When buying or selling a business much of the attention focuses on the sale price. This is understandable but it is usually not the amount which ends up becoming payable.
This is because most sale agreements provide for adjustments to be made to the sale price to take into account things like:
- A deferred portion of the price which maybe dependant on future financial performance of the business;
- An allowance for sales made, or work part-performed, by the vendor which have been pre-paid, but which the purchaser will need to honour;
- Significant expenses incurred by the business that are really for the benefit of the business largely after the purchaser takes over (eg. are major advertising campaign);
- Accrued entitlements of employees who are transferring with the business.
Employee leave entitlements can sometimes become a significant adjustment amount. One of our clients recently was running a business with leave entitlements exceeding $500,000. Because these entitlements had been earned by the employees of the business who were transferring to become employees of the purchaser, provisions should be included in the documentation making the purchaser responsible to pay those entitlements when they became due. To compensate the purchaser for this “inherited” expense, the sale price should be reduced by that amount. This is a common source of negotiation after the headline sale price has been agreed on, but it can make a significant difference to both parties.
Several issues arise when calculating employee leave entitlements which are to be adjusted between the vendor and purchaser:
- what entitlements are to be included;
- what allowance is to be made, if any, for entitlements which may have commenced to build up but which may never become due to the employee concerned;
- to what extent does the impact of income tax change the amount to be adjusted.
Naturally all employees should be paid their salaries up to the date on which the purchaser takes ownership of the business. But frequently the employees will have accrued some annual leave which they are not yet ready to take, some long service leave (if they have been employed for more than seven years continuously with the same Victorian employer) and unused sick leave.
Calculating a fair adjustment for unused annual leave is usually relatively simple. So too, is the calculation of accrued but untaken long service leave.
But what about the transferring employee who has been working in the business for six and a half years continuously and has had a good run with their health such that they have accumulated many weeks of sick leave (personal/carer’s leave)?
If that employee were to transfer to the purchaser upon completion of the business acquisition they may then decide to leave their new employment within the next six months for a variety of reasons. If they did so, then they would have no entitlement to long service leave because they would not have reached the minimum threshold of seven years’ service. The same employee would also have no entitlement to be paid out for unused sick leave.
On the other hand the employee may go on to have a long career with the purchaser and after only six months become entitled to 30 days long service leave (subject to the terms of the Long Service Leave Act). Fair for the employee who would have been working in the business for seven years. Not so fair for the purchaser who has only had the benefit of that employee’s service for a mere six months.
Similarly, that employee might have a change of fortune and having built up many months of sick leave entitlements with the vendor, suddenly become seriously ill within weeks of transferring to the purchaser. The employee is now entitled to be paid by the purchaser for all of their time off work sick up to the limit of their accrued sick leave entitlement. Again fair for the employee who would have been working in the business for seven years. Not so fair for the purchaser.
But on Completion Date these are unknown factors and the future could evolve either way.
At Moores we think it is fair that a purchaser and a vendor should share the risk of that liability crystallising. This will lead to an adjustment to the sale price. With the advantage of hindsight one might “win” and one might “lose”. But the extent of any win or loss are moderated, a bit like a motor car insurance policy for an agreed value.
We consider that it makes sense for appropriately negotiated pro-rata allowances to be worked into the transaction between vendor and purchaser so that the risks of influenza, a heart attack, car accident etc. are fairly shared between the parties.
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