Pacific Rim Business Brokers Pty Limited

9.  The Contract

As a buyer you might think that when you have agreed on the price of the motel, negotiations are over.  Sadly, this is not always the case.


The standard Contract for the Sale of Business – 2004 edition, contains a host of additional clauses which must be agreed between the parties.  If you are unaware of these clauses you might find that you, or your solicitor, have to enter into a series of minor negotiations that can be time consuming, expensive and at worst lead to a breakdown of the sale.


It is therefore important that you purchase and read the 10 page standard business sale contract.  It is easily obtainable from most good stationers.


Generally, the vendor’s solicitor will prepare the contract and forward it to your solicitor.  Nine times out of ten, all the additional clauses will be in line with business conventions in the industry, so it is important to know what these conventions are.


The Deposit


This is generally 10%.  You can ask for a smaller deposit and the vendor might agree under certain circumstances.  The general rule is the deposit must be substantial enough to cause a lot of pain to a purchaser who does not proceed to completion and forfeits the deposit to the vendor.


If you ask the vendor if he will allow a smaller deposit the vendor may be concerned that you do not have sufficient funds in place to complete the purchase and may ask for proof of funds.


The Deposit Holder


This is generally the agent, and sometimes the vendor’s solicitor.   Bear in mind if an agent holds your deposit before you exchange contracts, and you decide not to exchange, the agent is obliged to return your deposit to you.


Investing the Deposit


If the deposit is a substantial sum, the deposit holder will generally be instructed to invest the deposit in an interest bearing bank account, then split the interest 50/50 between the purchaser and vendor on settlement.  In the current low interest rate environment, many solicitors do not bother to tick the invest deposit box, thereby obliging the agent to hold the deposit in his non-interest bearing trust account.  Remember, 50% of the interest belongs to you, so unless the sum is inconsequential (and that means different things to different people) make sure the invest deposit box is ticked.


Restraint of Trade


Generally the contract prohibits the vendor from purchasing or establishing another motel or similar business within a certain distance from the motel you have purchased and for a certain period of time.  There are no generally accepted conventions for restraint of trade in the motel industry, but 50 kilometres and 3 years is reasonably fair.


You certainly don’t want the vendor buying another motel in the same town, then contacting all his old guests and inviting them to his new property.  However, if the vendor did that after 3 years you should be sufficiently established in your own business not to let this worry you.


It is a sad fact that while some moteliers think guests come to their property because of the motelier’s sparkling personality, in general people stay at motels for reasons of convenience, comfort and price.  The person who hands them the key to their room, or wishes them a happy trip in the morning, generally doesn’t affect the potential guest’s decision.

Training Period

The 2004 Business Sale contract suggests a training period 7 days before completion and 7 days after completion.


Running a motel is not terribly complicated, and after a few days most sensible and organised people can claim to be competent moteliers.  Learning the booking system, the housekeeping routines, restaurant operation etc is not hard and most people pick it up after a few days.  Becoming a great motelier will take a bit more time.


Vendors are generally less happy with pre-completion training than with post-completion training.   While the contract obliges the purchaser to complete on a certain date, if the purchaser is overwhelmed by the training process and has second thoughts about the prospect of running a motel, the pre-completion training period might become a bit tense.  Also, if the purchaser is interfering with the smooth running of the motel by upsetting the staff, not dealing well with regular guests, or “throwing a wobbly” the vendor will naturally be annoyed.


Post completion training, when the vendor has the money in the bank and a holiday to look forward to, generally finds vendors in more amenable moods.  If the purchaser makes silly mistakes, it’s his or her business that suffers, not the vendor’s business.


Therefore don’t be surprised if the vendor wants all training to be post completion.  You might agree to this, but ask for 14 days rather than seven.  In fact, most purchasers are keen to say goodbye to the vendor as soon as they have acquired the basic motel running skills.  As an independent business person you probably don’t want to watch your predecessor shake his head as you try new things or adjust schedules to suit your style of operation.

Trading Stock

Generally the vendor estimates the value of the trading stock – food, drink, cleaning materials etc.  If, when the stock is counted on settlement the value is above the vendor’s estimate, then the purchaser can demand the vendor reduce the stock to the estimated value.  This means that if the vendor has not carefully estimated the value of his stock he may end up with unwonted cans of baked beans, or enough alcohol for a number a parties.


Usually the vendor’s estimate is pretty close to the value of the stock, and we generally recommend over-estimating rather than under-estimating to avoid the inconvenience of carrying away excess stock.

Apportionment of Price

The price of a freehold motel is generally divided into Land and Buildings, Furniture and Fittings, Goodwill plus stock at valuation.   Land and buildings, furniture and fittings and goodwill form the total of the negotiated price.


The value of the furniture and fittings will generally be the value in the motel’s latest depreciation schedule adjusted for the period from 30 June to the date of completion.  If the value is higher the vendor will have to pay tax on the difference.  If the value is lower your depreciation allowance will be reduced and hence you will be liable for more tax.


Goodwill is an intangible asset.  There are many complicated definitions that cover this interesting aspect of the business, but from an accounting and taxation purpose it is just “the sum left over after land, buildings, furniture and fittings have been deducted from the total price.” 


If, at a later stage, you decide to sell off a lease of your motel, and there was no goodwill noted in the contract when you purchased the property, then the Tax Office may regard the sales as a piece of goodwill that you have created, and tax the amount of that sale as normal income.


Having goodwill apportioned in your purchasing contract may avoid this problem further down the track.  Naturally this is something you will need to discuss with your accountant.


Many freehold motels are sold with two interdependent contracts – a Contract for the Sale of Land which covers Land and Buildings, and a Contract for the Sale of Business, which covers goodwill, furniture and fittings.  You may be advised to buy the land and buildings in your own name, and the business in a company name.


There are many taxation and superannuation advantages and disadvantages to various methods of purchase and a good accountant will help you navigate this area.

Certificates and Inspections

The vendor must allow the purchaser to have the premises inspected to obtain any certificate or report reasonably required.  Generally a purchaser will obtain approval for finance before entering into a contract, and so a valuer will inspect the motel prior to exchange.


However, if completion of the purchase is subject to the purchaser obtaining finance (see below) then various parties such as the valuer, building inspector, pest inspector and bank manager may require access to the motel.


The standard contract also states that the purchaser will have access to any accounting records relating to the business inspected.  Once again, you generally inspect accounting records before exchanging contracts, but there may be good reasons for requesting and receiving a contract with completion subject to validation of the accounts.  If you are in competition with another party to purchase the motel, and the vendor says he will sell to the first party that exchanges contracts you may agree to this providing the contract is subject to substantiation of the trading figures.


When a motel is sold as a going concern there is no GST payable.  However, the standard clause states that if the Tax Office decides GST is payable then the vendor will present the purchaser with the Tax Office’s demand and the purchaser will promptly pay the 10% GST.  Note that this is extremely rare.  The vendor, purchaser and their accountants are usually very clear on whether or not the motel is sold as a going concern.


Furthermore, if the purchaser was forced to pay GST he could generally claim it back on his next BAS return.


Generally all money owing to the vendor and all money owed by the vendor up until completion is the vendor’s to collect and pay.  The purchaser should start on day one with no debtors and no creditors (apart from the bank).


As the purchaser receives payments from guests who stayed at the motel when it owned by the vendor he must pass these payments on to the vendor.  As most companies use credit cards this isn’t often a big issue.


It is generally accepted in the industry that the vendor hands the motel over to the purchaser with all rooms cleaned.  The vendor is entitled to the revenue from guests who stayed at the motel the night before settlement.  If an employee cleans these guest rooms after settlement has taken place, it is the vendor who should pay this employee.


Generally the vendor pays all housekeepers and the breakfast cook for work undertaken on the day of settlement.  The purchaser pays all restaurant staff for work undertaken on the day of settlement.


Adjustments must also be made for guests who are staying at the motel both before and after settlement.  Usually the vendor, working with the agent, prepares a list of these adjustments and the parties arrange payment without reference to the solicitors or the settlement.   Adjustments relating to water and council rates are prepared by the vendor’s solicitor and form part of the settlement.


The important thing to remember about employees is that the law in NSW does not allow the transfer of a business to affect employee entitlements.  Therefore if the vendor sacks all employees on settlement day and you re-employ them, and the vendor refuses to pay holiday or long service leave entitlements that were accrued when he owned the motel you will be responsible for their payment.  Naturally, you can sue the vendor for this amount, but only if you can find him and if the legal costs warrant this action.   Bear in mind the court may well take the view that the contract price was agreed between the parties knowing the liability for employee entitlements would be passing from the vendor to the purchaser.


The standard contract states that the purchaser will offer employment to each employee in the business he wishes to employ prior to completion.  This means you will need to interview all staff and decide who you want.  The terms and conditions of employment that you offer must be no less favourable than those offered by the vendor.


The vendor must then, on settlement, pay to the purchaser the monetary value of any entitlements accrued by the employees who stay with the business.  (The ones who are not offered employment by the purchaser must be paid out by the vendor).


Long service leave entitlements are calculated according to a table in the Contract for Sale of a Business.  The table works on probability theory as follows:


It is unlikely that an employee who has worked less than 5 years in the motel will remain with the motel for another 5 years and be entitle to long service leave.  The probability value is set a zero, so no money changes hands.  Of course, if that employee did stay for another 5 years you would have to honour long service leave accumulated over 10 years.


At the other end of the scale, an employee who has been with the motel for 9 years is very likely to be eligible for long service leave in one year’s time.  Therefore the vendor must pay you, on settlement the value of that employee’s long service leave multiplied by 60%.  If the employee does not stay for the remaining year then you have made a windfall profit (although you may also have lost a valuable staff member).


The long service leave calculator is about as fair a method of calculating employee payment adjustments as possible, but there will always be winners and losers on the margin.


The important thing is to make sure employees know that their entitlements are safe and have been adjusted between the purchaser and vendor.  Otherwise you might be presiding over a suspicious and mutinous workforce.

Subject to Finance

If you do not have finance in place you may ask for the contract to be subject to finance.  Many solicitors do not like this.  Ignoring business realities, they suggest that buyers get their finance approved first, then exchange contracts.


However, virtually all banks require a valuation before lending for a motel purchase.  If the nominated valuer is any good, he will have a lot on his plate and may not be able to value the property for a couple of weeks.  This means the buyer has to hope that no one else buys the property during this time, and that the money he pays the valuer is wasted.


We generally advise vendors to exchange “subject to finance” contracts providing there period before the contract becomes unconditional is not too long, and the terms of the loan that are acceptable to the purchaser are in line with current lending practices.  The “subject to finance” clause should include the loan amount required, the maximum acceptable interest rate and the maximum acceptable fees and charges.  It should also state that the contract becomes unconditional after a certain date unless the purchaser informs the vendor in writing that he was unable to secure finance with acceptable terms and conditions as set out in this clause.


We can, as agents, continue to offer the motel for sale to other parties providing the vendor does not enter into a contract with any of these parties before the day the contract becomes unconditional, and providing we tell the other potential purchasers that there is a conditional contract currently in place and signed.


In our experience over the past 20 years, 98% of deals with contracts “subject to finance” have settled.  The purchaser is comfortable paying valuation and bank fees, knowing that the motel will not be sold to a third party.  And the vendor is comfortable, knowing that he has a buyer in place who is finalising a loan that is in line with current lending practices.