[EP 275] The Devil’s in the Detail: Best Practice in Contracting for Business Brokers, Accountants & Advisors

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Intro [00:00:00]:

Ladies and gentlemen, good evening. Are you ready? Okay, here we go. You’re listening to the Deal room podcast. Join us as we bring you the inside scoop on business, sales and acquisitions, get across trends in the area and hear the industry’s best recount their real life tips, traps and experiences. Now here’s your host, Joanna Okie.

Joanna Oakey [00:00:25]:

Hi, it’s Joanna Oakey here, and welcome back to the Dealroom podcast, a podcast proudly brought to you by our commercial legal practice aspect, legal now, in today’s conversation, we have something a little bit different. As part of a presentation I did recently with the Australian Institute of Business Brokers, I covered some absolutely critical tips for and advisors working with business owners when they are buying or selling a business. The question that was asked was, when you are putting together a heads of agreement, what are the risks for you as a business broker? The answer was probably a lot longer than expected. But as you’re about to hear, we covered a lot of ground, explaining that the devil is in the detail when it comes to contracts and what creates binding relationships in them and risk for you. If you’re an advisor, this episode covers what actually constitutes the formation of a contract before it gets to a lawyer. What creates a binding relationship where the risk life you if you are an advisor to a business, and some of the traps I’ve seen advisors fall into when putting together an offer. So employee entitlements, for example, are just one of them. And lastly, I cover in this episode what you can do to avoid taking on unnecessary risk.

Joanna Oakey [00:01:58]:

But that still gets enough detail across to the deal team in a way that avoids slowing down a deal. Now, all of these are really important to keep in mind. So without further ado, here we go. On my take on where the risks.

Joanna Oakey [00:02:17]:

Are, the relevance of what is a contract, how do you form a contract? It’s not so relevant for the sale contract that we’re dealing with the business sale agreement, because that’s usually dealt with by solicitors and it’s quite a formal agreement. And as to whether there’s a binding contract is pretty obvious. Usually there’s not an issue with that. Where I think it’s particularly relevant to understand the things that contribute to a contract, things that maybe create issues with the creation of the contract. And when we’re talking about create a contract, what we’re actually talking about here is creating enforceability. So creating something that is enforceable by one party against another is the documents that you deal with that might be outside of when the time in which lawyers are engaged. So that can be heads of agreement, your letter of understanding, your mor, memorandum of understanding, letter of intent, whatever you’re calling mean. One of the fabulous things I think in this world is the number of different names you can give the one document.

Joanna Oakey [00:03:23]:

And people often say to me, okay, what’s the fundamental difference between a memorandum of understanding and a letter of intent, or an NBIO non binding indicative offer or a commercial terms document? There is no relevance of the title. All this is where we seeking to set out the high level commercial terms before the parties, before either of them go and commit expense to getting further into the deal. That’s the idea of these sort of high level documents. And the only question is the extent to which any of them are enforceable. So the name of the document, what you call it, doesn’t matter, it has no impact. What is important is whether and the extent to which any component of it would be seen to be enforceable. And so this is where you’ve got to be careful, because quite often you’re at the cutting edge of crafting these documents. And if that’s what you’re doing, you just have to be clear that you’re crafting it in a way where you’re not accidentally making it enforceable if you didn’t intend to, or not making it enforceable if you did intend to.

Joanna Oakey [00:04:34]:

Now, there’s generally what happens is in this office stage, the only bits that we want to make enforceable are usually two provisions. One is confidentiality. But you should always have a separate NDA or confidentiality agreement in any event to protect the seller’s information, confidential information, before passing it over to the buyer or prospective buyers, and the exclusivity. So quite often a buyer will want a period of exclusivity. And this depends on transaction size. But once we hit a particular transaction size, it will almost always be the case that the buyer wants a period of exclusivity while they’re committing funds to go and do their dd, and while you’re negotiating the sale contract. So where that’s the case, you just have to be careful that what you’re drafting doesn’t create a binding relationship if that’s not intended, or doesn’t achieve a binding relationship if that is what is intended. If you’re using an NDA, make sure you’re using and NDA that works properly, because that’s an example of something that you want binding.

Joanna Oakey [00:05:48]:

You want it to be binding in nature. And if you’re creating, I see so many different versions of these heads of agreement or commercial term sheets or whatever you call them in your own world. One of the issues that I do see from time to time is too much detail. The amount of deal that you put in this heads of agreement can be a direct reflection on the risk that you’re taking on board yourself. Because let’s say for an example, the area of employee entitlements, now employee entitlements, this area is fraught. And I’ve got to say I spend a lot of time training our team on it. These people who understand the law. I think as a whole industry wide, perhaps it’s even more confusing than anyone really even anticipates.

Joanna Oakey [00:06:43]:

I’ve just finished a client information sheet that we use to send out to our clients, that is eight pages explaining the high level things for them to be aware of. And I’ve just finished an internal guidance note for all of our team who work on these deals. That is 26 pages and that doesn’t even include all of it. So that’s an internal guidance note. So that just gives you an idea of the amount of complexity that is sitting behind employee entitlements. So what you don’t want to do is what I have seen happen in the past, you don’t want to in your heads agreement, commercial terms, whatever you’re calling it, set out a full clause about whether or not the buyer will recognize service, whether or not and how those things will be dealt with. Because you are probably weighing into and area that you probably don’t fully understand the consequences of on both sides. So don’t put that sort of detail into the heads of agreement.

Joanna Oakey [00:07:44]:

That’s something that the lawyers are paid to take the risk of in terms of explanation to their clients. So that’s an example of an area where I see people brokers put detailing that doesn’t need to be there. Well, I’ll give you an example of the complexity of the personal leave side if we talk about the three different state based contracts. So New South Wales, Victoria and Queensland, which is where sort of the volume of business sales activity happens. But if we just talk about the standard form contracts that come out in new south sales, Victoria and Queensland, we have three different approaches to personal leave and how personal leave is calculated there. So Victoria has a standard position of a calculation of 35% adjustment for personal leave. New South Wales has a tick a box exercise. You can apply adjustment, at which point it will be a 70% adjustment.

Joanna Oakey [00:08:47]:

70% adjustment is on the basis of a tax discount, not a contingency discount, if that makes sense. I’ll explain what that means in a second, but it only applies if there’s a ticker box. So if the box isn’t ticked, the personal leave liability will probably pass to the buyer. But there is no adjustment that is made if the box isn’t ticked. And Queensland, the REIQ contract just doesn’t distinguish personal leave. It’s dealt with in the same as all other leave. The problem is that personal leave is a contingent liability, not an actual liability. And that’s why we have this tic tacking between the buyer and seller sometimes if they understand the issues that are involved.

Joanna Oakey [00:09:35]:

And so I quite like the victorian approach, but just the mere fact, and here’s a funny thing, Reiq calls it sick leave. Now we haven’t called this sick leave for, I reckon, 20 years or so. So it’s still adopting the terminology that we used before the personal leave concept came in. So this is an example of how it’s such complex issue that it is different state to state. It’s not different legislatively state to state. It’s just different in how the state based contracts are prepared. So that just gives you an idea of how complex the issue is. Because these people who’ve created the state based contracts haven’t even got on the same level as to how to deal with all of this.

Joanna Oakey [00:10:20]:

If there’s an agreement in relation to personal leave, 70 30, in fact, there would always be a 70 30 split anyway, or 75 25. The 70% adjustment is on the basis of a tax deduction. Does that make sense? It’s not a deduction on the basis of the fact that personal leave is a contingent, not an actual liability. So that means if you’re out there negotiating with the buyer and seller to 70%, that is in fact what it would be anyway. So that’s not a contingent adjustment. A contingent adjustment might be the 50 50, but the way I actually do it is I look at the value of the employee entitlements and the length of service and then sometimes even sort of how the usage sort of sits. And then we work out some approach around there. I generally opt more to 25% or 35%, but that’s if I’m sell side.

Joanna Oakey [00:11:21]:

If we buy side, of course we might want more protection. But then there’s other ways that we can get to that. It doesn’t necessarily just have to be on the basis of the adjustment. But the point is, if you’re out there negotiating, boy, that’s a lot of stuff you have to have in your mind. I’d just be very careful and I think it’s very and the problem is you won’t necessarily end up with a lawyer on the deal who fully understands what’s going on in this area anyway. Right. And we all know we don’t want this sort of stuff to slow the deal down and create issues. So I completely understand you want to get in there on the front foot and try and help to negotiate something that seems to work for both sides.

Joanna Oakey [00:12:07]:

But just be aware that there’s a whole heap of risk there if it’s not properly explained to either party. And so I would suggest, by all means, go negotiate. Make sure you do it with a really big disclaimer of but I’m not a lawyer. I can’t tell you the ramifications in terms of the employee, the obligations that you have and employee entitlements as a whole. I would say it from that perspective. And then if you want to put something in the heads of agreement, you could say the parties have agreed that they may want to split it, something like this. So don’t use absolutes and don’t create the environment where it looks like you’ve advised a certain, I mean, by all means try and negotiate it, but just give yourself lots of buffer so no one’s holding you to account. If you haven’t explained what may happen when the buyer realizes the actual liability they’ve taken over, or the seller realizes there could have been a different way or that there was also something sitting in long service leave that they hadn’t contemplated or all of those sorts of things.

Joanna Oakey [00:13:23]:

Just give yourself protection is the answer.

Joanna Oakey [00:13:28]:

Well, that’s it for this episode of the Deal Room podcast.

Joanna Oakey [00:13:32]:

I hope you enjoyed this episode.

Joanna Oakey [00:13:34]:

And if you’ve got any other questions after listening through this, or if you’ve got a buyer or seller who is ready for contracting who needs help with this stage of their deal, please don’t hesitate to reach out to us.

Joanna Oakey [00:13:46]:

Check out the details in the show.

Joanna Oakey [00:13:48]:

Notes or contact me at joanna [email protected].

Outro [00:13:54]:

Au ladies and gentlemen, that will conclude this evening’s entertainment. Thanks for listening to the Deal Room podcast. To find out more about this episode and other episodes in the series, check out the show notes or head over to our website [email protected] au.