If you’re looking to purchase a small business for the first time, you’ll likely have many questions about all aspects of the proposed transaction. This is only natural since purchasing another business is very different to setting up your own business or working for yourself.
It’s impossible to know every business detail before you purchase it; much of the finer details will be discovered following your purchase.
However, by highlighting and isolating the most pertinent areas and building your due diligence around them, your risks are minimised as much as reasonably possible.
With this in mind, in this piece, we will look at the top five considerations as part of your due diligence when buying a small business.
Is it best to buy the business as a share or an asset purchase?
When a business trades as a company and you have targeted it for acquisition, one of the key early points to consider is whether you will be buying the shares in the company (i.e. the ‘lock, stock and barrel’ approach) or merely the assets of the company (i.e. the goodwill and equipment etc.).
The former is known as a ‘share purchase’, and the latter is known as an ‘asset purchase’.
The decision is critical for tax reasons as;
- When buying the shares in the company, you inherit its tax liabilities since you are purchasing the whole corporate entity, whereas generally, when buying only its assets, you do not.
You will also inherit all its other liabilities. In other words, you buy the whole thing ‘warts and all’ when buying as a share purchase.
- When buying as an asset purchase, you can cherry-pick the most valuable assets and leave behind those that are not.
As you might well imagine, as a very rough rule of thumb, asset purchases are often favoured by buyers, and sellers often favour share sales. The final decision will be reached by negotiation and, no doubt, the results of your due diligence.
What is the situation with their employees, and will TUPE apply?
You must know all the key details about all the business’s employees and have copies of their employment contracts etc.
Before deciding to proceed, you will need to know the salaries (and any bonuses and commissions payable), service periods, pension arrangements and any ongoing grievances and disciplinaries.
The reason for this is that generally when buying a business, you will inherit all the existing employees of that business under a piece of legislation known as the Transfer of Undertakings (Protection of Employment) Regulations 2006 (‘TUPE’).
When inheriting the employees under TUPE, you inherit all their employment rights and liabilities, and their period of continuous service is protected.
Further, any dismissal that is made in connection with a TUPE transfer will automatically be deemed an unfair dismissal.
Does the business own its intellectual property rights?
Suppose a business relies on intellectual property for its continued development and success, such as a technology or software business. In that case, it’s understandably fundamental to its value proposition that it owns the relevant intellectual property rights upon which it relies.
If it does not, you will need to see that at least the business has valid IPR licenses and factor these circumstances into your valuation. If you need further guidance on IPR it’s best to seek the advice of an experienced intellectual property lawyer.
Is the business facing any litigation?
The last thing you want to happen when buying a business is to be immediately embroiled in expensive and time-consuming court battles.
You must fully have disclosed actual and pending litigation before signing on the dotted line. This disclosure will likely include the merits of the litigation, any professional opinions obtained, the potential value of the claim/s and any insurance coverage which may be available.
Will the trade contracts be affected by the sale?
If the business depends on the value and regularity of its trading contracts, you must check the benefit of these contracts will transfer along with the company.
This is just as important with a share purchase as it is with an asset purchase, as often such contracts include ‘change of control’ provisions which may affect the terms of the contract in the event of a share sale occurring.
Seek expert legal guidance
Purchasing a small business can be a complex and overwhelming process. Still, by considering these top five considerations as part of your due diligence, you can minimise risks and ensure a smoother transaction.
From deciding whether to buy the business as a share or an asset purchase to understanding the situation with the employees and the business’s intellectual property rights and checking for any litigation or trade contract issues, these are all crucial points to consider.
