There are many ways to entering into business for yourself and buying a business is one of those ways. Buying a business can ease the learning curve involved and provide you with some established goodwill – that is, the immediate ability to generate turnover.
This article provides you with a discussion of the factors you need to consider when buying a business.
The Agreement – Share Purchase vs. Asset Purchase
You should thoroughly review the proposed sale and purchase agreement and seek a lawyer’s advice as to its effect. It must be determined whether you will buy the assets of the business or the shares. Each avenue has its pros and cons.
The Ontario Real Estate Association has approved a printed form of agreement, and it is common for this form to be used for the sale of small and medium-sized businesses. Larger sales should involve a tailored agreement prepared by a lawyer.
Goodwill, leasehold improvements, capital equipment, plant, fittings and fixtures, and inventory usually make up the purchased assets and the price is allocated among them. It is important that the purchase price is broken down into these components, with a value attributed to each one, in the agreement for the sale of the business.
Due Diligence
It is absolutely imperative that you investigate the business fully! Ask for detailed financial statements of the performance of the business and have them assessed by an accountant. Speak to the owner and ask questions. Speak to competitors and ask questions. Do everything you need to do to full understand the business you are considering buying.
Capital Equipment
What plant is included? “Plant” normally includes all items of machinery, implements, vehicles, furniture, fittings and fixtures.
The sale and purchase agreement should list in detail every item of plant that is being bought. This is usually done in a separate schedule to the agreement.
Is the plant owned, leased or under hire purchase? The seller can sell the plant only if the seller owns it at the date of the agreement to sell the business. If the plant to be transferred to you is leased or on hire purchase, the agreement to sell the business may specifically provide for those arrangements to be continued with you the buyer.
If the business premises are leased, it is important to ensure that chattels and fixtures belonging to the landlord are not included in the list of plant items in the sale agreement.
Whereas the buyer will want a high value on plant and equipment for a greater depreciation claim, the seller will want to sell it at no more than its book value to avoid tax on depreciation recovered on the sale.
Goodwill is the amount of money you are paying for the business above and beyond the value of the hard assets. Is the goodwill worth what the seller is asking for it? Are there any patents, trademarks or other intellectual property included in the goodwill, and if so, are they dependent on any licences? Ensure to fully understand the amount you are paying for goodwill and determine if it is worth the money.
The Premises
Do the premises conform to the proper zoning restrictions? Are they adequate for the business’ use? Ensure that the premises are properly zoned and that the cost of the premises is not prohibitive.
If the premises are leased, consent from the landlord is usually required before the lease can be transferred to the purchaser. Usually the landlord cannot unreasonably withhold consent.
Consider the nature, quality and approximate value of the stock. How is it to be valued? Normally, an estimated value is inserted in the agreement and the actual value as at the close of business on the possession date is determined by a physical stocktake.
Is any of the stock already secured and subject to a general security agreement. This is an agreement whereby a third party has secured an interest against the assets of a business.
Contracts Relating to the Business
What are the business’s existing contracts, such as contracts to buy goods, contracts to supply goods, and service contracts?
You will need to be satisfied that these contracts will pass to you with terms and conditions comparable to those that applied to the seller. It may therefore be advisable for the sale agreement to provide that the seller will introduce you to the business’s suppliers and customers, and that the seller will disclose all details of his or her past dealings with them and attempt to ensure that the relationships will continue with you.
You should consider what warranties exist for goods and services supplied to the business.
Are the assets included in the sale being acquired free of encumbrances? This means that the assets are the seller’s property, that no money is owed on any assets to third parties, and that the seller is able to pass title in the assets to the buyer. Agreements for sale of a business commonly include a warranty by the seller to this effect.
You should also consider including a warranty by the seller that he or she will pay and discharge all business debts and liabilities by the possession date.
What are the seller’s obligations for the supply of goods and services? What indemnities has the seller given or will need to be given by you?
You will need to see a full list of staff and details of the employment contracts.
It is usual for the seller of a business to warrant to the buyer that the seller will fully pay every employee up to the settlement date, plus holiday pay, along with any other entitlements owing to them.
Access to Business Records
It may not be practical for you to be given full access (called “due diligence”) to the seller’s business records, because of, for example, the seller’s confidentiality concerns. Instead, sale agreements commonly provide for an alternative form of access (called “limited due diligence”) whereby the seller discloses information to you in a memorandum and the accuracy of this information is warranted by the seller in the sale agreement. In this case, you the buyer will sign a confidentiality agreement.
Access to the Business before Settlement
Will you need access to the business before settlement to obtain valuations, to make alterations or to be introduced to customers?
Risk and Insurance
The sale agreement should specify when the risk in the assets passes from the seller to you. Normally this occurs on the closing date.
What types of insurance will you require? Types to consider are public liability insurance, insurance of the plant, and (less commonly) business interruption insurance.
Adjustments on Closing
Certain costs will need to be apportioned between you and the seller at closing. These costs include rent, hydro, etc.
Restrictive Covenants
In the Agreement of Purchase and Sale it is common for the buyer to restrain the seller from competing against the buyer in a similar type of business for a certain period (usually two years) and within a certain radius from the premises. However, a court will not enforce a restriction if the time period and the geographical area are unreasonable to the seller.
Pre-Conditions to the Sale of the Business
If there are things that need to be in place before you purchase the business, they should be inserted into the business as conditions to be satisfied prior to the sale. Conditions may include financing, consent of a landlord, a satisfactory inspection, etc.
Material Contracts and Licences
All material contracts should be reviewed before the business is purchased. Franchise and licence agreements should be reviewed to ensure they can be assigned.
The Business before the Sale
The Agreement of Purchase and Sale should include a representation and warranty from the seller that the seller will properly carry on the business as a going concern and maintain the goodwill of the business up to the closing date of the sale.
You may want to ensure you have the appropriate assistance after the business has been purchased. It is common for the Agreement of Purchase and Sale to include a requirement that the seller, or some other experienced person that the parties agree on, help the buyer for a period of time so that the buyer can get the benefit of the seller’s knowledge and experience.
HST Registration
It is desirable that the buyer register for HST so that the transaction can be zero-rated for HST purposes. If this is not done, no HST will be payable on the purchase price.
Your Team
In any business decision it is very important to have a strong team. Make to sure to consult the services of a good lawyer and accountant when buying a business. They can help you decide if the purchase is worthwhile, and ensure that it takes place with minimal difficulties.
Seeking the Advice of a Professional
If you have decided it is time to seek the advice of a professional ensure to email us your contact information and one of our lawyers will contact you promptly.
Nothing on this website constitutes legal advice. If you face a legal issue, you should take specific legal advice from a lawyer before taking any action. Three60Legal takes every reasonable step to ensure the accuracy of the information on this website. However, Three60Legal accepts no liability for any loss or damage arising in any way from the use of this site.
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