How to maximise goodwill when purchasing a business
In order to get the full benefit of the “goodwill” in the business you are purchasing, you should make sure all productive contracts of the business are transferred to you
The “goodwill” of a business is made up of many things including its current contractual arrangements. By way of examples; if the location of a café is important to its ongoing success, then the right to occupy that location is important, and therefore as part of the purchase you would want to ensure you have the right to occupy that location which is usually done by affecting an assignment/transfer of the lease of the premises to you (or your nominated entity); and, if the continued supply of a particular coffee bean is important to the café’s ongoing success, then as part of the purchase you would want to ensure you will receive adequate supplies of that coffee bean ongoing.
How do you place yourself in the best position to receive the benefit of the contractual arrangements?
The first step in the process is to undertake a thorough “due diligence” to identify what is driving the business’s goodwill. Once you have identified those drivers, it’s a simple matter of asking questions of the business’s current owner, as to whether those drivers of the subject of written contractual arrangements. If we were acting for you, we would write a letter to the business’s owner, or their lawyer, in expectation of receiving a written response which we can rely upon in the future if need be.
If any driver is not the subject of a written agreement, then you will know that if this driver is important to you, you need to secure your ongoing right to it by way of a written contract, including terms securing that right.
For any of the drivers that already are the subject of a written agreement, you need to then consider whether the ongoing rights are sufficient to protect the Business’s goodwill for a reasonable period of time. I.e., if the ongoing right is for three months only, that wouldn’t be satisfactory to me. I would want the ongoing right for a longer period than that…in some instances for a number of years. If the terms of the contract are acceptable to you, then arrangement should be made to transfer the contract to you (or your nominated entity). If the terms of the contract are not acceptable to you, then you should negotiate a new agreement with the supplier on terms acceptable to you.
If your “due diligence” is undertaken properly, it should also reveal if the business’s owner is operating the business by use of inter-entity licenses. This is a common practice used by business owners, and often a sensible strategy for taxation and asset protection purposes. The usual approach is for a separate entity to the entity that owns the business, to own the assets used in operating the business, and for that entity to license the use of those assets to the entity that owns the business. If you purchase the business, without the right, to use the assets required to operate it, essentially you will have purchased a “white elephant”.
This structure may be something that you choose to use when operating your business, but you do not want to fall victim to it when purchasing a business. The risk for a purchaser is that the purchaser fails to identify the existence of any such license and purchases are business with no right to use the assets of the business. The key to avoiding that risk is the undertaking of an effective “due diligence”.
If you are buying an existing business, you need to make sure that all necessary business contracts and arrangements are entered into or transferred prior to settlement, otherwise you may be unable to run the business as productively as you would like!
Regardless of the type of business there are usually a number of contracts or arrangements in place which are vital to the operation of that business. This could include a lease of the premises that the business operates out of or an arrangement with a supplier.
The more “obvious” agreements, like the lease, are unlikely to be forgotten when the business is being sold because it is crucial that the new owner has somewhere to operate the business from. This is relevant whether you are purchasing an existing business or starting a new business.
However, it is much easier to overlook some of the “smaller” agreements that more so operate in the background, but depending on the type of business there can be any number of agreements or arrangements which all work together in the running of the business.
For example, if you are purchasing a café you would need to consider whether there are any existing agreements with coffee or food suppliers, because if you purchase a café without discussing these agreements with the existing owner and having the agreements transferred to you (if appropriate) then you could find yourself trying to run a café without food or coffee on day one.
Similarly, we sometimes find that some people have their business structured in a way where the actual business owner does not own the equipment that is used to operate the business but rather they hire the equipment from another entity.
We usually find that the business owner and the equipment owner are related entities and they simply have their business structured in this way for tax reasons, however it is still important to make sure you obtain information about all of these arrangements to make sure you are actually buying everything you need to run the business.
If you are considering purchasing a business, it is a good idea to engage a lawyer to provide you with advice and act on your behalf in relation to the purchaser to ensure that all of the necessary enquiries are made so that you can purchase the whole of the business. Contact Turnbull Hill Lawyers for expert assistance with any business sale or purchase.