In our experience, the risks associated with business purchases fall into three categories:
- People
- Customers, suppliers and market dynamics
- The value exchange.
In this blog we're going to examine how to manage the 'people risks' of a purchase.
Beware the loss of key employees
There are some common risks associated with business purchases, particularly in small to middle-sized businesses that are substantially dependent on an owner or a few senior employees for their success.
Two things can happen if those personnel aren’t retained in the business in an active way:
- the business’ relationships with customers and suppliers may deteriorate; and
- the employees’ know-how and corporate knowledge will be lost.
Protect yourself in final contract – hard versus soft options
As part of the due diligence processes you need to identify the extent to which a business is reliant on individuals and protect against those risks in the final contract terms.
Here’s an example of how purchasers can use a ‘hard’ provision in the final contract to mitigate this risk:
A business you’re considering buying has very strong earnings, 20–25 employees, and is managed by a single director who founded the company 10 years ago. Relationships with key suppliers and customers are still heavily managed by that director.
A ‘hard’ provision in the final contract may require the vendor to agree to enter into a one-, two- or three-year full-time or part-time employment agreement, to stay with the business and share his or her expertise.
An alternative would be to make the sale conditional on some of the senior staff, such as the sales manager or operations manager, signing an employment contract and transferring as part of the sale.
Now here’s an example of how you could include ‘soft’ provisions to protect against ‘people’ risk:
While doing due diligence you find your potential business purchase is not heavily reliant on one individual, but you do want to tap into the corporate knowledge, expertise and relationships of the previous management or owner as a ‘sounding board’.
In that case, it’s common to have an agreed period post-completion and transfer that might see the manager or owner be on-hand for one week, one month or three months.
That’s usually on a complementary basis as part of the sale process, however anything outside an initial period may be on a paid consultancy basis.
Consider restraint of trade
It’s a competitive market and not all vendors are retiring and moving out of the industry.
Both the owners and senior people in the business can leave with a lot of knowledge and expertise that can be useful in a competitive environment, so it’s often wise to consider restraint of trade as part of the terms and conditions of any purchase contract.
Restraint of trade is a mechanism to prevent owners going into direct competition with the business post transfer.
It’s a difficult legal area and, as a purchaser, you’ll need to get some legal advice.
JPAbusiness offers a range of services for business buyers, including:
- Business finder services
- Valuations and market appraisals
- Custom due diligence
- Purchase negotiations support
- Transition and business planning support.
For more information about our services or for a confidential initial discussion with a member of our business advisory team, contact JPAbusiness on 02 6360 0360.
James Price has over 30 years' experience in providing strategic, commercial and financial advice to Australian and international business clients. James' blogs provide business advice for aspiring and current small to mid-sized business owners, operators and managers.