Buying a Business?
Ten top tips to avoid potential traps
by
Copyright © Lawson-West 2009
Introduction Buying a business is a complicated process. Apart from all the practical things to consider and organise such as takeover date, finance and stocktakes, there are a number of legal issues that sometimes get forgotten. These can cause you major problems later, not only because of the potential cost to you but also because of the effect on the business and the time needed to resolve the problem. These notes are intended to highlight some of the most common and dangerous traps and provide tips to avoid them but they are not exhaustive and frankly only give a flavour of the many problems that can arise. Please remember that buying a business requires considerable legal expertise and you should always use a solicitor who specialises in this area of law.
Copyright © Lawson-West 2009
Premises - It’s not just about the rent! Most business premises are rented and whether you take over an existing lease or take a new one, the lease document is prepared by the landlord’s solicitor to protect the landlord not you. As with any legal document it is not just a matter of checking what is in the lease but also what has been missed out. Trap 1 When you take over leasehold premises it is normal to take on liability for all repairs, either directly or by paying a service charge as well. Tip Find out your liability by having a survey of the property carried out by a professional to establish its condition at the time of the lease and so that you are clear as to your responsibilities. Secondly, if you are taking a new lease, it is sometimes possible to agree with the landlord that you do not have to return the property in a better condition than it is at the start of the lease. This is done by agreeing a schedule of condition which is a photographic record and description of the condition of the property. Trap 2 Some leases are “contracted out” which means that, as tenant, you will have no protection under the law once your lease comes to an end, and the landlord can insist that you leave at that time. However, just as importantly, it allows the landlord to demand an excessive rent knowing that the tenant must either accept the higher rent or leave. This is particularly important when a business depends on a location - such as a shop or restaurant. Tip If the lease is contracted out see if the landlord can be persuaded to change this - perhaps by giving you a new lease for a longer period. If satisfactory terms for this cannot be agreed then make sure you fully understand the implications and that the amount of your investment in the business and the property reflects the risk that you are taking. Copyright © Lawson-West 2009
Employees - claims waiting to happen! i) Taking on the Employees When you buy a business all employees automatically transfer to you as the owner of the business and on the same terms and conditions as before. However, you may decide you can run the business with fewer employees and therefore need to reduce the workforce. Trap As the new owner of the business it is you who will be liable for any compensation due to an employee - even if the person had been dismissed by the previous owner of the business. Tip Make full enquiries about any staff that have left the business in the last 12 months and why. Do not under any circumstances ask the seller to take any action against any employee that could lead to dismissal. Instead, your business plan should take into account the cost of any redundancies. The law does allow you to make changes to terms and conditions of employees in certain circumstances, provided you follow the
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ii)Reducing the workforce When buying a business the new owner often looks to reduce operating costs by redundancies. In addition to complying with the law regarding transfer of employees, there are clear rules and procedures to be followed in dealing with redundancies. Trap 1 Failure to follow the legal rules and normal dismissal procedures (as well as employees’ contracts) can and do lead to claims by employees. Trap 2 If you are buying a business and combining it with your existing business, then in selecting staff redundancy, you also have to include your existing staff in the process where it is appropriate to do so. In both the above cases, successful claims can result in very large compensation payments, and there is no limit to the amount of compensation if the employee can show that there has been discrimination against them. Tip Before buying the business be clear about the changes you intend to make and liaise with your solicitors as to the actions and procedures you will need to follow. Don’t forget that it is often the failure to follow procedures (not the rationale of the decision) that results in the claim and the compensation.
Copyright © Lawson-West 2009
Warranties - don’t rely on verbal promises Warranties are written promises about the business, usually given in the sale contract by the seller of the business. They are a key part of the contract because in making the decision to buy the business you will be relying very much on the information given to you by the seller. Trap The rule of “buyers beware” applies to a very large degree because the seller generally does not have to provide information unless you ask for it. Tip Make a note of any important statements or answers to important questions given by the seller as the negotiations proceed. This is important because it is very easy to forget these issues when focusing on the many practical aspects that need to be sorted out. Make sure your Solicitor knows of these issues so that they can be confirmed in writing and then backed up by warranties in the contract.
Buying From a Company - Beware the ‘man of straw’ A company is a legal person in its own right. Therefore, if you buy a business from a company (without buying the company itself) you would have to sue that company if there was any breach of contract.
Trap If the company is worthless (this may be because you have bought the main assets) you will not receive any damages even if there is a clear breach of contract by the company (for example a breach of a promise under the warranties). Tip Ask the directors of the selling company to give personal guarantees that the company will not be in breach of its contract with you. This will make them personally liable and not only will it give you added legal protection, it will make sure that the people giving the warranties take them seriously! Copyright © Lawson-West 2009
Buying the Company itself - is it a pig in a poke? Sometimes it is better to buy the whole company (i.e. the shares of the company) rather than just the business or the main assets of the company. Trap The company remains liable for all its existing debts and other liabilities and for any action that people take against the company in the future e.g. for negligence or breach of an existing contract that the company may have entered into. Tip “Due diligence” enquiries (i.e. questions about the company and its performance and history) are essential in these cases and it is crucial not to cut costs in this area. Again personal guarantees by the directors and/or shareholders of the company being sold should be obtained if the shares you are buying are themselves owned by a company.
Anti-competition Clause - be reasonable! It is normal to have a clause in a contract that the seller will not set up a competing business within an agreed radius and within an agreed time. This can be very important, and buyers often want these periods and time scales to be as long as possible. Trap Restraint of trade clauses must be reasonable otherwise they may not be enforceable at all e.g. a clause not to open a competing restaurant within 50 miles for the next 10 years would almost certainly be unenforceable. Tip It is best to stay on the side of caution by considering carefully and realistically what would be reasonable parameters, by looking at the type of business area in which it operates.
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Business Contracts - are they worth the paper they’re written on? One reason for buying a business could be the existing contracts that the business has with certain customers. Trap Not all contracts can be transferred automatically, and usually the consent of the customer is needed. When the contract of the customer cannot be transferred for some reason then the value to you of the business you are buying may be severely reduced, and you may need to consider renegotiating the price. Tip Check the fine print of all the contracts you wish to take over and make sure they can be transferred to you (called “novation”). Also include a clause in the contract that the seller of the business will co-operate with you and if necessary perform the contracts with the customer on your behalf and in accordance with your instructions (and at your expense).
Seller’s Liability - Take it to the limit! Sometimes the seller’s liabilities under the sale contract are limited in some way, e.g. by an agreed maximum based on the purchase price of the business. It is also common to see liability limited for a specific period which the seller will obviously want to be as short as possible. Trap In addition to the purchase price of the business, you may incur other major costs e.g. refurbishment of premises. In these situations, if there is a serious breach of contract by the seller the amount you stand to lose could be considerably more than the purchase price. Tip Make sure you know the total amount of your likely investment and that this is reflected in any financial limit placed on the seller’s liability. You also need to make sure that any minimum claim limit is not set too high so that it will prevent you claiming if there are a number of minor problems which, individually, are minor but which together begin to become serious. Copyright © Lawson-West 2009
Statutory Requirements - know all the rules! Business owners have a number of legal requirements with which they must comply. In relation to property, these include asbestos management and fire risk assessments but there are a number of other statutory obligations, notably health and safety and duty to employees. Trap Just because a seller says he has complied with all statutory requirements does not mean that the business will do so in the future and, indeed, the seller may not know that he is in breach of legal obligations. Tip Know the rules and regulations that affect your business and industry. In particular consider whether the changes you propose to the business will necessitate any other actions to comply with your legal responsibilities. What may seem minor technical breaches can incur substantial fines and so it is usually worth employing a specialist advisor to carry out a risk assessment or advise you generally in these areas.
Copyright © Lawson-West 2009
