It is a sad fact that nearly 50.00% of businesses fail within 4 years of being established.
Likewise, insolvency experts estimate that about the same percentage of acquired businesses are no longer operating under the acquiring ownership structure within 4 years of acquisition.
Why is it so?
From my long experience as a commercial lawyer (who has previously held senior leadership positions in industrial and service companies) much of the reason for the existence of these sad percentages is attributable to the business owners not having invested sufficient capital (cash!) in “de-risking” their investment in the time prior to making the investment.
This lack of attention to “de-risking” is illustrated by a “she’ll be right mate” approach or the “wish becoming the thought” on the part of the business owner, that is “we wish we didn’t have to invest in properly de-risking; therefore, we think we don’t have to.”
In other words, these business owners are not prepared to recognize how they should go about things and to ensure that they have adequate upfront cash to pay for the “things.”
The purpose of this article is to explain the “things” that can and should be done (at the cash cost to the business owner) to ensure that their investment is de-risked as much as possible.
I have set out what I consider to be the Top 5 “things” for action and payment, whether a new business is being established or a business is being purchased. They are remarkably similar.
| No | “The Thing” | Business Establishment | Business Purchase |
| 1 | DUE DILIGENCE | ||
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i. Market Research: pay a market researcher to investigate the saleability of the product/s to be sold/being sold |
Yes. | Perhaps. | |
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ii. Business Analysis: pay your accountant to prepare a business case (projected cash flow, showing how much you will have to borrow and/or inject as equity; profit and loss and balance sheet); |
Yes. |
Yes. Also, review the client base; client lists; sales contracts (do they allow for change of control in the business) and how all of these along with operating costs have been and will be converted into a cash profit. |
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iii. Intellectual Property (IP): pay your lawyer to advise on: a. how you will protect/maintain protection of IP put into the business /already in the business e.g. copyright; designs; trademarks; domain names etc; and b. will there be or are there any infringements of the IP of other parties? |
Yes. Also, can the IP be assigned to the business by the holder of the IP
|
Yes. Also, has the IP been properly assigned to the business AND are the employment contracts with business employees worded to have employee IP development vest in the business |
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iv. Charges against the business (PPSR registrations): pay your lawyer to conduct searches |
NA | The Seller will have to release these before you settle under the contract to pay for the business. | |
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v. Compliance Risk: pay an expert to advise on what rules and regulations you will have to comply with, for example: – Work Health and Safety Ø Will the operating equipment and systems comply? Ø Will there be or are there adequate operating policies and procedures? |
Yes. | Yes. | |
| 2. | THE RIGHT OPERATING STRUCTURE | ||
| Pay a tax accountant to advise you on what will be the best structure to minimise tax and optimise value creation and possible sale | Yes. | Yes. | |
| 3. | GOVERNANCE | ||
| Pay a lawyer to advise on the type of agreement appropriate to regulate the rights and responsibilities of the investors in the business , e.g. a shareholders’ agreement (covering who fills what roles; obligations to contribute future capital; buy out; death and TPD and insurance relating to this.) |
Yes. And do you want the documented right to control sale of an interest in, or the whole of, business? |
Yes. And do you want the documented right to control sale of an interest in, or the whole of, the business? |
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| 4. | INSURANCES | ||
| Speak to your broker about paying for the following insurances: key man life; directors and officers indemnity insurance; public liability; general and cyber. | Yes. | Yes. | |
| 5. | COMMERCIAL AGREEMENTS | ||
| Pay a lawyer to put in place /review employment agreements; commercial leases and other trading agreements which should comply with Australian Consumer Law and the rules of the ACCC. | Yes. |
Yes. And including the Business Sale Agreement and the pre-conditions to settlement e.g., satisfactory due diligence; obtaining finance; new lease/assignment of leases over property and equipment; and releases of PPSRs. |
From reading this table, it should be obvious that there are significant costs involved in properly de-risking both the establishment of a business and the purchase of a business.
Before going too far down the track, investors should speak to the advisers mentioned in the Top 5 and prepare a budget on what the cash cost will be to them up front and treat this as a front-end investment and ensure that they can fund it all.
If your “wish” is that you should pay for proper de-risking of your investment then it will “become your thought” to action.
After all, the upfront cost of properly de-risking is akin to insurance against catastrophic financial loss, along with the fact that, in those circumstances, investors will almost certainly have their personal guarantees for financing and leases and other matters called in: there goes the house!
For an obligation free discussion please call
Jim Wilson- senior solicitor
Owner, Better Business Lawyers- Gold Coast/Tweed
M: 0415 645121
E: jim@bblawyers.biz