A Practical Guide to Acquiring Small or Family Businesses
Essential considerations for individuals and couples looking to purchase small or family businesses, with actionable financial and tax advice.
Introduction
Acquiring a small or family business can be a rewarding investment, but it requires careful planning and thorough financial analysis. Individuals and couples must navigate complexities like family trusts, shareholder loans, tax implications, and client dependencies. This guide provides actionable advice to ensure you make an informed purchase decision while minimising risks.
Key Areas to Consider When Acquiring a Small or Family Business
1. Understand the Ownership Structure
Small and family businesses often involve complex ownership arrangements, such as family trusts or loans from shareholders.
Practical Steps:
- Review Trust Deeds: Examine the terms of any family trusts for restrictions on selling shares or distributing profits.
- Identify Loans from Shareholders: Check for unpaid shareholder loans that may need repayment before or as part of the transaction.
- Verify Beneficiaries and Trustees: Ensure all stakeholders agree on the sale.
Example:
A small business may have an unpaid shareholder loan of $100,000. If this loan isn't addressed, it could reduce the effective value of the business. Negotiate whether the seller will write off the loan or include it in the purchase price.
2. Assess Financial Records for Hidden Risks
Review financial statements and tax returns to identify potential red flags.
Key Areas to Review:
- Major Assets: Ensure vehicles, equipment, or property used in the business are included in the sale and accurately valued.
- Unreported Liabilities: Look for off-balance-sheet liabilities like guarantees or overdue taxes.
- Revenue Concentration: Determine if a significant portion of revenue comes from a single client, posing a risk if the client leaves.
Example:
If 40% of the business revenue comes from one customer, request a copy of the client contract and ensure it includes terms that favour continuity.
3. Tax Implications and Depreciation
Understand the tax consequences of the transaction, including depreciation of assets and potential Division 7A issues.
Practical Steps:
- Depreciation Review:
- Request a depreciation schedule for all assets.
- Check for under-claimed deductions that could improve the tax position post-acquisition.
- Division 7A Loans:
- Identify loans to shareholders that could create tax liabilities if not repaid.
- Discuss with a tax agent how to structure these loans under Division 7A rules.
Example:
The seller’s depreciation schedule might show a truck with a written-down value of $20,000 but a market value of $50,000. Factor this into negotiations, as higher depreciation claims can reduce taxable income post-acquisition.
4. Review Legal and Operational Risks
Evaluate contracts, intellectual property, and regulatory compliance.
Key Areas:
- Client and Supplier Contracts: Ensure contracts are transferable and check for restrictive covenants.
- Intellectual Property: Confirm ownership of trademarks, patents, or domain names.
- Regulatory Compliance: Verify that the business complies with industry-specific regulations.
Example:
A café might lease its premises under a contract that requires landlord approval for a sale. Obtain written approval before proceeding.
5. Analyse Key Metrics Using Excel
Excel can help you model the financial and operational impact of the acquisition.
Steps:
- Cash Flow Analysis:
- Build a cash flow model to forecast post-acquisition income and expenses.
- Include scenarios for optimistic, realistic, and pessimistic outcomes.
- Break-Even Analysis:
- Calculate the revenue needed to cover fixed and variable costs.
- Client Dependency Analysis:
- Use Excel to visualise revenue by client and identify concentration risks.
Example Table:
| Metric | Value Before Acquisition | Value After Acquisition |
|---|---|---|
| Annual Revenue | $500,000 | $520,000 |
| Net Profit Margin | 20% | 18% |
| Key Client Revenue | $200,000 | $210,000 |
6. Ensure a Smooth Transition Plan
Discuss the transition of operations with the seller to minimise disruptions.
Consider:
- Employee Retention: Identify key employees and negotiate retention bonuses or agreements.
- Handover Period: Arrange a transitional period where the seller stays on to train and support.
- Operational Knowledge: Request manuals, processes, and software access as part of the sale.
Example:
In a manufacturing business, the seller may need to introduce the buyer to major suppliers to ensure continuity.
Best Practices for Small Business Acquisitions
- Hire Professionals: Engage a chartered accountant and a solicitor experienced in business acquisitions.
- Negotiate Contingencies: Include terms in the sale agreement to address post-purchase risks, such as revenue clawbacks.
- Use Excel Tools: Leverage Excel dashboards for detailed financial analysis and scenario planning.
- Plan for Working Capital: Ensure the business has enough cash flow to operate post-acquisition.
- Validate Seller Claims: Verify revenue, expenses, and assets through due diligence.
Q & A
1. What is the biggest risk when buying a family business?
A: Unclear ownership structures and undisclosed liabilities like shareholder loans or overdue taxes are common risks.
2. How do I handle significant client dependencies?
A: Request contracts from key clients and include conditions in the sale agreement to retain them post-purchase.
3. What are the tax implications of Division 7A loans?
A: Division 7A treats unpaid shareholder loans as taxable dividends if not properly structured. Consult a tax agent to mitigate this risk.
4. Should I include or exclude major assets in the acquisition?
A: Always confirm the ownership and value of major assets and negotiate their inclusion in the purchase price.
5. How do I verify the seller’s financial statements?
A: Engage a chartered accountant to perform due diligence, including reviewing tax returns, bank statements, and supplier invoices.
Conclusion
Acquiring a small or family business is a complex but rewarding process. By addressing key areas like ownership structures, tax implications, and client dependencies, you can minimise risks and position yourself for success. Using tools like Excel for financial modelling and analysis provides clarity and confidence throughout the acquisition journey. With the right preparation, you can make a sound investment and achieve your entrepreneurial goals.