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Are you selling a business? Do not misrepresent your takings!

The recent case of Shah v Hagemarad [2018] FCA 19 has been a timely reminder that the Court can overlook a Contract in circumstances where it is found that the Vendor has provided false or misleading information about the financial position of business

The Facts

In a nutshell, the Vendor misrepresented the sales of their business in order to achieve a higher sale price and the Purchaser issued proceedings in the Federal Court on the basis that the Vendor had engaged in misleading and deceptive conduct in order to induce the Purchaser to buy the business.

In this particular case, The Vendor was selling his Subway franchise and as usual practice, the Vendor provided the Purchaser with several documents in relation to the turnover of the business – including average weekly and monthly sales. The Purchaser sought to undergo a trial period, whereby he monitored the takings of the business for a two day period in order to ascertain if the business was, in fact, making $15,000-$16,000 per week as demonstrated in the paperwork provided to the Purchaser.

The Purchaser alleged to the Court that he had relied upon the documentation provided by the Vendor and that the Vendor had fabricated a large number of fake sales during the trial period in order to receive a higher sale price for the business. The Purchaser argued that had he known the true figures of the business he would have never agreed to the sale price of $460,000.

The Vendor sought to rely on several clauses of the Contact that were directed at protecting the Vendor against being sued by the Purchaser. These clauses are fairly standard in most Contract of Sale of Businesses and basically state that the Purchaser enters into the transaction solely as a result of their own due diligence and that the Purchaser cannot rely on any representation about the business.

Despite the protective terms of the Contact, the Federal Court found that the Vendor sold the business when it was having poor trading performance and cash flow problems and the Court concluded that the Vendor:

· ought to have known that the documents containing the figures were relied upon by the Purchaser in purchasing the business; and

· had created “fake sales” during the trial period to inflate the sale price and that this was as a misrepresentation.

The sale price of the business is generally ascertained from the takings and on the basis of the business making $15,000 to $16,000 per week, the price of $460,000 was achieved. As the business did not take this weekly amount, the actual value of the business was significantly lower and the Vendor was ordered to pay the Purchaser $300,000 which was the difference between the purchase price of the business ($460,000) and the true value of the business ($160,000).

The case is a warning to prospective Purchaser’s that they should test and verify the accuracy of the documentation provided by the Vendor. A trial period – which is a period of time whereby the Purchaser attends the business premises to monitor the takings of the business is usually the best way for a Purchaser to test out the takings of the business. In this case, the Purchaser only had a two day trial period – it may be prudent to have at least a 7 day period.

This case also serves as a timely reminder that it is essential for the Vendor to provide correct and accurate documents to a purchaser and to consult with the appropriate professionals – selling agent, accountant, and lawyer in order to avoid any issues post-sale and settlement.

Selling Agent

It is vital to consult with an appropriately qualified selling agent, otherwise known as a business broker to assist in the sale of your business. Generally, the selling agent will meet with you, seek a copy of all relevant documentation such as profit and loss, financials and lease documentation and then provide an estimate of price.

Although there are several formulas you can utilise, there is no black and white answer to valuation techniques. The most commonly used methods are;

i) Asset Valuation;

ii) Capitalised Future Earnings;

iii) Earnings Multiple; and

iv) Comparable Sales.

If the business is no longer profitable, and there seems to be no indication of profit to be made in the future, selling or closing your business may be the best option and a good selling agent will advise you accordingly.

The selling agent will negotiate the terms and conditions of the transaction between the Vendor and the prospective Purchaser and once they’re in an agreement in principle, the selling agent will seek that the parties sign a Heads of Agreement. The Heads of Agreement are then converted into a Contract of Sale of Business.

Lawyer

A lawyer converts the Heads of Agreement into a Contract of Sale of Business, often elaborating and refining the agreement in principle. It is prudent that you obtain the legal assistance of a lawyer who specialises in this area as a sale of business touches on various areas of law – employment, leasing and commercial law and numerous acts of legislation both State-based and Federal such as, Estate Agents Act 1980, Retail Leases Act 2003, Competition and Consumer Act 2010 (Cth) and the Corporations Act 2001.

A most common and vital piece of advice is do not attempt to prepare the contract yourself!

The lawyer will also facilitate the sale by assisting with the transfer of the lease, any licenses, and permits as well as the business name.

Accountant

If your business is to sell under $450,000, your Accountant must complete and provide a

section 52 Statement by a vendor of a small business. The statement provides accounting

information about:

a) the trading of the business for the current accounting period (year to date figures); and

a) the trading of the business for the previous two accounting periods, unless the vendor has not owned the business for that long; and

b) Must include a statement by a practising accountant that the information is in accordance with the vendor’s books of account.

It is mandatory to provide the Section 52 Statement prior to any offer being made on your business.

The accountant will also provide you with important tax advice – is the sale of business a Capital Gains Tax (CGT) event? Does Good and Services Tax (GST) apply to your sale?

Selling a business is an exciting time, but making sure you get the right professional team around you is imperative!

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. If you have any additional queries in relation to law matters and selling your business, Argent Law is able to help you.

The article was written in collaboration with Argent Law, a law firm based in Melbourne.

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