A contract, lease, franchise agreement, finance document or licence may require consent even though the legal entity operating the business has not changed.

A purchaser accepting the entity's historical risk will also usually seek extensive contractual protection from the seller. This may include:

• detailed warranties about the business and its records;
• tax indemnities;
• indemnities for identified risks;
• limitations on distributions before completion;
• adjustments for debt, cash and working capital;
• retention of part of the purchase price;
• security for warranty claims; and
• restraints preventing the seller from competing after completion.

An entity sale may reduce the number of individual assets requiring transfer, but it will not necessarily result in a shorter or simpler sale agreement.

Asset sale or entity sale: which is better?

There is no structure that is automatically best for every transaction.

An asset sale may offer the purchaser greater control over the assets and liabilities being acquired. However, it may require numerous transfers, consents and new applications.

An entity sale may preserve operational continuity, but it may expose the purchaser to the entity's historical liabilities.

The appropriate structure will depend on factors including:

• the legal structure of the existing business;
• the nature and transferability of its assets;
• its contracts, leases and licences;
• the identity and preferences of the purchaser;
• the risks within the existing entity;
• employee arrangements;
• financing requirements; and
• the taxation consequences for both parties.

Legal, accounting and taxation advice should be obtained before the parties commit to a particular structure or finalise the allocation of the purchase price.

Section 52 statements

When is a section 52 statement required?

For certain sales of small businesses in Victoria, the seller must provide the purchaser with a Statement by a Vendor of a Small Business, commonly called a section 52 statement.

Consumer Affairs Victoria states that the requirement applies to the sale of a small business at a price of up to $450,000. The statement is completed using the prescribed form and is usually prepared with the assistance of the seller's accountant.

The statement contains information about the business and its recent financial performance. It must be provided to the prospective purchaser before the purchaser enters into a binding (or intended to be binding) document relating to the sale, or before a deposit is accepted.

Failure to provide a compliant statement, or the inclusion of inaccurate or incomplete information, may give the purchaser statutory rights concerning the transaction. The seller should therefore begin preparing the statement early and ensure it is consistent with the business's accounting and taxation records.

The section 52 requirements should also be considered before the parties sign:

• heads of agreement;
• an offer to purchase;
• a business broker's sale document;
• a conditional contract; or
• any other document intended to create legal obligations.

The legislation remains in force, and the application of section 52 can depend on the structure and substance of the particular transaction.

A section 52 statement is not a substitute for due diligence

A section 52 statement is an important disclosure document, but it is not a guarantee that the business will continue to perform in the same way after completion. A purchaser should investigate whether the reported earnings are sustainable.

Relevant questions may include:

• Has the owner been working without receiving a commercial salary?
• Does the business depend heavily on one customer or supplier?
• Have unusual or non-recurring items affected the accounts?
• Are related-party rent and expenses recorded at market value?
• Will the purchaser need to employ additional staff?
• Is major equipment approaching the end of its useful life?
• Has maintenance or capital expenditure been deferred?
• Can cash sales be independently verified?
• Will rent, insurance, wages or supplier costs increase after completion?

The purchaser should compare the information in the section 52 statement with the financial accounts, tax returns, business activity statements, payroll records and other supporting documents.

For sellers, inconsistencies between documents can undermine purchaser confidence and lead to requests for a price reduction, further warranties or additional security.

What should a purchaser investigate?

Ownership of the assets

The purchaser should confirm that the seller owns each material asset and has the legal right to transfer it.

Plant and equipment may be leased, financed or subject to a registered security interest. The Personal Property Securities Register is the official national register of security interests in personal property, including goods and company assets.

The purchaser should also investigate the ownership and registration of:

• trade marks;
• domain names;
• software;
• copyright material;
• confidential information;
• designs;
• business names; and
• social-media accounts.

The business premises and lease

For many businesses, the lease is one of the most important assets. The purchaser should review:

• the remaining lease term;
• available options;
• current rent and future rent reviews;
• the permitted use;
• assignment requirements;
• the need for landlord consent;
• security deposits and guarantees;
• repair and make-good obligations;
• redevelopment or demolition provisions; and
• whether the premises remain suitable for the business.

A profitable business may have limited value if the lease is about to expire, the permitted use is inadequate, or the landlord will not consent to an assignment.

Employees and entitlements

The parties should identify which employees will continue with the business and how responsibility for their entitlements will be allocated.

Where there is a transfer of business, the new employer may be required to recognise an employee's prior service for many entitlements. Different rules can apply to annual leave, redundancy, long-service leave, unfair dismissal and notice of termination.

The sale agreement should address:

• offers of employment;
• accrued annual leave;
• personal leave;
• long-service leave;
• redundancy;
• notice obligations;
• superannuation;
• employee records; and
• adjustments to the purchase price.

Contracts, franchises and licences

The purchaser should identify every contract that is important to the ongoing operation of the business. These may include:

• customer and supplier contracts;
• distribution arrangements;
• franchise agreements;
• software and technology licences;
• equipment leases;
• finance facilities;
• maintenance contracts;
• government contracts; and
• regulatory approvals.

The parties should not assume that these arrangements will automatically transfer. Some contracts prohibit assignment without consent. Others permit termination, or require notification, when ownership or control of the business changes.

Tax and GST

The transaction structure and purchase-price allocation may have significantly different taxation consequences for the buyer and seller.

An asset sale may, in appropriate circumstances, qualify as a GST-free supply of a going concern. However, this treatment is not automatic. The statutory requirements must be satisfied, including requirements concerning what is supplied, the continuation of the enterprise and the parties' written agreement.

Tax advice should be obtained before the structure and the purchase-price allocation are finalised, not after the contract has been signed.

How does the contract allocate risk?

Due diligence identifies the risks. The sale agreement determines who will bear them.

Depending on the transaction, the agreement may need to address:

• the assets or ownership interests being sold;
• excluded assets and liabilities;
• the valuation and treatment of stock;
• employee-entitlement adjustments;
• landlord, franchisor and regulatory consents;
• the transfer of material contracts;
• repayment of finance;
• release of security interests;
• warranties concerning the business;
• specific indemnities for identified risks;
• confidentiality;
• restraints of trade;
• training and transition assistance;
• deferred consideration and earn-outs;
• security for future payments; and
• what happens if a condition is not satisfied.

A poorly drafted asset schedule may leave the purchaser without something essential to operating the business. Conversely, a broad warranty or indemnity may expose the seller to substantial claims long after the purchase price has been received.

What should a seller prepare before selling?

Prepare before going to market

A seller should not wait until a purchaser begins due diligence before examining the legal and financial condition of the business. Preparing early gives the seller an opportunity to identify and address problems that might otherwise delay or derail the transaction.

A seller's pre-sale review may include:

• reconciling financial accounts and taxation records;
• preparing the section 52 statement where required;
• documenting related-party transactions;
• confirming ownership of intellectual property;
• reviewing the lease and its assignment requirements;
• identifying contracts with assignment or change-of-control provisions;
• checking employee records and accrued entitlements;
• reviewing licences and registrations;
• identifying PPSR registrations requiring release;
• resolving outstanding disputes where possible;
• collecting corporate and trust records; and
• preparing an organised due diligence file.

Good preparation may also improve the seller's negotiating position. A purchaser is less likely to seek a price reduction or extensive security where the information provided is complete, accurate and well organised.

Consider how you will be paid

A high headline price does not necessarily produce a low-risk transaction for the seller. The seller should consider:

• how much of the price is payable at completion;
• whether any amount is deferred;
• whether payment depends on the future performance of the business;
• how an earn-out will be calculated;
• who will control the business during an earn-out period;
• whether the purchaser has sufficient funding;
• what security will support future payments;
• whether the seller will be released from guarantees; and
• whether part of the price will be retained to secure warranty claims.

A seller financing part of the transaction may remain financially exposed to the business after giving up ownership and control of it.

Common questions

Is it safer to buy the assets rather than the company?

An asset sale may allow a purchaser to avoid assuming some historical liabilities, but it is not automatically risk-free. The purchaser must ensure that every essential asset, contract, lease and licence can be transferred, and that the agreement clearly states which liabilities are assumed.

Does a share sale mean that contracts do not need to be transferred?

The company generally remains a party to its existing contracts. However, those contracts may contain change-of-control provisions requiring consent, notification or renegotiation when ownership of the company changes.

Does a section 52 statement guarantee the business's financial performance?

No. It provides prescribed financial information but does not guarantee future revenue or profitability. A purchaser should undertake independent legal, financial, taxation and commercial due diligence.

Who is responsible for employees when a business is sold?

The answer depends on the transaction structure, whether employees transfer to the purchaser, the relationship between the employers and the applicable employment legislation. The agreement should clearly allocate responsibility for accrued entitlements and employment-related liabilities.

Should the parties sign heads of agreement before obtaining legal advice?

Heads of agreement can create binding obligations, even where the parties expect a more detailed contract to be prepared later. The proposed structure, conditions, exclusivity provisions, deposit arrangements and section 52 requirements should be considered before the document is signed.

Look beyond the purchase price

The purchase price is only one part of a business transaction.

A purchaser must understand whether it is acquiring selected assets or the entity that owns the business, what liabilities may accompany the acquisition, and what consents are required before the business can continue operating.

A seller must consider what it will retain after completion, what disclosures and warranties it will be required to give, whether it will be released from existing guarantees, and how securely the purchase price will be paid.

The most important question is therefore not simply "How much is the business worth?" It is: "What exactly is being bought and sold, and who will bear the risks that come with it?"

Early legal, accounting and taxation advice can help the parties select an appropriate structure, identify problems before they disrupt the transaction, and record the commercial agreement accurately. Whether you are preparing a business for sale, considering an acquisition or negotiating heads of agreement, enquire with us today.