by Natalie Macdonald-Spence
It is an exciting venture to purchase an existing business. Businesses go on sale for various reasons- perhaps the owner is emigrating, retiring or just moving on to other projects. Here are some points (amongst others) to consider before signing on the dotted line.
The business
Naturally, one needs to be aware of the the ins-and-outs of the business you are considering purchasing. To do this, it is advisable to undertake a comprehensive due-diligence prior to purchasing the business, or at least, make the purchase subject to the satisfactory outcome of a due-diligence investigation. An attorney with corporate-commercial experience would be the ideal person to assist you with the due-diligence, as they would have an excellent understanding of what to look for in business acquisitions, and which areas may present potential risks for you as a purchaser. A due-diligence exercise should consider the client base of the business, reputation of the business as well as the financials of the business- a high turnover does not always mean a high-profit margin.
Lease Agreements
If the business is currently situated in a prime location, or has an existing lease agreement, it is important to consider the terms of the lease agreement. If the location is essential for the business, you would need to make sure that the lease will still subsist for a number of years, and hopefully with a right of renewal. It would not be ideal to have an established client base within a certain area, only to find that you have to find less-than-suitable premises in the event that the lease expires, and you have to move relatively soon. Location can sometimes be the make-or-break of your business!
Licenses
There may be licenses associated with the business you are purchasing- software licenses, liquor licenses, trading licenses etc. If these are not transferred to the new owner, you may find yourself in a legal pickle- so be sure to include that all contracts and licenses necessary for the business are transferred.
Tax
The purchase of the business may attract Value Added Tax on the sale price. There are very specific requirements in terms of the VAT Act, 1991, to zero-rate the transaction where the business is sold as a going-concern. If the transaction does not strictly meet the requirements set out in the VAT Act, then SARS will levy VAT on the sale price (if the seller is a VAT vendor), which can result in cashflow issues for the purchaser.
Restraint / Non-Compete
It is normal to include a non-compete and restraint in a sale of business agreement, which will restrict the seller from opening a similar or competing business or participating directly or indirectly in a competing business within proximity of the existing business. This will avoid a situation where the purchaser pays a substantial amount for the goodwill and client base of a business, only to have the seller re-direct the business to a newly established business. Trade secrets also have value, and when in the hands of competitors this can be detrimental to your business.
Trademarks and "show-how"
If there are trademarks associated with the business purchased, the ownership of these trademarks should be assigned to the purchaser. The seller should also warrant that he/she has a registered trademark and provide proof of registration, and confirm that any marks that the business currently uses do not infringe on any existing trademarks of other businesses. There may also be essential "know-how" and "show-how" which the seller may need to impart to the purchaser in order to assist the purchaser to operate the business, and therefore in such cases it is vital to include that the seller should handover whatever documentation/training material is necessary in order to conduct the business under new ownership.
Section 34 of the Insolvency Act, 1936
In terms of section 34(1) of the Insolvency Act, the sale of a business (or intended sale) or any part of a business must be advertised in two issues of an English newspaper and two issues of an Afrikaans newspaper which circulates in the district(s) in which the business carries on its trade, as well as by a notice in the Government Gazette. The notice needs to be published at least 30 days and no more than 60 days prior to the date of the transfer of the business. Failure to advertise, or failure to advertise within the prescribed timelines, may be detrimental for the purchaser, as non-compliance with Section 34(1) results in the transfer being void against the seller's creditors for a period of six months after the date of the transfer, and the trustee of the seller's insolvent estate may void the sale. This means that the purchaser may end up with no business (in that it has been set aside once voided) and the purchaser may struggle to reclaim his money paid for the business, and will have to make a claim against the insolvent estate. Sometimes parties are tempted to avoid advertising (contrary to the Act), but as seen above, failure to do so could have dire consequences for the purchaser.
Employees
On the transfer date of the business face section 197 of the Labour Relations Act, 1995, provides that the contracts of employment (together with accrued leave, sick leave, employment benefits etc) held by the current owner of the business are automatically transferred to the new owner on the same terms. It is not possible to transact out of the Labour Relations Act, and the terms of employee contracts may only be varied provided the variation is on better terms.
Defective products and the adjustment account
The purchase price you pay for the business usually takes into account the stock you are acquiring with the business. Sometimes the stock may be defective or missing, or perhaps past their sell-by date, in which case, there should be a stock take done on the date of the transfer of the business, and an adjustment account prepared where provision is made for the "adjustment" of the purchase price in the event any stock is defective or missing, so that the purchaser does not pay for such goods.
Confidentiality
At all times, both parties should agree to strict confidentiality pertaining to the transaction, both before and after. We therefore usually include a well-worded non-disclosure and confidentiality to protect the interests of both parties.
Concluding remarks
The above comments are just a few of the things you need to consider when purchasing a business. It is crucial to ensure that you seek legal advice when doing so, from an attorney who is experienced in the field of commercial law. Spence Attorneys can assist you, whether you are selling a business, or acquiring one, as well as assist in franchise matters. Contact Natalie Macdonald-Spence, our director, via email at natalie@spencelaw.co.za to obtain advice in this field.
DISCLAIMER: The above article is for information purposes only, and should not be regarded as legal advice, nor substituted for legal advice or acted upon, and it may contain errors and/or omissions. Always seek legal advice from an attorney. Spence Attorneys will not be held liable for any person acting and/or failing to act on the information contained herein.
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