Failing to plan is planning to fail.
There is no substitute for diligence and preparation, particularly when navigating the complex path towards buying or selling a construction business.
This article outlines some key considerations before you look to buy or sell.
Share sale v asset sale
Firstly, it is important to understand the structures of a business sale. There are two common ways to sell your business:
- Asset sale (what is usually meant by a ‘business sale’) – selling the assets of the business; or
- Share sale – selling the shares of the company to transfer the ownership of the business.
Understanding the distinct differences between the two structures is critical to achieving a successful business sale or purchase.
A business sale generally refers to the sale of assets of a business. In this form of sale, ownership of the assets of the business is transferred from the seller entity to the buyer entity at settlement. The buyer is not acquiring the shares of the seller entity, so the sale excludes the liabilities of the seller entity.
Examples of assets of a business include the plant and equipment, stock, work in progress, intellectual property and goodwill.
Where the business operated by the seller was the only operation conducted prior to the business sale, it is common for the seller entity to be wound up and de-registered after settlement.
In a share sale, the buyer purchases only the shares in the company that owns the business assets. Typically, all assets remain with the company unless the contract excludes them from the sale.
This form of sale is popular among sellers from a tax planning perspective:
- Firstly, a small business can access the small business capital gains tax (CGT) concessions where the shares sold are regarded as ‘active assets’.
- Secondly, individuals or trusts that own shares in a company can claim the 50% CGT discount on the sale of the shares – where the company is not able to claim the 50% discount in the sale of the assets.
Unlike the business sale, the company will remain in existence after settlement and continue to operate the business. Therefore, customers and other third parties should see no difference in their dealings with the business from before to after settlement.
From the buyer’s perspective, you are not adopting a ‘clean skin’ entity because the seller company has been in existence for a certain period and has had time to accumulate liabilities, which you will be inheriting after the sale. That might include potential liability for work done, historical taxation liabilities, or risks associated with the conduct of the previous/existing directors.
Therefore, it is extremely important in this instance to conduct a more thorough due diligence, not only on the assets and contracts of the business, but also of the seller entity itself. Further, warranties provided by the shareholders should be more extensive, for the buyer’s protection.
As a buyer it is important to establish what kind of entity is going to be acquiring the business. This requires careful planning and consideration to avoid the cost and difficulty of trying to restructure the business down the track – when capital gains tax and duty may be imposed.
For this reason it is extremely important to obtain tax and general financial advice before determining which entity to use for the acquisition, be it your current trading entity, a holding company, or a subsidiary like an operations company.
Primary contractual terms
In a business or asset sale, you’ll want to describe the assets that are being purchased. This may include tangible items like plant and equipment as well as intangible assets such as intellectual property, logos and trademarks.
A good sales contract will include provisions for how the stock is to be valued, by whom and what will happen in the event of a dispute.
There should be a description of all licences used to operate the business and provision made for either the transfer of, or application for new, licences. In the construction industry this will have particular relevance given that many licences are not transferable, so the contract should contemplate sufficient time for the buyer to apply for a new licence taking into account the uncontrollable workings of external regulatory bodies. Buyers should also ensure they have lined up an appropriate individual to act as a licence nominee at the time of drafting the sale contract.
The business sale agreement should oblige the seller and customers to novate all partially completed build contracts to the buyer. This will involve a review of the seller’s build contracts to confirm they contain an appropriate novation provision.
This will all be on top of the important commercial terms, such as the purchase price and how work in progress and pre-payments are to be dealt with. What constitutes the purchase price is often more than simply a dollar amount: it can include a deposit, multiple instalment payments, deferred and contingent consideration, and earn out amounts. These can be key tools for a buyer to ensure their investment in the business is protected.
Due diligence is the process of reviewing large amounts of information and documentation to determine whether there are any causes for concern in the target business.
Discovering these issues may assist the buyer in negotiating a lower purchase price or even recognising when it is appropriate to abandon an acquisition.
Buyers can provide questionaries to sellers to seek information and request documents relevant to the sale. Additional key information can be found via publicly accessible searches, for example, the Personal Property Securities Register, the Australian Securities and Investments Commission, land titles registries and Court litigation searches.
In share sales an investigation into the structure of the seller entity will be an additional important consideration. Beyond the seller company’s constitution, minutes, resolutions and register, the buyer should review any existing shareholders agreement which may specify a defined process for the sale of the seller’s shares, including any rights of pre-emption afforded to remaining shareholders.
Where the seller is a trust or partnership, the relevant deed should be reviewed to confirm that it contains all requisite powers, for example, to own assets, to run a business and to sell assets. All amendments to the deed should also be requested and reviewed.
Financial advisors should be involved in reviewing all financial statements, books and records of a target, while legal advisors will assist in reviewing the terms of key contracts including confirming:
- they are in writing (rather than just handshake deals);
- where desirable, they can be transferred (such as the novation of partially completed build contracts);
- whether there are any preconditions to transfer;
- there are no onerous provisions;
- where undesirable, they can be terminated easily.
One contract that will be of particular importance to the business is the lease of the business premises.
The sale contract will usually specify whether the existing premises lease is to be assigned, or terminated and a new lease entered into.
In large, the seller and buyer will adopt the following roles in the assignment of the lease process:
- seller – obtaining the landlord’s consent, making payment and signing documents.
- buyer – providing information such as business CV, referees and financial statements.
Where a new lease is to be entered into with the buyer, the terms of the new lease should be negotiated by the buyer and landlord concurrently with the terms of the business sale contract by the buyer and seller. This is because there will be little point in entering into the sale contract if the buyer does not agree to the terms of the lease.
Having said this, even where a contract refers to an assignment of lease the buyer can negotiate with the landlord for amendments to be included in the deed which documents the landlord’s consent to assignment. In this instance the successful assignment of the lease should be a condition precedent to settlement in the business sale contract, and the drafting will be important to ensure the buyer has maximum flexibility in determining whether to accept an assignment on its own terms.
Regardless of whether an employee is going to work for the buyer after settlement, their employment must be terminated by the seller as from settlement because the nature of the employment agreement is personal between the employee and the seller.
However, a seller will need to make certain employees redundant where the buyer elects not to employ them after settlement.
To avoid being made the subject of employment claims it is important for the seller to ensure that these employees receive the correct amount of redundancy pay. This can be determined by an examination of employment contracts and applicable awards under the Fair Work Act.
If the buyer does choose to re-employ an employee, there will usually be a continuation of their existing entitlements – annual leave, sick/personal leave and long service leave – provided the requirements of a transfer of business under the Fair Work Act are met.
A restraint clause will prevent the seller and its key persons from setting up a competing business within a certain area and period after settlement.
From a legal perspective, restraints are prima facie void as a limitation on an individual’s earning capacity. For a restraint to be effective, it must be shown to be necessary to protect the goodwill of the business and be reasonable in its extent and duration.
Sellers are often concerned with what will happen to their confidential business information, like customer and sales details, if the contract does not settle.
A non-disclosure or confidentiality agreement will oblige the buyer to use the confidential information only for the purpose of determining if it wishes to make a purchase of the business.
Equally, a business sale contract should contain a provision covering this possibility where the contract is signed prior to due diligence being conducted by the buyer.
GST will not be payable on a business sale where the business is a going concern. This means that everything necessary for the continued operation of the business must be transferred, operation must continue up until settlement, and the buyer is, or is required to be, registered for GST.
The capital gains tax withholding regime requires the buyer to withhold 12.5% of a purchase price of $750,000 or more where the seller is not an Australian tax resident, and remit this amount to the Australian Taxation Office (ATO). This regime is only applicable to the sale of real property, including where land is included in the assets of a company, and for certain shares defined as ‘indirect Australian real property interests’, which means it will most likely be relevant in the context of a transfer of business via share sale.
To avoid having the buyer remit 12.5% of the purchase price to the ATO, the seller must provide a declaration that it is either an Australian resident or that the shares are not indirect Australian real property interests – this can be contained in the sale agreement itself.
Finally, although abolished in NSW, VIC, SA and the ACT, transfer duty is still payable in QLD, WA and the NT on the transfer of business assets. It is useful to be aware that where the sale includes only personal property and/or intellectual property, no duty is payable.
Buying and selling a business is not a straightforward matter, with multiple moving parts and considerations at different stages of the transaction process, so it is crucial that you plan and obtain appropriate advice right from the outset.
If a business sale or purchase is on your radar, speak to our experienced commercial team who will navigate you through the considerations most important to you.