Buying a business: the basics of due diligence

Check what you are buying before committing

Due diligence means independently checking the business, its records and the risks of the proposed purchase. It helps you decide whether to proceed and what conditions, price adjustments or protections to negotiate. It does not guarantee that every problem will be discovered.

The Australian Government's guide to buying an existing business recommends reviewing financial records, business operations and legal documents before signing the contract. Get advice before signing a heads of agreement or paying a deposit too: preliminary documents may contain binding obligations.

An asset purchase is different from a share purchase

In an asset purchase, the agreement identifies the assets being acquired and liabilities being assumed. Contracts, licences and the lease may require consent, assignment or replacement. Statutory obligations may still apply even if the contract says that the seller retains a liability.

In a share purchase, the company continues to own its business and remains responsible for its liabilities. Buying its shares therefore requires investigation of the company's history as well as its current trading position. Change-of-control clauses can still require consent even though the contracting company stays the same.

A practical checklist

• Financial position: ask your accountant to reconcile tax returns, BAS, profit and loss statements, cash flow, debts and sales records. Distinguish recurring earnings from one-off income and test the assumptions behind forecasts.
• Assets and security: identify the owner of stock, equipment, intellectual property and other assets. Check whether equipment is leased or financed and whether security interests are registered on the Personal Property Securities Register. Agree how relevant securities will be released at completion; a search alone does not discharge them.
• Contracts and premises: review key customer and supplier contracts, termination rights, lease expiry, options, rent reviews, permitted use, make-good obligations and required consents. Do not assume an option or a licence transfers automatically.
• Operations and compliance: check licences, permits, insurance, disputes, consumer warranty obligations and ownership or permitted use of brands, websites and business records. Consider privacy obligations before exchanging customer or employee information.
• Employees: check contracts, applicable awards or agreements, pay records, accrued entitlements and any underpayment concerns.

These checks build on the government's buying-a-business guide. The scope should match the deal and industry rather than rely on a generic checklist alone.

Employee entitlements need separate attention

Where the Fair Work Act transfer-of-business rules apply, the new employer generally has to recognise prior service for many entitlements. Exceptions and special rules differ between entitlements, and whether the employers are associated entities can matter. The Fair Work Ombudsman's transfer-of-business guidance explains the treatment of leave, redundancy and notice.

Do not treat a negotiated adjustment between buyer and seller as a substitute for meeting employees' legal entitlements. Have the transfer rules, any continuing industrial instrument and applicable long-service-leave law checked for the workforce concerned.

Turn findings into contract terms

If a problem is identified, options may include further enquiries, changing the price, requiring a consent or release before completion, or negotiating warranties and indemnities. Their value depends on their wording, limits and the seller's ability to meet a claim. A buyer should not assume they can walk away after signing unless the contract or law gives that right.

Allow sufficient time for advisers to review the documents and confirm what must happen before completion. Finance, tax, lease and employee issues should be considered together.

This article provides general information about Australian law, with a NSW focus where indicated. It is not legal or tax advice and does not take your circumstances into account. Obtain advice about your own situation before acting.