Whether you intend on purchasing a small retail business or
the business operations of a listed public company, the same fundamental
approach should be applied: do your due diligence first!
As advisors to purchasers of businesses of various types and
sizes, we are regularly involved in conducting legal due diligence.
However, a purchaser’s pre-contractual due diligence should
not be limited to a lawyer’s review of legal matters, but should extend to:
- Inspection of plant and equipment: being a physical investigation by the purchaser (or preferably by qualified contractors on behalf of the purchaser) into the state of plant and equipment and other hard assets sold with the business. If there are any problems with those assets, then the purchaser’s lawyer should be in a position to negotiate amendments to draft sale contracts requiring the vendor to rectify those problems prior to settlement. Physical due diligence should also indicate whether the sale price reflects the true value of the physical assets being sold;
- Inspection of the premises including the landlord’s fixtures, fittings and installations. Again this should be done by a qualified person on behalf of the purchaser and a report provided. Issues arising out of that report should be dealt with in the sale contract to ensure the vendor rectifies issues prior to the purchaser taking possession of the premises and potentially becoming liable for hidden problems.
- Financial due diligence into the business including a detailed review of the financial statements of the business for at least the last five years. The purchaser’s accountant should report on the financial status of the business including whether the purchase price is reasonable based on the business’s financial performance in recent years.
- Enquires with the local council and with owners of adjoining businesses as to potential changes to the local environment, such as the construction of roads, the construction of multi-level buildings adjacent to the business premises and other matters which might lead to business disruption in the future.
Ideally legal due diligence will involve at least the
following:
- An investigation into the status of the vendor: If the vendor is a company, what is its registration status with ASIC? In this regard, the assets of a deregistered company are vested in ASIC and cannot be dealt with by that company until re-registration, which may be problematic;
- Determining whether the vendor a trustee: If it is, then the sale contract should record the vendor as being the trustee of a trust to ensure the purchaser will acquire both legal and equitable title to the business assets;
- Personal Property Security Register searches to determine the existence security interests which may be registered over the assets of the vendor. This will identify the parties from which the vendor must obtain releases of those security interests prior to or at settlement;
- An examination of significant contracts held by the vendor including the extent to which plant and equipment is leased by the vendor. Also, significant customer contracts should be reviewed to determine whether those incomes streams can be assigned to the purchaser at settlement. If they are not capable of assignment then, the sale price may have to be reduced to reflect the loss of those income streams;
- A review of the premises lease documentation including a determination of the extent of time remaining under the lease and options and, consequently, the amount of time the purchaser will have to obtain a return on its investment. If there is insufficient time remaining under the lease we suggest the sale contract be made conditional upon the vendor obtaining the landlord’s consent to extending the term of the Lease as part of the transfer of lease documentation;
- A review of the status of all licences and permits held by the vendor to conduct the business which are to be transferred to the purchaser at settlement – thereby enabling the purchaser to lawfully conduct the business at the premises on and from settlement; and.
- Review of employment agreements and liabilities.
Once
each area of due diligence has been undertaken and the material issues have
been identified, it becomes the purchaser’s lawyer’s role when negotiating the
sale contract to have included in the contract specific obligations on the
vendor to rectify those issues prior to or at settlement. Of course, that depends on how willing the
vendor is open to bearing the cost of rectifying those issues.
Quite
often impatient purchasers pay the price for poorly conducted and/or limited
scope due diligence. Although sale contracts
may offer some form of vendor warranties (covering things such as the operational
condition of plant and equipment) they can be little comfort to a purchaser
when after settlement the vendor has disappeared overseas on vacation or doesn’t
have the finances to compensate the purchaser for breach of a vendor warranty. On that basis, we firmly believe quality
pre-contractual due diligence which extends beyond legal due diligence is
prudent practice all purchasers should consider adopting.
At
Nevett Ford Melbourne we have experienced commercial lawyers with extensive
experience in assisting purchasers of all types of businesses.
