In brief - There are various methods of reducing risk when acquiring a business

The methods for reducing risk when buying a business include conducting due diligence to identify any potential problems, excluding particular assets and/or liabilities from the acquisition, obtaining warranties from the seller in relation to the business and obtaining indemnities from the seller in relation to specific liabilities.

Due diligence

Due diligence assesses the risks and opportunities associated with a proposed transaction and serves to confirm all material facts in relation to a sale. Generally, the purpose of due diligence in the context of an acquisition is to assist the buyer in assessing the level and nature of legal risk to be acquired. This information may have a large impact on the sale price and other terms of the sale agreement. Where problems are identified, these can be dealt with by excluding the relevant asset, obtaining an indemnity or reducing the sale price.

Due diligence will focus on the material commercial, financial and legal issues affecting the seller's business. The buyer and its financial, legal and other specialist advisers may prepare a due diligence report which is sometimes provided to the bank which is financing the deal.

Excluding certain assets and liabilities from the acquisition

To manage and minimise risk, a business sale agreement may typically include an exclusion of liability provision. By excluding certain assets from the acquisition, the buyer may avoid the possibility of becoming liable for any of the seller's undisclosed or unknown liabilities which are linked to those assets.

Warranties

Warranties are generally representations made by the seller about the business. A sale agreement will usually contain warranties relating to all of the assets being acquired.

The purpose of warranties is to:

  • Obtain information
  • Create a mechanism for adjusting the purchase price
  • Create a mechanism for sharing risk
  • Protect the buyer against undisclosed liabilities

Warranties are usually limited contractually by the seller and are qualified by information disclosed to the buyer. As well as limiting the number of warranties provided, the seller may seek to limit the time period and/or the dollar value of warranties.

Indemnities

Indemnities are intended to protect one party from a specific liability and to reimburse that party for a specific loss. Claims under indemnities are usually not qualified by disclosures or restricted by contractual limitations.

Indemnities serve to increase the scope for which damages are recoverable by the buyer, as claims under indemnities are made on a dollar for dollar basis and are usually not restricted by the rules for contractual claims like warranties.

No substitute for legal advice

The dictum 'buyer beware' is never more apt than when you are considering buying a business. Those who live to regret purchasing a business have typically been swept away by the romance of a particular scenario and have not considered the proposed acquisition objectively before deciding to proceed.

If you are considering buying a business, obtaining advice from a lawyer who specialises in business acquisitions is the most foolproof way to safeguard your position and save yourself from making a bad decision.

Swaab Attorneys was the highest ranking law firm and the 13th best place to work in Australia in the 2010 Business Review Weekly Best Places to Work Awards. The firm was a finalist in the 2010 BRW Client Choice Awards for client service and was named the winner in the 2009 Australasian Legal Business Employer of Choice Awards.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.