21 Dec Point to consider during the sale of a business
How to acquire the “human assets” when buying a business
For many businesses, their people are the most valuable assets. Key employees can offer important skills and expertise, knowledge, reputation and relationships – attributes which are often critical to a business’ success.
So, when purchasing a business, along with other assets such as plant and equipment, the premises and goodwill, it is important to also consider whether to acquire the “human assets”.
Purchasers can entice and incentivise key employees to remain with the business after it changes hands by including contractual protections in the form of an earn out provision in the sale of business agreement, and restraint of trade clauses in the sale of business agreement and their employment contracts.
Earn out Provisions
An earn out clause in a sale of business agreement is used to reflect an agreement between the seller and purchaser that part of the purchase price will be paid after completion of the sale, and conditional upon the business achieving certain financial or performance objectives.
For example, where key business people hold a stake in the vendor company, and a purchaser wishes for those people to remain in the company or business, then an earn out provides an incentive for them to stay on in some director or management capacity, and to continue to make real efforts to help the business succeed. An earn out period will also give the purchaser some time in which they can build their own knowledge of the business, and to establish new and independent relationships with clients.
In negotiating an earn out provision, purchasers should think about practical issues such as:
• What will happen in the event that the business only achieves part of an earn-out milestone, or if the key individual leaves the business;
• The extent to which the seller and purchaser will have ongoing control over the business, and how that will tie in with the milestones. For example, if the purchaser has the ability to make major changes to the business, then the seller may argue that this relieves them from future responsibility for the business’ performance; and
• The ongoing level of support that the purchaser will provide in meeting future targets, especially if the business purchase is an acquisition by another company.
Restraint of Trade
Including a restraint of trade covenant to cover the employment of key individuals can also incentivise those people to stay with the business, and protect the business’ client and supplier network. The clause may state that the key individuals are prohibited from:
• soliciting or “poaching” clients or accepting approaches from clients and, if required, other employees from within the business after their departure; and/or
• damaging key relationships which the business has in the event that the vendor does depart the business for whatever reason, whether voluntarily or due to termination.
To achieve this, the clause may restrict the individual from operating in the industry generally for a specified period of time and/or within a specific geographical areas following termination of employment or a settlement of a sale of business or sale of shares.
As a matter of public policy, people have a fundamental right to be able to earn a living. In line with that thinking, if a restraint of trade clause is challenged, then the courts will consider that clause is only enforceable where the party seeking to enforce the clause can demonstrate that it is reasonable in all the circumstances.
The question of reasonableness will depend upon all relevant circumstances including the scope of the restriction (such as time period, geographical area), and the level of skill and expertise of the individual, as well as the amount of remuneration or other financial benefit provided to the employee under the contract (such as the acquisition of shares in the company).
Contractual terms such as earn out provisions and restraint of trade covenants can be useful tools for purchasers who are acquiring a business and wish to retain key persons after the sale is complete.
However, it is important that these contractual terms are carefully drafted to ensure that the terms stand up as enforceable, and will practically cover all of the issues which are important to the parties, as well as minimise the risk of disputes.
Do you have queries relating to the sale or purchase of a business? Contact Solari and Stock Miranda on 8525 2700 to make an appointment with one of our Commercial Law Team or click here to request an appointment.