Law Society CPD Presentation

Sale of Shares
A company is a legal entity that can own assets and enter into contracts in its own
right. Shares in a company are a bundle of rights representing ownership of a
company. A sale of a company’s shares takes place when a shareholder sells their
shares to another party. If a purchaser buys all (or at least a majority) of the issued
shares in a company, the purchaser will effectively obtain control of the company,
including the assets and liabilities of the company.

A share sale is distinct from a sale of business assets. In a share sale, all assets remain
the property of the company, and instead the underlying ownership of the company is
transferred to the new shareholder(s). In this situation, all of the assets will remain
the property of the company. A sale of business assets involves the sale of the
individual assets of the company to another party such that those assets are no longer
held by the company, however the underlying ownership of the company (ownership
of the shares) remains unchanged.

Due to the complexity of share sales, there are important considerations for both the
exiting shareholder who is selling their shares (the vendor) and the party buying the
shares (the purchaser).

Vendor Considerations
Generally there are fewer considerations for vendors than there are for purchasers,
however there are still important aspects that a vendor must consider.

Due Diligence and Preparation for Sale

Due diligence is the comprehensive review of a business, especially to determine the

extent of its assets and liabilities. The vendor does not have any obligation to
undertake due diligence, as this onus falls to the buyer. Despite this, it is still
worthwhile for the vendor to premeditatedly get theirs and/or the company’s affairs in
order, as this can increase the value of the shares for sale, strengthen the bargaining
position of the vendor and facilitate a smoother and faster transaction. The
comprehensive requirements of due diligence will be discussed later in this paper.

Importantly, advisors must ensure that they have identified the correct vendor entity.
In some instances shares are held by trusts or companies. For example an ASIC search
may reveal that the vendor is the registered owner of the shares but those shares are
not beneficially held. This means the individual holds the shares in his or her capacity
as trustee and the relevant share sale agreement should reflect that.
Warranties

A warranty is a contractual statement of assurance given from one party to another,

(such as vendor to a purchaser), that certain conditions or circumstances exist.

It is very common for the purchaser to insist on warranties as a mechanism to mitigate

the risk they take on as a result of a share sale. It also allows the purchaser to
determine whether a lower purchase price can be negotiated (as a result of increased
risk) and provides a basis for breach of contract if the vendor gives a false or untrue
warranty. When acting for the vendor, an advisor should make the vendor aware of
the warranties the purchaser will likely ask for and the consequences of signing the
agreement where such warranties are false, knowingly or unknowingly.

Directors’ Guarantees

If the vendor is also a director of the company then they may have previously provided
a director’s guarantee. A director’s guarantee is a personal guarantee, which is often
signed by directors when a company is entering an agreement, such as a loan
agreement. The director’s guarantee is a further assurance that the director will be
liable for the company’s debt or commitment if the company does not meet that
obligation. Some director’s guarantees contain terms which limit liability to a particular
timeframe or transaction. However depending on the terms of the agreement this
personal liability can potentially last forever, meaning that a former director can be
liable for a company that they are no longer involved in. This could lead to the vendor
being liable for the company’s debts long after the share sale.

There are limited options to discharge a director’s guarantee. The director could
request that the creditor releases them from the agreement and could request that
the purchaser (or incoming directors) sign a director’s guarantee in the original
director’s place. However there is no obligation for this to happen so it should be
explicitly agreed between the parties.

Pre-emptive Rights

Vendors should also be aware of any pre-emptive rights relating to their shares that
may affect the sale. Pre-emptive rights, which will be discussed in detail later in this
paper, are rights which allow existing shareholders to purchase the shares for sale
before third parties. This can restrict the vendor’s ability to sell shares and can also
affect the price for which shares are sold. Advisors should always request copies of
governing documents such as the constitution of the company and any shareholders
agreement to check.

Purchaser Considerations
When a party purchases the shares in a company, they will inherit a company with all
its known and unknown liabilities. Therefore, the purchaser must undertake detailed
due diligence which is often time-consuming, and costly. The purchaser can mitigate
this risk through warranties, indemnities, and insurance, however warranty limitations
and the vendor’s credit level post agreement can make claims quite ineffective. A
comprehensive list of practical due diligence considerations is outlined later in this
paper.

Security Interests and Encumbrances

A security interest, such as a mortgage, is a legal right granted by a debtor to a creditor

over the debtor's property which enables the creditor to have recourse to the property
if the debtor defaults in payments or other obligations.

In many instances, a company will offer its assets as collateral for a security interest
held by suppliers as security for payment of goods and services. A list of the relevant
security interests can be found by searching the personal property securities register
(PPSR). When security interests are initially registered it is common for the nominated
collateral to be ‘all present and after acquired property’. This is the equivalent of what
was previously known as a fixed and floating charge. This means that the security
interest is not limited to one item but rather covers all the asset of the business
(including future assets) so the effects can be quite far reaching.

When purchasers purchase shares in the company and control the underlying
ownership of the company’s assets, they also effectively take on responsibility for any
security interests. However if the purchaser is not well informed about the details of
these security interests the default of payments may significantly disrupt the business.

In the event of a default on payments by the company, the creditor may be able to
enforce its interest and take away the assets from the company, decreasing the value
of the company’s shares acquired by the purchaser. Therefore it is important for the
purchaser to know which of the company’s assets have a security interest (if not all),
who the creditors are in these arrangements, and the terms of the repayment. This
will allow the purchaser to understand the risks that they are taking on.

Warranties

As discussed earlier, the purchaser may ask the vendor to provide warranties that
certain conditions within the company exist. The purchaser is in effect requesting the
guarantee of certain circumstances.

Generally speaking warranties come in different forms. A warranty in an agreement

may be a statutory warranty, warranty for performance or a warranty that is a
representation. The most common type of warranty found in a share sale agreement
are warranties relating to representations, often about the state of the assets or
financial performance of the company.

However, the purchaser also needs to be aware that there are certain limitations on
warranties. The enforceability of warranties has been widely debated and the subject
of litigation. Advisors should always draft the warranties so that they are certain and
should consider drafting clauses which explain the consequence of a breach. In the
event that technical terminology is used in a warranty, that terminology should be well
understood or clearly defined.
It is also important to realise that whilst warranties protect the parties against the
unknown, they are only true at the point in time they are given, so the purchaser will
need to have them repeated to ensure that they are up to date where there is a delay
in execution of the purchase.

In the event of a sale, common warranties that a purchaser may request include:

 that the vendor has authority to enter into and perform its obligations under
the share purchase agreement, including that the vendor has the power to sell
the shares (they are the owner/registered holder of the shares);
 that the shares consist of the entire issued and allotted share capital of the
company if the transaction is for the full sale of the company;
 that there are no security interests or encumbrances affecting the shares (or
that they have been accurately disclosed);
 that the vendor has made a full and fair disclosure;
 that the vendor, including the company and any subsidiary companies, are
solvent, including:
o that no order has been made or is due to be made to wind up the
company;
o that no administrators have been appointed to the company; and
o that the company has not stopped paying its debts;
o that the company has carried out its business in the ordinary and normal
course (i.e. it has been functioning without the threat of liquidation);
 that the company’s accounts give a complete and accurate view of the
company’s financial position;
 that the company has prepared the accounts in accordance with accounting
standards and laws;
 that the financial records have been completed and there is no outstanding tax
liabilities;
 that there are no arrears, audits, or disputes in relation to tax returns, ABN,
GST registration, PAYG or BAS;
 that the company is not engaged in any current litigation proceedings or
alternative dispute resolution, and that there is no threat of litigation;
 that the company is not subject to any outstanding orders, judgments, awards,
or decisions;
 that plant and equipment is all in suitable working order and regularly
maintained;
 that the company holds the appropriate licenses to conduct its business; and
 that all employee entitlements have been disclosed.

This list is non-exhaustive, and warranties can be tailored to the individual business.

Tax Red Flags

From a tax perspective, a business asset sale and share sale usually involves the
consideration of three broad taxes:

1. Stamp duty
2. Goods and Services Tax (GST)
 3. Capital Gains Tax (CGT).

The purpose of this paper is not intended to discuss indepth tax considerations and
issues that may arise but rather simply note some tax red flags which may signal to
advisors that the transaction may result in adverse tax consequences. Whilst the three
taxes above are the most common in a sale transaction, please note that there are
other tax considerations such as land tax and payroll tax which cannot be ignored. It
is highly recommended that tax advice be sought.

Stamp Duty

In South Australia, the state government has abolished stamp duty on the sale of
shares. Accordingly, the purchase price should not be subject to stamp duty.

GST

For GST purposes, each sale transaction is considered to be a ‘supply’. Broadly

speaking, a sale transaction could be a taxable supply, GST free supply or an input
taxed supply. Each supply is defined by A New Tax System (Goods and Services Tax)
1999 (Cth) (GST Act) and leads to its own GST consequences.

The sale of shares is defined under section 40.5 of the GST Act as a financial supply.
All financial supplies (as that term is defined under the GST Act) are input taxed
supplies. The consequence of the sale transaction being an input taxed supply is two-
fold:

1. GST is not payable on the supply

2. Input taxed credits cannot be claimed for any purchases made in pursuance of
the supply.

Practically speaking, this means that the purchase price for the shares should not have
GST added to it. The issue relating to input taxed credits is something that is more
relevant for the purchaser’s accountant but the purchaser should be made aware of it.

CGT

CGT is payable on a capital gain made from the sale of a capital asset. 1 Shares in a
company are a common type of capital asset. Accordingly, the sale of shares will
trigger CGT. The tax liability arising from a capital gain is borne by the seller of the
capital asset (vendor) and CGT is added to the vendor’s assessable income which
means that the amount of the capital gain will be included in the vendor’s assessable
income for the financial year in which the sale agreement is signed.

It is relatively straightforward to determine that CGT has been triggered and the
calculation of the amount of the capital gain is often undertaken by the vendor’s
accountant. However, the Income Tax Assessment Act 1997 (Cth) (ITAA 97) sets out

1
Income Tax Assessment Act 1997 (Cth), s 104-10.
a number of concessions and exemptions which, if satisfied, allow a taxpayer to reduce
the amount of the capital gain.

The capital gain exemption regime is complex and tax advice should be sought. Not
all vendors will satisfy the relevant tests to obtain an exemption. However, for the
purpose of this paper, advisors should be aware of one issue that arises which is often
missed. One of the tests required to be satisfied prior to the application of the CGT
small businesses concessions is the ‘significant individual test’. In an attempt to
simplify these issues, this paper will proceed on the assumption that the vendor is an
individual.

The significant individual test (for an individual vendor) requires the vendor to be a
significant individual. A ‘significant individual’ is a technical term under the ITAA 97
and means an individual with a direct or indirect small business participation
percentage of at least 20%.

The direct small business participation percentage is the smallest of:

1. percentage of voting rights;

2. percentage of entitlements to dividends; and
3. percentage of entitlement to capital distributions.

The significant individual test can become problematic where there are different
classes of shares in a company and each class holds different rights.

For example, let’s say ABC Pty Ltd has a total of 100 ordinary shares on issue. All
ordinary shares have voting rights, entitlements to dividends and entitlement to capital
distributions. Joe Bloggs holds the 100 shares in his own name and accordingly holds
100% of the company.

To determine Joe’s direct small business participation percentage, an advisor will

consider that he has 100% of the voting power, 100% of the entitlement to dividends
and 100% of the entitlement to capital distributions. As the smallest percentage is
100%, Joe has a small business participation percentage of 100%. As Joe hold a small
business participation percentage of more than 20%, he satisfies the significant
individual test.

However, now let’s presume that ABC Pty Ltd has two shareholders with the following
shareholding:

Andrew 50 A Class Shares

Brittney 50 B Class Shares

A class shareholders hold voting rights, entitlement to dividends and entitlements to

capital distributions. B class shareholders on the other hand do not hold any voting
rights but do hold entitlements to dividends and entitlements to capital distributions.
The company’s constitution has a provision that directors can distribute dividends and
capital distributions to one class to the exclusion of other classes.

In the event that you are acting for Britney, her direct small business participation
percentage would be determined as follows:

1. she has 0% of the voting power because her class of shares does not hold
voting rights;

2. she has 0% of the entitlement to dividends because there is no

guarantee/entitlement she will receive dividends (as a result of the
constitutional provision)

3. she has 0% of the entitlement to capital distributions because there is no

guarantee/entitlement she will receive capital distributions (as a result of the
constitution provision).

The smallest of those three percentages is 0% and Britney has a small business
participation percentage of 0%. As she does not have a small business participation
percentage of at least 20%, she is not a significant individual and this could bar her
ability to apply the small business CGT concessions.

The same analysis would be applied for Andrew. Andrew has:

1. 100% of the voting power (as he is the only shareholder that has the ability to
vote)

2. he has 0% of the entitlement to dividends because there is no

guarantee/entitlement he will receive dividends (as a result of the constitutional
provision)

3. he has 0% of the entitlement to capital distributions because there is no

guarantee/entitlement he will receive capital distributions (as a result of the
constitution provision).

As neither Andrew nor Britney are significant individuals, this may result in a higher
amount of CGT being payable.

Although it is not essential for advisors to have an in-depth understanding of the

mechanisms of the CGT concessions, where the vendor holds a class of shares that
has different rights to the other shareholders, advisors should recommend that the
vendor seeks tax advice to fully understand the tax liability that will arise as a result
of the sale.

It is also important to ensure that if the exiting shareholder or director has taken a
loan from the company, the loan should not be forgiven as that will also trigger adverse
tax consequences in accordance with Division 7A of the Income Tax Assessment Act
1936 (Cth).
 Potential Restrictions
Pre-emptive Rights

Pre-emptive rights give existing shareholders the option to purchase existing shares
from the vendor before any third parties, which can impede share sales to third party
purchasers. It is therefore essential that vendors and purchasers confirm whether the
other shareholders have pre-emptive rights.

Pre-emptive rights are commonly found in shareholders’ agreements, but can also be
found in the company constitution. If the company does not have a constitution, the
replaceable rules found in the Corporations Act 2001 (Cth) will apply. The replaceable
rules state that existing shareholders have pre-emptive rights on the issue of new
shares but not on the transfer of shares. 2

In the event the company’s constitution or shareholders’ agreement are inconsistent

there should be a provision within the shareholders’ agreement that states which
document prevails.

The purpose of pre-emptive rights on a transfer of shares is to protect existing

shareholders by allowing them to take up any shares before third parties. This enables
them to increase their ownership interest while also preventing unknown external
parties from becoming shareholders in the company. Pre-emptive rights to buy shares
are generally proportionate to a shareholder’s existing ownership stake, therefore all
shareholders have an equal right to purchase shares.

If the shareholders have pre-emptive rights, there is usually a prescribed process that
must be followed. This is generally found in the company constitution or shareholders’
agreement. Typically the company’s directors or selling shareholders must prepare a
notice setting out the terms of the issue or the sale. The notice will need to include
details of the number of shares on offer and the price per share. This notice is circulated
to all existing shareholders and the existing will have a timeframe during which they
can take up the offer contained in the notice. Each shareholder wishing to purchase
shares will need to tell the board in writing how many shares they wish to purchase.
If the total number of shares taken up is greater than the total number of shares on
offer, each shareholder will be allocated shares in their respective proportions. This
could be less than the amount they wished to purchase. If the total number of shares
taken up is less than the total on offer, any remaining shares are either re-offered to
the shareholders or offered to a third party.

The vendor should be aware that the pre-emptive rights process usually forbids shares
being sold to third parties for a different price than they were offered to the existing
shareholders. Therefore the vendor should carefully consider the price at which they
offer the shares to existing shareholders.

Although advisors should be aware of the pre-emptive rights process, in some

instances the sole shareholder or all shareholders may want to sell their shares to a

2 S 254D Corporations Act 2001 (Cth).

third party. As a result of this, pre-emptive rights provisions are rendered superfluous
and the parties agree that they don’t need to be followed. Advisors should make sure
they are aware of such provisions so they can draft appropriate waivers dispensing
with any formal requirement to follow the process. Advisors acting for the purchaser
should insist on either sighting the waiver prior to the sale or including a waiver
provision within the agreement itself.

Tag Along Rights

In addition to pre-emptive rights, the shareholders’ agreement or company

constitution may include other rights which can complicate a share sale.

Tag along rights occur when a vendor wishes to sell the shares to a third party
purchaser. Some shareholders’ agreements will stipulate that each shareholder has a
right to require the purchaser to purchase an equal portion of their shares as they are
purchasing from the vendor. The prescribed process for pre-emptive rights usually also
applies to tag along rights. These rights may require the purchaser to buy a larger
portion of the shares than originally envisioned which may make a share sale more
difficult.

When acting for the purchaser, advisors should be aware as to how many shares are
in the company and how many are being offered for sale. In the event less than 100%
of the shares are being purchased, tag along and drag along rights may become an
issue.

Drag Along Rights

Drag along rights also occur when a vendor wishes to sell the shares to a third party
purchaser. Under this provision the vendor has the right to require the remaining
shareholders to sell their shares to the third party purchaser. The prescribed process
for pre-emptive rights usually also applies to drag along rights. Drag along rights can
assist a third party purchaser in buying a larger share of the company.

There is often a requirement that the vendor sells a certain percentage of shares within
the company before they can exercise their drag along rights so a purchaser who is
obtaining a minority interest may not have this ability.

Deed of Accession

In the event the purchaser is not obtaining 100% of the shares, it may be that the
remaining shareholders require the purchaser to enter into a deed of accession for the
shareholders’ agreement. This would mean the purchaser is bound by the provisions
of the shareholders’’ agreement so advisors may need to review those documents to
ensure their general terms (including voting rights, quorum provisions, procedures to
transfer shares ) are appropriate for the purchaser.

Directors’ Power of Refusal

Depending on the company constitution or shareholder’s agreement, directors may

have the power to refuse to register a transfer of shares. Or if the replaceable rules
are in effect directors can refuse to register the transfer if the shares are not fully paid
or there is a lien over the shares, for any reason (if the company is a proprietary
company).3

Due Diligence
Unlike a business asset sale, a share sale does not involve the transfer of individual
assets however due diligence is an essential step of the share sale process for the
purchaser to ensure that they understand the risks and liabilities that are being
acquired. It is also important to ensure that the purchaser fully understands the
operation of the business and can manage the impact of the sale on key contracts.
Due diligence should be undertaken by the purchaser with the assistance of a lawyer,
financial advisor and accountant in order to adequately consider any legal, financial,
tax or operations related issues. Below are some important considerations:

Financial Records

It is extremely important that a purchaser has a thorough understanding of the

company’s financial position before committing to a sale. This will ensure that the sale
price has been correctly valued, and that the purchaser is not going to be impacted by
any unknown financial liabilities.

Advising the purchaser that its accountant should be involved in the sale is
recommended as accountants are often more significantly involved in the financial
affairs of their clients and will understand the effects of the financial records.

Therefore it is useful for the purchaser to examine documents including the company’s
financial accounts, such as the balance sheet and the profit and loss statement, the
accounting policy, the historical audit files, the debtors ageing report and the trading
data for the last three years.

When examining these documents, the purchaser should consider whether there are
any cash flow or debtor problems and whether there may be new or increased costs
which could arise after the sale. Furthermore, a poor history of financial record keeping
may indicate mismanagement and raises questions about whether the company is
complying with its obligations under the Corporations Act.

When looking at a company that undertakes audits, advisors should look for any
qualified report. A qualified report means an auditor has found adverse circumstances
and the financials do not reflect a true and fair view of the company’s financial
performance. If a qualified report has been issued in the past, the purchaser should
investigate whether the issues have been subsequently addressed.

Company Details

In order to understand the structure of the company the purchaser should request an
organisational chart if possible. An ASIC search should be used to confirm this

3 SS 1072F(3), 1072G Corporations Act 2001 (Cth).

information. Company registers, such as the register of shareholders, register of
directors and register of charges also provide valuable company information. The
purchaser should ensure the company minutes and records reflect the same position
as ASIC. In the event a transfer of shares has occurred in the past, but no-one has
informed ASIC, that transfer is still legally valid and the shareholding presented by
ASIC that has been relied on by the purchaser is incorrect.

The purchaser should also thoroughly examine the company constitution and any
shareholder agreements. As discussed earlier these documents may contain pre-
emptive rights, however they also contain important information about how
shareholders can vote, make resolutions and appoint directors. These clauses will
directly impact the purchaser’s control over the company.

The purchaser may also wish to examine any other agreements, such as option
agreements, which may further specify the rights of shareholders and further issued
shares in the company at a later date.

Finally examination of the minutes of meetings of the board and the shareholders can
help the purchaser to better understand the relationships between the different parties
and can indicate potential governance issues.

Taxation

The purchaser should carefully review the company’s ABN and GST registration to
ensure that they are compliant. The purchaser should confirm that the business is not
in arrears on any of its tax payments by checking the company's taxation returns and
BAS for at least the past three years as well as reviewing its PAYG withholding
statements.

Furthermore the purchaser should ensure there are not any unpaid amounts, audits,
disputes or penalties by reviewing any correspondence with the ATO or the business’
tax advisors. If there have been any tax losses the purchaser should request an
explanatory statement from management. Working with the purchaser’s accountant
to review these issues is very important.

Financial Contracts, Securities and Charges

As discussed earlier, the purchaser takes on significant liability when purchasing shares
in a company . Therefore it is important to review any bank or corporate guarantees,
charges or mortgages. Particularly the purchaser should take note of the outstanding
debt in these arrangements, when payments are due and the consequences of default
on a payment. Of particular importance is whether there have been any previous
breaches of these arrangements. Examination of the company’s indemnities and
priority or subordination agreements is also vital for this reason.

The purchaser should review any operating leases, hire purchase agreements,
purchase agreements and rental agreements and take note of when these agreements
terminate, the ongoing payments and whether any of the terms of these agreements
have been breached by the vendor. Any evidence of previous default of payments
should be questioned.

Insurance

The purchaser should examine the company’s insurance policies to ensure that they
are sufficient to cover any potential liability that the company may face. Depending on
the business the company should have policies which cover public and product liability,
workers compensation, plant and equipment and any other compulsory insurances
specific to the industry. Review of these policies should make note of the premiums,
the date for payment of the premiums, the expiry date of the policy, and the monetary
amount covered by the policy.

The purchaser should also request details of any claims notified or made, as any claims
may affect the insurance premiums and payments for future claims. In particular, the
purchaser should insist on speaking with senior management and questioning whether
they envisage any future claims.

Commercial Contracts

The purchaser should request to review any commercial contracts of the company,
including:

 sales, distribution, agency, licensing, manufacturing or franchise contracts

 supply or purchase agreements;
 agreements with sub-contractors;
 joint venture or partnership agreements;
 distribution, management or transportation agreements;
 contracts with government entities;
 contracts entered outside the normal course of business; and
 material acquisition or disposal of shares or assets.

Review of these documents will provide the purchaser with a comprehensive overview
of the company’s activities and obligations and will assist in the valuation of the
company.

The purchaser should take note of the value of each commercial contract, any
payments required, whether specific performance is required by a certain date, the
expiry date and any possible renewal periods. It is important to make note of adverse
contract terms which could impose a liability on the purchaser or restrict the company’s
trade. Examples include unfair contract provisions, terms containing product
warranties, terms restricting business operations in a region, terms which allow the
contract to be terminated or varied unilaterally, terms which allow the contract to be
terminated or varied if there is a change in ownership of the company, terms which
may be breached in the course of the operations of the company and terms which
restrict the disposal of assets.

As the business entity is not changing, there is no need to consider the assignment of
contracts however there may be provisions for termination in supplier contracts due
to the change of control provisions. A change of control provision stipulates that the
contract terminates where a transfer that results in a change of more than 50%
(generally)of shares of the company occurs. If this provision is present in a major
contract, the purchaser and vendor need to deal with that before the sale.

In relation to companies which are founded and effectively managed by one person,
you should also take note of provisions relating to key personnel and the process of
changing that person. In some instances the purchaser may want to keep the vendor
involved in the business as an employee to facilitate a smooth transition.

Real Property

During the due diligence process the purchaser should review any leases, assignments
options and licenses that the company is party to. If the company owns property, the
purchaser should search the Lands Titles Office records for the title and also ensure
there are no encumbrances. When reviewing these documents the purchaser should
note the current rent, any plans for the properties, the address and description of the
properties, the zoning of the properties and any impending zone changes and any
mortgage or charge over the property. The review of these documents should confirm
the property holdings of the company and make note of any issues in retention of
payments or retention of title issues, as well as any capital works deductions.

Intellectual Property

Intellectual property assets can form an important part of the company’s value. The
maintenance of intellectual rights is important for the branding and proportion of a
company. Therefore it is important that the purchaser examines the intellectual
property of the company, including patents, trademarks and copyrights. Some forms
of intellectual property can be registered with IP Australia and the World Intellectual
Property Office so searches of those databases are paramount. The business, trading
and domain names should also be searched. The purchaser should confirm that any
logos are registered as trademarks.

The purchaser should confirm the ownership of this intellectual property, any
assignments or licences to use the intellectual property, any infringement of the
company’s intellectual property rights and any upcoming payments or actions required
for the continued maintenance of the company’s intellectual property.

Litigation

Litigation is a costly and ongoing burden that may be inherited with the purchase of
shares. Therefore, due diligence should be conducted into whether there are any
current disputes, litigation, arbitrations or proceedings affecting the company. Any
potential threat of litigation should also be disclosed. This will allow the potential
purchaser to make an informed decision about whether to continue with the sale and
whether to renegotiate the sale price.
Specific industries will also have statutory obligations that must be adhered to (for
example, food preparation). A purchaser should investigate whether there have been
any previous breaches of concerns.

Environment and Licences

Depending on the industry, environmental considerations can significantly impact the

company’s ability to trade. The purchaser should review all environmental licenses,
registrations, approvals or permits to ensure that they are current, valid and cover the
scope of the company’s activities. Any environmental reports, environmental
management plans, audits or inspections should be reviewed for adverse findings.
Whilst conducting due diligence the purchaser should take notice of the ongoing work
needed to comply with the licences and whether this is financially viable. Finally, the
purchaser should review whether there have been any claims, proceedings or
complaints against the company, as these could impact the company’s ability to
operate moving forward.

Beyond environmental licences any further licences required for the operation of the
business should be reviewed. These include building licences, liquor licences, gaming
licences, NDIS registrations, property licences to carry on aged care homes etc.)

Plant and Equipment

It is important to ascertain the condition of the plant and equipment of the company
in order to accurately value the company. The purchaser should review the current
status of the plant and equipment as well as any repairs undertaken and the company
maintenance policy. The policies for writing off repairs and maintenance costs should
be considered as they may be contributing to operating costs of the company. Any
abnormal write offs should be questioned. The purchaser should request the fixed
assets register and plant depreciation schedule. Purchasers need to be aware of the
state of particular plant and equipment that is essential to the operation of the
business.

Trust Documents

For tax purposes, shares in a company are often held in a trust. However the sale or
transfer of shares from the trust may give rise to complications. Therefore it is
important that the purchaser reviews the trust deed, trustee minutes, title documents
and any unit trust registers. Review of these documents will inform of any procedures
that must be followed for the sale or transfer of the shares as well as confirming that
the shares in the company are actually held by the trust.

Employment and Staff

The company’s employment contracts can give rise to significant and ongoing liability.
Therefore the purchaser should ensure that it has a thorough overview of the
company’s employment affairs and access to all employment documentation,
including:
  A list of all employees, title, employment status, location, applicable awards,
entitlements;
 All employment contracts;
 Employment policies, practices and procedures;
 Redundancy and severance awards and agreements;
 Outstanding employee entitlements;
 Any claims or disputes;
 Leave entitlements;
 Superannuation arrangements and whether the company is in arrears; and
 information regarding independent contractors.

In doing so the purchaser should look for any possible breaches of employment
conditions which may give rise to a claim and the purchaser should also take note of
whether the employment affairs give rise to any debts.

Practically speaking, employees can be one of the most difficult aspects of purchasing
a business as the change in employment circumstances can cause some employees
anxiety and unrest. These issues are not strictly legal but advisors should encourage
purchasers to have open and frank discussion about employees who are troublesome,
being performance managed or hold key knowledge of the business and would be
detrimental to lose.

Work Health and Safety

Improper occupational health and safety can give rise to litigation. Therefore, to reduce
its liability the purchaser should thoroughly review all occupational health and safety
documentation. In particular the company’s policies and procedures and safety
inspection records. The purchaser should note any accident reports investigations,
prohibitions, improvement notices, penalties or convictions.

Other Practical Considerations

Given that a significant amount of the company’s sensitive information is disclosed to

external parties during the due diligence process, the company should ensure that
there is a confidentiality agreement that governs the use of the information being
provided by both parties. This also ensures that competitors do not engage in the sale
process merely for the purpose of accessing sensitive commercial information.

Some parties choose to set up a data room where all of the company’s documents and
the index of these documents can be made available to potential purchasers. This is
now done virtually, where the documents are uploaded to a password protected
website for that purpose. Data rooms can be quite useful but are most appropriately
used for large transactions where there is a significant volume of documents and the
advisors are going to be heavily involved in the due diligence process.

Finally, to prevent the vendor re-engaging with the company’s clients or competing
with the purchaser, it is useful to ensure that there is a covenant not to compete in
place. This can often be found in the shareholders agreement, but if not can be included
in the share sale agreement. The covenant not to compete can be tailored to the
company and could specify a geographical area, industry and period of time in which
the covenant applies. However, these restraint clauses are only enforceable if they are
considered reasonable to protect legitimate business interests.