Selling a business

Introduction

The sale of a SME (small to medium sized enterprise) business as a going concern usually involves the sale of the assets of the business i.e. the goodwill, fixed assets & stock.

It is much less common with SME’s for a sale to be by way of the sale of shares(as buyers do not wish to risk becoming liable for any contingent liabilities -such as unpaid & back taxes – which they would be liable for , if a share sale had taken place.

In both forms of sale (share or assets sales) there are taxation, financial & accounting issues, which must be considered and for this reason vendors should consult with their accountant and lawyer when considering selling a business.

There are many issues to consider when selling a business and the following are only some of the issues.

Allocation of the Purchase price between Tangible & Intangible assets

In addition to the value of the fixed assets and stock included in the sale of a business it is usual to add an amount for goodwill,where goodwill exists.

The breakdown between goodwill and fixed assets, is important because if you sell the fixed assets for more than their depreciated value, the amount by which the sale price exceeds the depreciated value will be treated as profit on which tax will be payable. It is desirable for a vendor to increase the value of the goodwill to the highest price the vendor can negotiate with the purchaser.

The Purchaser will want the reverse (i.e. a high fixed assets figure and low goodwill figure) as the business buyer will wish to depreciate to the maximum amount possible thereby reducing tax payable-goodwill is generally not tax deductible to the purchaser(though there are exceptions such as site goodwill).

Details of the fixed assets will be attached to the sale & purchase .There is no need to value the individual fixed assets. The purchaser may decide if they want to depreciate fixed assets at more than the Vendors depreciated value.

How do you value a business?

There is no one method that can be used to value all businesses and experienced business valuers will usually consider several methods. Please refer to “valuing a business” in the library, for a more detailed explanation of the various valuation methodologies used.

Price and Value are different things.

A valuer will usually provide an opinion of fair market value. This is the cash value a willing buyer will pay a willing seller where both parties are fully aware of the relevant facts and neither is compelled to buy or sell.

Price may vary significantly from value depending on the motivation of the parties and their respective negotiating skills.

What factors affect the price of businesses?

Whilst historical profits & expected future profits are very important, there are also a number of other factors which affect the price of SME businesses.

Buyers may pay more for a business that offers an attractive lifestyle and in times of higher unemployment there is often a strong demand for businesses providing employment for the buyer and possibly family members.

How to maximise your exit price

First impressions are important .A clean and tidy business – right from the outside to the entire inside areas is important. Fixed assets should be in good operational order.

Buyers (and their accountants/advisors) will want to see a well prepared information memorandum along with up to date financial accounts, monthly sales figures, GST returns, copies of leases .Without this information being available, a vendor is not ready to start the sales process.

It is important to be able to show prospective buyers how easy it will be to take over the business. This is made easier if you have an operating manual which lists details of suppliers, major customers, how the business works operationally, service providers etc

When discussing the business with buyers, be truthful with everything you state. Misrepresentations and omissions may result in court action which is very expensive.

Using an experienced business broker will ensure Vendors maximise their exit price whilst maintaining confidentiality.  It is very important that competitors, suppliers, staff & customers do not become aware that a business is being marketed or is for sale until the appropriate time (which is usually when a deal is virtually complete).

Whilst the sale process is going on it is important for business owners to carry on running their businesses as usual to maintain the goodwill of the business. A sale may take on average from one to four months to complete. The goodwill of the business must be maintained throughout this period.

Goods and Services Tax (G.S.T.)

Certain conditions must be met if the sale and purchase of a business is to be zero rated (i.e. no GST is added to the sale price) under the Goods and Service Tax Act.

If the sale is not zero rated and GST is payable it is important to check with your accountant as to when the GST is payable, otherwise vendors might be faced with paying GST before receipt of the sale price.

For a sale to be zero-rated the business must be sold as a going concern to a person or company registered for GST at the date the agreement for sale and purchase is signed, if the sale is conditional, or by the date the agreement is declared unconditional.

The sale and purchase agreement should always be noted as Plus GST if any (to protect the vendor).

Leases

Most businesses operate from leased premises where a lease is already in existence. On the sale of a business it is necessary to get the landlords consent for the new buyer to take an assignment of the existing lease or take out a new lease. This will be a condition in the sale agreement.

The term of the lease and rights of renewal are very important for several reasons including that it is expensive to move premises for many businesses.

When Vendors assign/ transfer a lease to a purchaser, Vendors may still remain liable under the lease until the term of the lease including any rights of renewal expire or the lease is changed in some important manner without the Vendors consent. For this reason it is important to find a financially sound purchaser because if the purchaser becomes bankrupt, or being a company goes into receivership, the landlord will look to the Business Vendor for the rent and all other payments due in terms of the lease. It is of course possible sometimes to negotiate a lease or assignment where this ongoing liability is not required by the landlord.

Turnover warranty

The standard business agreement for sale and purchase includes a turnover warranty. This is a statement of the turnover for the business for the period of the warranty (a period prior to the settlement date). It is not a guarantee that the turnover will remain at the figure included in the agreement in the future.

Restraint of trade

It is usual for an agreement for the sale and purchase of a business to restrain the vendor from operating a similar business within a defined area and for a specified time. If business owners wish to continue in the same type of business they must give careful consideration to the area and period of restraint.

Staff

If the business employs staff, it is important to know what wage and redundancy issues might arise if the purchaser does not wish to employ all the staff.

There are certain categories of staff, such as those that provide cleaning and catering services, who have the right to elect to transfer to the purchaser. It is important that owners understand whether any of their staff fall into these categories.

Name of business

Buyers will usually wish to continue to use the name of the business, especially if it is a well known name. The purchaser has paid for the right to use the name as part of the goodwill.

Clauses in Sale & Purchase Agreements

The standard Auckland District Law Society /Real Estate Institute of New Zealand Fourth Edition 2008 (3) version of the business sale and purchase agreement contains many of the standard clauses required in a business sale. However each sale must be carefully considered and special clauses added as needed. Examples of additional clauses which are sometimes added include clauses relating to: debtors, creditors, announcements, confidentiality, due diligence to name a few.

WARNING

Nothing set out above should be taken as legal or accounting advice.

I have only attempted to highlight some of the factors to take into consideration when selling a business.

It is essential for business owners to involve independent professional advisers (including both legal and accounting) at the earliest opportunity.

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