Drafting a purchase contract

After you and the seller have agreed on a price for the business and what the price covers, you'll usually draw up a contract to give legal force to your agreement. A written contract ensures that both parties clearly understand what each is agreeing to provide, for what cost and for what method of payment.

You should consult a legal adviser and accountant for advice on the tax and legal implications the transaction has for you.

Types of purchase contracts

There are basically 2 types of contracts:

  • purchase contract for the assets of a business (i.e. you purchase only specific assets that the business currently owns)
  • purchase contract for shares in the business (i.e. you purchase all the shares in the business and, so, take over all its assets and liabilities).

Before deciding whether to buy shares or assets consider the following:

  • When you buy assets, it is relatively easy to establish whether the assets are unencumbered and that you are not inheriting any potential liabilities that may be associated with the sellers past history (e.g. pending legal action, tax disputes, overdue creditors)
  • When you buy shares in an existing company, you are exposed to all outstanding claims against the company in which you will own equity. Even if the seller agrees to provide legal indemnities, you may be exposed to unexpected claims.

Make sure you seek professional advice before you sign the contract.

What to include in the purchase contract

Price

This will usually be a break-up of the purchase price, allocating specific amounts to goodwill, plant, equipment, stock, etc. You should seek accounting advice regarding allocations of assets, as this has serious taxation implications.

You should determine exactly what aspects of the business you're interested in buying. For example, the business manufactures an item and sells it in a store. You'd need to determine if you want to buy both parts of the business.

Type of purchase

You need to determine if you want to make an offer for the business's assets, its shares, or both.

Payment method

What you will pay, how and when.

Seller's involvement after purchase

This might include providing you with training so you can continue operations in a seamless manner.

Restraint of trade covenant

This protects you from loss of business through the seller's opening of a competing business within a reasonable proximity.

Any other conditions

This might include the things you and the seller each agree to do before settlement, and arrangements for current employees.

In addition to the basics of price and purchase, contracts should address contingencies such as:

  • whether the purchase is subject to finance approval by a bank or other financial institution
  • your defaulting on instalment payments
  • the seller providing inaccurate or false financial information
  • the seller having more liabilities than were known at the time of purchase
  • the seller not owning some of the claimed assets
  • material changes in the business occurring before the transaction is closed
  • the seller opening a competing business in a location too close to the business they've just sold you.

Most of these provisions work to protect you, the buyer, since the seller knows what they're selling and the amount to be received. You'll want to limit your risks as much as the seller is prepared to allow.