SELLING A BUSINESS

You have been in business for some time and now you want to sell your business. How should you go about it? What price should you ask for? Will you have to pay tax on the sale price?

MAKING THE OFFER KNOWN

You have a number of options here. Perhaps the most popular is to advertise in the local paper. It is usual to include in the advert a general description of the business, its location and the annual turnover figure. Some give the reason why the owner is selling. Often the advert will give the phone number of the seller's accountant and wording to the effect that further details may be obtained from the accountant. This is probably better than giving one's own phone number. Some advertisers ask people to reply to a box number. This is probably the least desirable course of action.

You should also remember the trade press when advertising. Often this brings better results than the local paper. Almost every occupation has its trade press. For example, newsagents and stationers have Australian Stationer & Newsagent, hardware stores have the Australian Hardware Journal, booksellers have Australian Bookseller and Publisher, farmers have Australian Farm Journal etc. If your business is specialised and needs skill to operate it, then you should advertise in the trade press. Another way of making your offer known is word-of-mouth. You inform your suppliers and anybody else that might be interested. You may want to conceal from the public and your staff that you are selling the business. You may, therefore, try to effect a sale initially by relying on word-of-mouth advertising. Another option is to place the sale in the hands of an estate agent. He will list it on his books and also advertise it for you. A further service which he can perform is to do a direct mail shot to all prospective buyers in the area. He could also send details, for example, to all accountants and lawyers in the area. Another option is to put a card in the window or on the door. This is probably the least desirable form of advertising. It can detract from the value of the business and make the intention known to too many people.

When you advertise, there is every likelihood that you will receive responses from persons who have little desire to buy the business but who are just curious. Your advertising should be designed to screen out these.

What documents and information should you make available to a potential buyer? If the prospect is a genuine buyer and he is a competent person, then he will want to inspect your financial records. Often, he will pass on the records to his accountant to examine. The records which he will require and which you should have available are: a) your Tax Returns for the past five years, b) Profit & Loss Statements and Balance Sheets for the past five years, c) Cash Book covering the past five years and d) bank statements for the past five years. You should prepare a list of all fixtures, fittings and equipment which you intend to sell with the business. This should be available to potential buyers. You should also prepare a list of contracts which you have with suppliers etc. You may have an exclusive contract to sell certain goods. Or you may have a franchise. These can be valuable rights. But make sure that you will be able to transfer the contracts to a purchaser. The potential buyer will want information about the lease arrangements. From a buyer's point of view, the best arrangement is to be able to obtain a new lease from the landlord in his own name, with an option for renewal. If possible, you should make known to a potential buyer that you are willing to stay on for a month or so after the sale as an employee to train the buyer in the business. A potential buyer will also want know how many employees you have and how many are likely to stay on if he buys. He will want to know their existing Long Service Leave entitlements, holidays due and superannuation entitlements.

WHAT PRICE SHOULD YOU ASK?

Many people think there is a formula, based on turnover, to calculate this. This is not true. The answer really is fairly simple. Let us take an example. Suppose an investor has $100,000 to invest. If he were to put this money in a bank at present, he would get approximately 6% interest i.e. $6,000 per year. If he were to invest it in buying a business, he would expect at least a similar return i.e. a Net Profit of $6,000 per year. The Net Profit of $6,000 would be, of course, after paying wages to himself for working in the business. However, interest rates are expected to rise and long-term interest rates are quoted at about 10% at present. So, he would expect at least 10% interest. But there is a much greater risk attached to money invested in a business compared to money deposited in a bank. Because of the greater risk, he would expect at least 15% interest. Let us suppose that the business you own makes a Net Profit of $80,000 per year before taking out any wages for the owner. What is the value of the business? Let's say the wages of a manager (yourself) would be $30,000. As we said above, an investor would expect a return of 15% p.a. on the investment.

Net profit 80,000
less owner;s wages 30,000
TRUE NET PROFIT    $ 50,000

Expected return on investment is 15% p.a.

Value of business is 50,000/15 X 100 = $333,333.

This means that if I invest $333,333 at 15% pa, I will get $50,000.

Now, assume that the business comprises the following assets. Plant and equipment, $50,000. Stock, $150,000. What is the value of Goodwill? It is the balance of the purchase price.

Plant and equipment

  50,000
Stock 150,000
Balance i.e. goodwill   133,333
VALUE OF BUSINESS  $ 333,333

    

In this case, $333,333 (say, $330,000) should be the asking price for the business. Most often, the buyer will not have the cash to pay the full purchase price. He or she will need finance. You should not overlook financing the deal yourself. If you invest the money from the sale in a bank at present, you will get about 6% interest. On the other hand, if the seller borrows the money from a bank, he will pay about 10% interest at present. Obviously, if you can loan him a portion of the purchase price at say 8%, you will both be getting a better deal. Your accountant can prepare a schedule of monthly repayment terms once you have agreed on 1) the amount to be borrowed, 2) the number of years for the loan and 3) the interest rate. But what happens if the buyer does not meet the loan repayments, you may ask. The answer is to foresee this possibility and obtain adequate security for the loan, in the first place. This could be some or all of the following: a charge over the assets of the business, a right to re-enter and take over the business if loan repayments are not met, a mortgage on the buyer's private house, a guarantee by the spouse of the buyer etc.

Once you have arranged finance, you must consider the actual sale procedure. There are generally three options open to you and the buyer. The first is termed WIWO - "walk-in-walk-out". With this option, there is no written agreement. The buyer presents himself at the business on an agreed day. He pays over a bank cheque to you. You hand him the keys and walk out. This type of agreement is common in the sale of small businesses such as a retail shop in a shopping centre. The next option is as follows. You agree on terms. Then one of you writes down the terms in black and white. You both sign the document and each keeps a copy. This may be better than WIWO but it is fraught with legal ramifications. You are taking a calculated risk. The third option is to go to a solicitor and have a written agreement drawn up by him. This is the more expensive option. In Victoria, New South Wales and South Australia, you must give certain details in a prescribed statement to the buyer.

Whatever procedure you adopt, you should consider the following matters.

PLANT AND EQUIPMENT

You, the seller must prepare a list of plant and equipment included in the sale. You must also state the values attaching to each item. These are often what are called the tax written-down-values. It is important that you both agree as to the items handed over and their values. Otherwise, you could have tax problems. You should also make sure that you have paid off all Bills of Sale or Hire Purchase agreements on all assets. Do not include any plant or equipment which is leased by you.

LEASE

If possible, arrange for a new lease to be available to be signed between the landlord and the purchaser. The other alternative is to assign the existing lease for its unexpired term. However, if you want to do this, you must have the landlord's consent first of all. If the new owner moves in without a lease in his name, he could have problems later in renewing the lease or selling the business.

STOCK

Normally, the quantity of stock fluctuates from day to day. You cannot fix the price to be paid for the stock until the day comes to hand over possession of the business. The normal agreement, therefore, provides that the stock will be valued jointly by seller and buyer at date of entering into possession. It will be valued at cost price. Obsolete, damaged stock etc will be written down.

BUSINESS NAME

Have a completed transfer form available. This will have to be signed by both seller and buyer and registered at your local Business Affairs office.

FIXTURES & FITTINGS

Often these are included in the list of assets to be sold with the business. But often in these cases, the seller does not actually own the fixtures. It is the law that fixtures belong to the landlord and not to the tenant. So if you list these, you should point out to the buyer that you are listing them for memorandum purposes only and that they do not form part of the sale.

EMPLOYEES

In the agreement, the buyer should assume liability for the entitlements of employees such as Long Service Leave, holidays due, Occupational Superannuation. If the buyer does not assume responsibility, then the employees should be paid out their entitlements before the sale proceeds.

TRAINING

Agree on the terms of any training period to be provided by the seller to the buyer after sale e.g. how long, wages to be paid etc

SELLER STARTING UP SIMILAR BUSINESS

The buyer might be put out if you were to immediately start up a similar business next door to him after the sale. Consequently, he might wish to include in the written sale agreement a provision that the seller, for example, will not trade in a similar capacity for three years within two kilometres of his previous shop. However, the buyer cannot impose too onerous conditions on the seller, otherwise they will not be legally valid. For example, a stipulation that the seller must never own a similar shop again would not be legally binding.

UTILITIES

Make sure the phone, electricity, garbage collection, Post Office box number, fax number, rates, are transferred into the buyer's name.

TAXATION

A liability to Capital Gains tax may arise on the sale of the business. If you purchased the business prior to 19th September 1985, then no liability to Capital Gains tax will arise. If you bought the business after this date, them you will have to pay Capital Gains tax. Normally, Capital Gains tax will only be payable on the profit on the sale of the Goodwill. Equipment and Fittings will normally be sold at approximately their tax written down values. There will be virtually no profit on the sale in such cases. Any profit that does arise will form part of the normal profit and will not be taxed as a capital gain. However, as mentioned, you will pay Capital Gains tax on the profit from the sale of the Goodwill. This is subject to two reductions, though. Firstly, you pay tax only on the profit that exceeds the CPI increase. Secondly, only 50% of this reduced profit is taxable. If the sale of the business occurred between 1985 and 26th February 1992, the exempt portion was 20% and not 50% as now. An example will make things clearer.

Suppose John Smith bought a store on 1st January 1986 at a cost of $200,000. The Goodwill accounted for $50,000 and other assets ( i.e. stock, equipment etc) accounted for $150,000. John Smith sold the business for $400,000 on 1st June 1992.

The selling price was split up as follows.

Equipment 100,000
Stock 150,000
Goodwill 150,000
TOTAL        $ 400,000

Capital Gains tax is calculated as follows.

Goodwill, cost   50,000
Goodwill, sale 150,000
PROFIT ON GOODWILL   $ 100,000

The CPI index on 1st January 1986 was 150.5. It was 217.1 on 1st June 1992. Consequently, we increase the cost of the Goodwill by the CPI i.e $50,000 X 217.1/150.5. This comes to $72,126. The new profit on sale of Goodwill is therefore $77,874 (i.e. $150,000 less $72,126). However, as mentioned earlier, only 50% of this is taxable i.e. $38,937.

How much tax will be paid on this? This will depend on how much other income the tax-payer received for the year. One fifth of the Capital Gain is added to this income. The tax rate applicable to the top slice of this income is applied to the whole of the taxable capital gain.

Let us take an example. Assume that John Smith had other income for the year of $30,000. This could have been his earnings from the business prior to sale.

Other income 30,000
add 1/5th of Capital gain i.e. 1/5 of $38,937 =  7,787
INCOME                                                      $ 37,787

Top rate of tax applicable to $37,837 is 47.5%

Tax at 47.5% on capital gain of $38,937 is therefore $18,495. John Smith will of course pay tax in the normal manner on his other income of $30,000 in addition to the Capital Gains tax. It will all be included in one assessment after the end of the financial year.

Consequently, if John Smith intends retiring when he has sold the business, it would be in his interest to sell the business in the beginning of the new financial year. His retirement income would place him in a low tax bracket for that year. Capital Gains tax would be correspondingly reduced. However, it should be noted that there are some peculiar provisions with regard to Capital Gains tax. A business is deemed to be sold not when it changes hands but when the contract is signed. Consequently, the contract should be signed early in the financial year, if this is possible.

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Copyright 1994.




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