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.
GST
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.
Adjustments
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.
Employees
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.