Found a business you want to purchase? Stop! It is really important you know exactly what it is you are buying and how you will operate the business. These can make all the difference in determining whether a business will profit from the get-go, or whether the business will produce only headaches and grey hairs.
Have I done my Financial Due Diligence?
You need to do your homework. Consider the financial viability of the business and the industry.
Look over the financial statements of the business. Request the seller provide you:
- BAS (Business Activity Statements) for at least the last four quarters;
- Accounts for the last two financial years (Both Balance Sheets and Profit and Loss Statements);
- Current year financials;
- Tax returns for the last few years; and
- Assets and liabilities included in the sale.
Familiarise yourself with the overheads of the business. Determine whether you have room to grow, or whether you can keep costs low.
When will you break-even with the cost of purchase of the business? A year? Three?
What other financial risks are there? Is your business seasonal? Will you need to take a loan out to finance the business, and what risks does this contain. Will you be leasing? Will the current lease prohibit you from expanding in a way you may wish to. Does the business have a large number of accounts receivable? Who will take on the responsibility for chasing debts?
To determine these questions, you will be required to put a lot of time in early to ensuring everything is satisfactory. It may also require having a lawyer advise you of what risks may occur, or attempt to renegotiate the terms of the lease or the sale of the business. Finally, Make sure you have a properly defined “due diligence” clause that allows you to walk away from the purchase if you do not like what you find.
How do I want to structure my business?
Are you purchasing a business where the owner is a sole trader? Do you wish to trade as a sole trader, a company, or incorporate a company where the director is a trust?
These are three different options available to you. Each option comes with its own strengths and weaknesses.
Sole Trader:
A sole trader conducts business under their own name. For example, if Joe Black was to buy a business called “Loganholme Luxury Lanterns,” the business’s official name would be “Joe Black (ABN NUMBER) trading as Loganholme Luxury Lanterns.”
If a person conducts business as a sole trader, they are the business. They do not need to register a company and pay the fee associated, and amending the structure of the business does not require amendments being made through ASIC. Also, you do not need to register for Goods and Services Tax (GST) unless your annual GST turnover is $75,000 or more.
There are some serious draw-backs when conducting business as a sole trader, especially when the operations of the business can be vast or complicated. One thing to consider is that you will be personally liable for any debts or lawsuits that involve the business. Should a judgement or debt be greater than the worth of the business, your personal assets such as your home or investments may be sold to recover the costs owing. Also, you are not able to pay yourself as an employee of the business or include yourself in Work Health and Safety (WHS) Policies. As your business prospers, your tax will do. There is very little one can do as a sole trader to reduce tax.
Company:
A Proprietary Limited company (known in short as Pty Ltd) is its own legal personal. You are not the business; you merely own the business. Usually, you will want to ensure that you are a director and shareholder of a company, even should you be the only director or only shareholder of the company.
The positives of having a company is that your liability is limited. Should the company be sued or default on a debt, your personal assets are safe. You may also pay yourself a wage as an employee, including yourself in WHS policies, and carry out purchases and make expenses under the company’s name, which are more likely to be tax deductions if they can be bought under the company. There is no muddying of personal and professional finances either; all financials relate entirely to the company. Setting up a company is quick, simple, and relatively inexpensive.
Trust:
Another popular alternative is to trade through a family trust. Ideally, you would become the director of the company and have the company act as the trustee for that trust. Why would you do this, you ask? Two reasons: Liability and tax minimization. Liability of a trust is the responsibility of the trustee, not the beneficiaries, so responsibility for your actions rests with the trust and not you personally. Therefore, the beneficiaries, who receive income under the trust, are not liable for debts of the trust. The company becomes liable for these debts, which is advantageous as companies can limit liability. Further, trusts are not considered a taxable entity. Money that goes into the trust does not get taxed; that money is only taxed when it is included to the beneficiary’s income (as income tax). Discretionary trusts (or “family trusts” as they are commonly called) may be set up to allow the trustee to make distributions of the trust property at their discretion. The flexibility of discretionary distributions allows trustees to provide in the most efficient way, with consideration to policies surrounding tax rates and thresholds. Importantly, trustees owe beneficiaries numerous duties, so care must be afforded that a beneficiary is someone whom you trust that will not abuse that position of power.
Setting up a trust is also simple and inexpensive. The process requires legal assistance in preparing the trust deed.
Have I negotiated sufficient protections?
It is a good idea to send a letter of intent to the seller. This letter summarises the important terms and conditions of the purchase. This might include, for example, the price of the purchase, assets being purchased, a restraint of trade clause prohibiting the seller from setting up a new business in the same industry and competing with you, whether you pay the purchase price as a lump sum or in installments from trading profit, and any other essential terms of the contract. This is ideally sent before the contract is drafted to iron out what you would like included in the contract of sale and, while not legally binding on the seller, assists the Courts in constructing what you prioritized in the sale and what was relied on by you.
- Article by Sam Shakibaie @ MADSEN LAW
