There are many advantages to buying a small business instead of starting your own. It removes the greatest period of risk, and means you can walk straight into a potentially high functioning enterprise and hit the ground running.

The only real concern is that you might not be buying what you think you are. The sale of a business can be a complicated process, and could leave you with less than you thought you were paying for. The following is a handful of crucial things to consider before you sign the papers.

What do you know?

Making your after-hours hobby into a full-time occupation may be an appealing idea, but make sure you’re not about to buy a business that you are not qualified to run.

“You might dream of owning a car retailer, but have you ever sold anything? Have you got any selling skills?,” asks Graham Long, chair of the valuers chapter of the Australian Institute of Business Brokers. “Look at your own personal knowledge and skills and capabilities, because that will govern what sort of business you go and look at.”

Have you got the cash?

Similarly, it’s essential to make sure you can you actually afford to run the business you want to buy, and still maintain the cost of your desired lifestyle.

“You need to look at your own financial position and cash flow requirements,” says Long. “Obviously, the moving expenses, education, mortgages, loans, paying for utilities, and all those sorts of things [need to be considered]. What do you need to live off?”

These considerations also factor in to how much money you’re able to borrow to finance the purchase.

“That’s an important one these days, because financial institutions are not [generally] lending for businesses,” admonishes Long. “As I understand it now, a financial institution will want a clear demonstration of your ability and whether or not you’ve got the capacity to service the cash flow requirements [before they lend to you].”

Another potential trap is to think you can just afford to buy the business and keep it operating, when, in fact, your cash flow is actually going to fall short.

“Put a budget in place, and make sure your funding budget is adequate, because it will always cost more than you thought it would cost,” says Craig Devlin, a director of Devlin & Co, an accountancy and business advisory. “If you end up with enough money to buy the business and think you’ve got enough in working capital for the first three months, and you don’t, then you put the whole investment at risk. You should always have more cash than you think you need to fund it.”

Make the contract explicit

It may sound like a no-brainer, but it’s worth being especially pedantic about what the contract actually means. Take nothing at face value; if you’re concerned about the meaning of a clause, then enquire about it.

“The best time to have an argument with your purchaser is before any money changes hands,” advises Devlin. “Clarify everything. Ask questions. Do your due diligence. Make sure that you know exactly what you’re doing. Even with the best intentions, people can get the wrong idea about things.”

He brings up the analogy of the agreement drawn up by a group of American entrepreneurs and Dame Joan Sutherland over a performance at Carnegie Hall. The contract specified that her fee was $100,000, but when it came time for the bill to be settled, a dispute arose over whether the amount was to be in American or Australian dollars. The contract had specified neither, but both party had assumed that it would be in their favour.

Document everything

This analogy leads into the vital need to make sure every part of the agreement is clearly and unequivocally written out in the contract.

“If it’s not written down, it doesn’t mean anything,” says Devlin. “Clarify the terms in the contract. If the vendor tells you something and you’re relying on it, write it down, and get it signed off.”

This is especially important when it comes to verbal discussions over the conditions of sale. They might promise you a lot, but if it’s not written down, it shouldn’t factor into the price.

“[A conversation is] not what’s written down, it’s not what you signed, it’s not what the contract says,” says Devlin. “There’s a lot of effort that should be taken in documenting it and getting it written down.”

Customer and supplier longevity

One detail that is especially worth delving into is whether all the supplier and customer contracts will carry over with the sale. Sometimes, businesses have special arrangements with suppliers and customers that simply can’t be sold on.

“They might have a wonderful contract with a customer that can’t be assigned to a new purchaser, or the customer might have a veto right, or the right to void the contract if there’s been a change in control of the company,” warns Devlin. “It’s very important to make sure that the business that you’re buying can continue on.”

What are you buying?

For tax purposes, it matters a great deal what form of entity the business is set up as. Is it a company or a trust?

“In small business, you generally don’t want to buy a company, because the capital gains tax concessions that are within a company are quite substantial compared to the concessions that are in a trust,” says Devlin.

He explains that purchasing a company, in whole or in part, means that the purchaser is susceptible to the possibility of being saddled with a substantial capital gains tax bill. Another issue is that, as the new owner of a company, you are now susceptible for all of its past tax payments. If an audit turns up an inconsistency that happened years before you owned the business, it’s still your problem.

Often, the purchase of a business as a company is unavoidable. Devlin goes on to explain that the way to deal with the accompanying issues is to insist on the inclusion of conditions, or warranties, in the contract.

“You would have the outgoing vendor and the directors guarantee individually and collectively that there’s no tax issues, and those warranties would stay for seven years,” he says. “If a tax issue came up later on, then you would have a fallback to those people. Typically what you would do is you’d put a sum of money in escrow. You might insist they put several hundred thousand dollars in for five years, and then halve that for the remaining two, so if something crops up, you’ve got access to funds, and if at the end of the time nothing’s cropped up, those funds go back to the vendor.”

The purchase of a company that’s formed as a trust carries less potential tax liability with it.

“Effectively, if you were in a trust, your effective tax rate on the re-sale could be between 0-16%. The effective tax rate if you sold the business as a company could be 46%. Have you got the right entity to buy? Have you checked to see whether a trust, a company, or a unit trust is most appropriate? It does vary, and you need to make sure that you’ve got the right entity in which you operate.”

Retention allowance

A similar approach can be taken to any guarantees of income that the seller is touting in order to make the proposition of buying their business more attractive. A portion of their turnover might depend solely on a specialised skill that the current business owner has, and can’t sell on. This poses a problem, as either party could be genuinely unaware of this discrepancy at the moment of sale. This is where retention allowances come in handy.

If the business owner claims the business collects $500,000 in fees every year, the purchaser can propose a retention clause that entails they only pay 80% of the price up front, and the final 20% when they do, in fact, end up collecting the advertised amount in fees.

“Typically what you do is put that retention in a solicitor’s trust account, or something like that,” says Devlin. “If the conditions are fulfilled, then the money’s theirs. If the conditions aren’t fulfilled, it goes back to the purchaser.”

Are the staff on board?

This may seem like a small detail, but it’s an important one. Staff, especially those that have been with the business a long time, can prove to be a significant asset, and should be considered as such when a business is bought.

“Human resources are your most important intellectual capital, so interview the staff.  You’re going to want to know if they want to stay, if they’ll sign contracts – all those sorts of things,” says Devlin. “You need to make sure you’ve got a business that will continue on.”

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