When purchasing a business or rental property, proper due diligence is critical to ensuring a sound investment and avoiding unforeseen risks.
While the commercial and legal aspects of an acquisition are important, financial due diligence plays a crucial role in uncovering potential liabilities, assessing the true value of the asset, and structuring the transaction appropriately. Some considerations of many below:
Share Sale vs. Asset Sale – Broad-Level Differences
One of the most critical decisions when acquiring a business is whether to pursue a share sale or an asset sale. Each approach has distinct financial, legal, and tax implications and should be considered as it impacts the level of trading and historic risk you are inheriting with the purchase:
Share Sale: The buyer acquires the entire company, including its assets, liabilities, and contractual relationships and historic trading. This approach is necessary when contracts and licenses cannot be transferred. However, one of the key risks lies with what may have occurred in prior trading years.
This could be anything to agreements made with businesses, employer disputes and tax matters, etc (although there can be limited protections in the Sale & Purchase Agreement).
Asset Sale: The buyer purchases selected assets (eg, inventory, property, equipment, IP, customer contracts), typically leaving behind the seller’s liabilities. This approach offers flexibility but requires careful consideration of how to transition essential agreements and contracts.
This is the most common form of purchase/sale as this limits the prior trading risks and doesn’t assume all liabilities of the business. Each transaction must be structured with careful attention to purchase price allocation, tax consequences, and the impact on employees and customers.
Common Due Diligence Issues in Recent Transactions
Commercial Rent Arrangements: In business acquisitions, lease agreements often form a significant component of the expenses and future liability. Understanding the lease structure, rent review dates, and termination clauses is essential.
We have seen examples where the rent charged was low, due to the fact the property was held in a related parties trust or company – once the business was then purchased, the rent would likely increase to true market value.
Agreements and Contracts: Many business operations rely on key contracts, such as supply agreements or government contracts. Some agreements cannot be assigned, meaning a share sale (instead of an asset sale) may be the only viable transaction structure to retain the benefits of those contracts.
Examples we have seen included a business that had government contracts and therefore a share sale was required so the contracts could roll over correctly,
Other Income: Sellers may present financial statements that reflect one off or non-recurring income, it is crucial to understand what income is likely to recurring so you have an accurate picture of expected turnover and profit levels.
Key Supplier and Customer Dependence: Some businesses heavily rely on a single supplier or client. If a key relationship ends post-sale, the business’s viability may be at risk.
Restrictions on Lease Transfer: Business premises are often essential, but some commercial landlords impose strict assignment clauses, requiring new lease negotiations that may lead to increased rent or stricter terms.
Professional advice from accountants, lawyers, and tax specialists is indispensable in navigating the complexities of an acquisition. By taking a structured and detail-oriented approach, buyers can avoid costly mistakes.
Disclaimer – While all care has been taken, Johnston Associates Chartered Accountants Ltd and its staff accept no liability for the content of this article; always see your professional advisor before taking any action that you are unsure about.
JOHNSTON ASSOCIATES, Level 1, One Jervois Road, Ponsonby, T: 09 361 6701, www.johnstonassociates.co.nz
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