January 2011 - ON THE MOVE
ON THE MOVE - Deciding to purchase a business.
PUBLISHED QUAY LAW LEGAL ARTICLE by Ian Mellett (Quay Law NZ)
In this article, Auckland lawyer Ian Mellett of Quay Law NZ Barrister and Solicitors discusses some of the legal matters that you should consider when deciding to purchase a business.
The decision to purchase a business is both exciting and daunting. On the one hand it signifies the start of a new venture, yet on the other it raises the uncertainty and risk inherent in any commercial undertaking. You may also be unsure as to whether to buy an existing business or to start your own from scratch. Generally speaking when you buy an existing business, there should be existing customers from day one which will ensure an instant cash flow. However if you start from scratch, then you will need to generate new customers. Both approaches have their own hurdles that you will need to overcome, and particularly so in light of the tough economic climate currently prevailing. It is important that you engage your professional advisors at an early stage in the process. Your lawyer and accountant, along with a business broker if there is one involved, are well placed to give you the necessary input and advice to enable you to make an informed decision. There are various aspects which require careful consideration. Some of these are set out below:
It is preferable to use the standard Legal Areement for Sale and Purchase of a Business which has been compiled, and amended over the years, by the forms committee of the Auckland District Law Society. The agreement, much like its counterpart for residential and commercial property transactions, is designed to cater for the needs of both the vendor and the purchaser. Always ask your lawyer to cast his eye over the agreement before you sign the document. There are a number of things that need to be considered, including the names of the vendor and purchaser; what is being sold; the price; terms of payment; warranties by the vendor; conditions such as the obtaining of suitable finance, solicitor’s approval (if appropriate) and due diligence; possible restraints of trade and all issues relating to existing employee contracts.
It is recommended that the purchaser be reflected as (name)….. “and/or nominee.” This will give you the opportunity to discuss the most appropriate purchasing entity with your lawyer and accountant. Issues such as limited liability protection, tax, succession planning and the like, all need to be considered prior to settlement. There are various options, including but not limited to sole proprietorship; partnership; limited liability company and trading trusts. I will discuss the advantages and disadvantages of these entities in an article sometime in the new year.
This is the most important aspect of any business purchase, as it provides you with an opportunity to perform an in-depth analysis across the entire spectrum of the business. Your accountant will be able to assist you in inspecting the financial statements for the past 3-5 years (this will vary from business to business) in order to judge the “financial health” of the business, and to raise any concerns or request further information if necessary. Your lawyer will be able to assist you with all the legal aspects of the due diligence process. These include, but are not limited to, reviewing all lease and/or licensing agreements; patents and copyright (if any); stock valuations, and evidence of ownership of equipment and assets (and whether these are unencumbered or not). He will also ascertain what is being sold namely the business and its assets, or the shares. The last issue is extremely important, as it will determine how certain aspects of the purchase need to be dealt with from a taxation perspective. Generally, due diligence only needs to be done once you have signed the Agreement. However, in practice, much of this work is often done in finding out about the business and in determining what amount to offer. Now you will need to decide! Due to space constraints, I have only briefly touched on some of the more significant aspects which you need to consider when purchasing a business. My recommendation is that you consult your lawyer (and accountant) early in the process to ensure that the proposed transaction proceeds smoothly. There is a cost associated with obtaining professional advice, but it is my experience that this will be far cheaper than the cost of getting it wrong.
ON THE MOVE - Legal entities to consider when buying a business in NZ
PUBLISHED QUAY LAW LEGAL ARTICLE by Ian Mellett (Quay Law NZ)
In this legal article, Auckland lawyer Ian Mellett reviews the various legal entities that are available to you when deciding upon the appropriate operating structure for your New Zealand business.
In a previous published article, I discussed the matters that should be considered when deciding to purchase a NZ business. A key aspect in this process is necessarily the choice of the most appropriate purchasing entity. It is important that you obtain the requisite advice from both your lawyer and accountant, as they will be in a position to explain issues such as limited liability protection, tax and succession planning to facilitate an informed decision being made.
There are four main entities that are predominantly used to operate businesses in New Zealand, namely the sole proprietorship, partnership, limited liability company and trading trust. Each of these is discussed briefly below.
Also known as a sole trader, this is a type of business entity that is owned and operated by one individual on his or her own. The key characteristic is that the owner is inseparable from the business, in other words there is no legal distinction between the owner and the business. The owner controls, manages and owns the business, is entitled to all the profits but is also personally liable for all losses, debts and taxes. A sole trader is usually able to establish the business without following any formal or legal process and can employ other people to assist in running the business.
The obvious advantage of a sole proprietorship is that it is easy to start and run, and there is no requirement regarding registration. The major disadvantage is that the business owner/s has unlimited personal liability for all business obligations (including amongst others debts and taxes), which means that personal assets are potentially at risk. Sole traders also often lack credibility in the marketplace, and it is invariably more difficult to sell this type of business.
A partnership is an arrangement where individuals and/or entities agree to co-operate to advance their business interests. Most frequently, a partnership is formed between one or more businesses in which the partners (namely the owners) work collectively to achieve and share any profits or losses. It is recommended that the partnership be established by way of a formal partnership agreement. The partners share responsibility for running the business, share in any profits or losses as stated in the partnership agreement and are liable for any debt within the partnership. The partnership itself does not pay income tax, but instead distributes the partnership income proportionately to the partners who then pay tax on their own respective shares.
The main advantages of a partnership are that no registration is required to commence business, and this entity can provide an effective way to share business operation costs. The disadvantages are that partners may be held liable for debts incurred by the other partners, personal assets are potentially at risk and complications may arise if a partner dies or wishes to leave the partnership.
Limited Liability Company
This entity is by far the most popular and successful form of business structure. A company is a formal and legal entity in its own right, being separate from its shareholders or owners. The protection that a limited liability company affords to its shareholders is the primary reason for selecting this type of operating entity. If the company is unable to pay its debts, the shareholders are not liable for the business debts of the company unless their shares are not fully paid up, or they have given personal guarantees to lenders or creditors, or they are also directors of the company and have traded recklessly. This situation should be contrasted with a sole proprietor or partner who will always be exposed and personally liable for any business debts that cannot be met by the business.
The advantages of a limited liability company are continuity of existence (a company will continue to exist until it is removed from the Companies Office register), transferability of shares (making it easier to sell a company or pass on to others such as children) and marketplace credibility. The disadvantages are that directors need to clearly understand their responsibilities under the companies legislation, and the fact that the limited liability protection can easily be eroded in practice by the requirement to provide personal guarantees to certain lenders or creditors.
Until relatively recently, the choice of business structures in New Zealand was generally limited to the entities discussed above. However, trading trusts have increased in popularity over the last ten to fifteen years and have now emerged as an alternative option to owning and operating a business. Essentially a trading trust is a discretionary trust similar to a family trust, but instead of merely holding investment assets it actively carries on a business and derives business profits.
One of the key advantages of using a trading trust is the flexibility that it provides, particularly with regard to the allocation of business profits to the beneficiaries of the trading trust. Trading trusts are, however, a topic on their own, and I would suggest that anyone interested in utilising this type of business vehicle contact our offices to obtain more detailed information.
It goes without saying that it is critical to “get the structure right upfront”. This is also particularly important in light of the Inland Revenue Department’s stance that a change in operating entity “downstream” has occurred not for commercial but rather for tax (and possible tax avoidance) reasons.
Remuera Lawyers - Quay Law, Level 1, 427 Remuera Road, Remuera, Auckland.