Buying a small business?

Many people decide to purchase a small business as a going concern, be it a pub, bed and breakfast, cafe, or something a little more unique.  You might already have a lot of experience in how to run the particular business (or, at the very least, bags of enthusiasm) but the legal process to acquire that business can sometimes be a little daunting.  We understand this is an exciting time but it is vital that you consider all of the financial and practical implications before you commit, as getting it wrong will have an impact on you personally.

This note is intended as a general overview of the legal process in buying a small business and considers some of the main points your solicitor will discuss with you.  A good solicitor will not only guide you through the various procedural steps but will work with you to understand what is important to you and your business and tailor their advice to your needs.

Initial instructions to your solicitor 

It is important that you feel comfortable talking through any concerns or queries you have with your solicitor and it advisable to speak to them about these before you make a commitment to proceed. At Crombie Wilkinson we are happy to have an initial discussion without any obligation for you to instruct us to act on your behalf.

Once you have instructed a solicitor to act on your behalf in buying a small business, there are certain procedures they will need to comply with to open their file and act on your behalf. These include:

•  You supplying evidence of your identity (to comply with money laundering regulations) and confirming whether you are buying the business in your individual name, a company name or through another vehicle (such as a partnership);
•  Your confirmation as to where the funds for your purchase will be coming from (e.g. savings, from a family member or a loan from a bank);
•  Providing monies on account to cover the cost of third party charges we may need to incur on your behalf.  These are known as disbursements.

Your solicitor will write to you outlining their terms and conditions of business, including details as to their charges. In small business transactions an estimate of costs rather than a fixed quote is usually supplied and the solicitor will normally charge for their time spent by reference to an hourly charging rate.  In certain circumstances your solicitor may be willing to provide a fixed quote for their costs, so it is always worth discussing this with them first.

At this point, your solicitor will take some detailed instructions from you and make contact with the solicitor acting for the seller.  If there is an agent involved, they will collate some of this information in a document known as Heads of Terms.  This will assist your solicitor, and the seller’s solicitor, when preparing a first draft of the agreement.

Due Diligence

Due diligence is the process of finding out key information about the business you are buying.  This exercise will help you to determine whether the business you agreed to buy is as you expected, and, perhaps more fundamentally, is worth the price you agreed to pay for it.  Due diligence can be an extensive exercise but your solicitor should work with you to find out what you already know about the business and what your other advisers (accountants, tax advisers etc) will be assessing, to avoid duplicating any enquiries.  Your solicitor will prepare a due diligence questionnaire to send to the seller’s solicitor, who will then work through the questions with the seller.  The answers provided will determine whether further enquiries need to be raised.

Most small business transactions we see involve the transfer (or a lease) of a property as the main part of the transaction.  The property will normally be the business’s biggest asset and your solicitor will investigate the seller’s title to the property and raise enquiries.  More information about the extent of these investigations can be found in our guides “Buying or Leasing a Commercial Property” and “Guide to Entering into a Commercial Lease”.

Negotiating the Contractual Documents

While the information from the due diligence exercise is being collated, your solicitor will be negotiating an agreement (or contract) to record the terms of what has been agreed between the parties.  The agreement can be quite lengthy and covers a number of different areas, including the assets of the business which will be transferred to you, regulatory requirements, warranties about the business, restrictions on the seller after completion, indemnities and limitations of liability.

We have explained some of common areas covered in an asset purchase agreement below

Property

Most small businesses require some form of property from which to operate.  It is likely that you will either be buying the freehold of a property from the seller, or otherwise be taking a new lease from a landlord, or, more commonly, the transfer of the remainder of the term of an existing lease (known as an assignment).

The agreement will contain a section about the documentation necessary to transfer the interest in the property to you and your solicitor will be able to negotiate the contract terms and incorporate conditions which the Seller must fulfil, as appropriate.  More information on the property implications of a small business transaction are dealt with in our guides “Buying or Leasing a Commercial Property” and “Guide to Entering into a Commercial Lease”.

Goodwill

Goodwill is essentially the good name and reputation of the business.  It is what makes customers come back time and time again.  There are different types of goodwill, depending on whether it is attributable to certain individuals or simply to the location of the business, no matter who owns it.

The goodwill of the business is an important asset and you will need to ensure this is transferred to you.  This is normally dealt with by way of an assignment of goodwill but it will also be covered off in the agreement.

Goodwill can cause problems with the amount of stamp duty land tax (SDLT) payable, as HM Revenue and Customs require SDLT to be paid on the value of the goodwill, where it is attributable to the actual property, rather than being personal to the business.  Your solicitor will be able to consider this with your accountant.

Stock or work in progress

The purchase price agreed with the seller will often not include stock (or work in progress, if the business is a service industry, such as an accountancy practice).  Stock will change on a daily basis, as the seller continues to trade from the business, so the parties often agree to do a stock check as soon as possible after completion.

In a small business transaction, you might not feel it necessary to appoint an expert valuer to carry out the stock take and you may be prepared to agree a value with the seller directly.  It is important that you discuss this with your solicitor, who will be able to draft safeguards into the agreement in the event there is a dispute with the seller over the value of the stock.

Leased assets

Some small businesses, particularly those in the services industry, may have assets which the seller does not own outright, such as photocopiers.  The process of getting these transferred to you can be quite difficult, given the terms of the original finance or lease agreement with the seller, which will often prevent the goods from being transferred to another person.  Your solicitor will make enquiries of the seller and if there are any assets held on a lease, which are fundamental to the business, they will be able to advise you how best to ensure you are able to use these.

Employees

All businesses need people and employees’ rights are protected by law under what are commonly referred to as the “TUPE Regulations”.  The general rule is that all of the seller’s employees will be automatically transferred to you on completion.  The TUPE Regulations impose a number of requirements on both you and the seller and the consequences of ignoring these can be very costly, with heavy fines being imposed.

In a small business, this exercise is particularly important, as employees’ arrangements are not always formally recorded.  Your solicitor will be able to point out the risks and discuss the best ways to protect you in the agreement.

IT

Computers are an important part of day to day life and the vast majority of businesses now rely on computers to operate.  You need to ensure that any licences the seller has to use key software for the business are transferred to you, along with any rights to maintain and upgrade the software in future.

Even if the business does not have IT equipment and software, it will invariably have a simple website or Facebook page.  Your solicitor needs to ensure the agreement deals with the transfer of any domain names and passwords and that the seller is obliged to co-operate with you after completion.

Warranties and indemnities

This is an important section of the agreement.  A warranty is basically a statement made by the seller about the business, which, if it then turns out to be untrue, will entitle you to claim damages.  The warranties will cover the areas mentioned above, as well as more general statements about the business.  For example, you will want the seller to confirm that the business accounts have been prepared in accordance with generally accepted UK accounting principles and do not overstate the profits of the business and that the position has not changed between the date the accounts were provided and the date of completion.

Although the idea of seeking damages for a breach of warranty sounds appealing, the realities of enforcing a claim mean that buyers are often put off pursuing one, as they can be costly and involve a large investment of your time.  A good solicitor will discuss the warranties with you in detail and consider the likely consequences to you of a breach and whether you would want to pursue the seller for damages.  By adopting this approach, you will end up with a workable set of warranties and a much more adequate agreement while saving a good deal of time and stress in the process.

An indemnity is a very useful tool for a buyer to consider in the agreement.  It differs from a warranty in that it is a promise from the seller to reimburse you in respect of a particular type of liability, should it arise.  Indemnities are helpful but they do need to be drafted carefully, as any ambiguity could reduce their effectiveness.

Restrictions on seller

You will have invested a good deal of time, money and effort in buying your business, so you want to ensure the seller does not damage that business by setting up in competition with you and draw your customers and staff away.  We can advise you of the different levels of protection we can build into an agreement but, also, what is appropriate and is likely to be acceptable if it is ever challenged by the seller in court.

Limitations of liability on seller

Given the protections you will be seeking by including warranties, the seller will no doubt try to limit the circumstances in which you are able to claim against them by providing for this in the agreement.

Common ways of doing this include limiting their warranties by time, capping the level of their liability or having a minimum level of loss before you can make a claim.  The limits will depend on the circumstances of each transaction, the respective bargaining strengths of each party and the negotiating skills of the solicitors.  A good solicitor will be able to advise you on whether the proposed limits are acceptable in the particular circumstances, so it is important that you consider these.

Report on title and getting you signed up

Your solicitor will usually produce a report summarising the results of their investigations and enquiries to explain any problem areas identified and advise you of the contents of the proposed documentation.  They will also keep you up to date throughout the transaction.

Your solicitor will either arrange to meet with you to go through all the documents that you need to sign, or will send these to you with instructions as to how the documents should be signed.  Usually, at least one of the documents will require an independent person to act as a witness to your signature.

Exchange / Completion

Once the above points have been addressed and both parties are happy to proceed, your solicitor and the seller’s solicitor will be able to exchange and complete.  This might be done simultaneously but there could be a period of time between exchange and completion.  Exchange is the point at which you are contractually bound to proceed with the purchase on a particular date in the future.  If you do not, you will be in breach of contract and the seller will have a number of remedies against you.  Completion is the point at which legal ownership of the various assets you have agreed to buy in the agreement are formally transferred to you.

Post-Completion formalities 

After completion has taken place, your solicitor will deal with any post-completion formalities.  If your business purchase has involved the transfer of a property, or the grant of a lease, SDLT may be payable and your transaction might need to be registered with the Land Registry.  More information can be found in our guides “Buying or Leasing a Commercial Property” and “Guide to Entering into a Commercial Lease”.

For further information, contact Andrew Darnton, an associate solicitor in the commercial property team at Crombie Wilkinson:

Telephone: 01904 624185
E-mail: a.darnton@crombiewilkinson.co.uk