You have found the right business. The financials look strong, the location is perfect, and the customer base is loyal. You agree on a price that reflects not just the stock and equipment, but the "goodwill"—the reputation and client relationships the seller built over years.
Imagine handing over the cheque, taking the keys, and opening the doors. Three months later, revenue drops by 40 per cent. You discover the previous owner has opened a similar business five kilometres away and emailed their entire former database to offer a "grand opening discount."
This scenario is not hypothetical. It happens frequently in Australia when buyers fail to secure a watertight sale of business contract review. The primary mechanism to prevent this is the "Restraint of Trade" clause. However, getting these clauses right is a delicate balancing act. If they are too weak, they are useless. If they are too strong, a court may strike them out entirely.
The Value of Goodwill
When you buy an existing business, a significant portion of the purchase price is often allocated to goodwill. You are paying for the probability that existing customers will continue to patronise the business.
If the seller can immediately compete with you, that goodwill effectively evaporates. The law recognises this risk. Unlike employment contracts, where courts are very reluctant to stop someone from earning a living, courts are generally more willing to enforce restraints in a business sale. The logic is simple: the seller received payment for the goodwill, so they should not be allowed to take it back.
However, protection is not automatic. It must be explicitly written into the contract.
Non-Compete vs Non-Solicitation
Restraint clauses usually fall into two categories. Understanding the difference is necessary for an effective business agreement review.
Non-Compete Clauses
A non-compete clause prevents the seller from operating a similar business within a specific area for a set time. It stops them from setting up shop down the road.
For example, if you buy a dental practice in Geelong, a non-compete might ban the seller from practising dentistry within a 10-kilometre radius for three years. This gives you clear air to cement your relationship with the patients.
Non-Solicitation Clauses
Non-solicitation fails to stop the seller from opening a business, but it restricts who they can target. It prohibits the seller from approaching your clients, suppliers, or staff.
This is often harder to police. If a former client walks into the seller’s new shop of their own accord, a non-solicitation clause usually won't stop the seller from serving them. It only stops the seller from actively enticing them.
The "Reasonableness" Trap
Many buyers assume that a stricter clause is better. They ask for a restraint that covers "all of Australia" for "10 years." This is a dangerous mistake.
In Australia, a restraint of trade is prima facie void (invalid) unless the party relying on it can prove it is reasonable. It must protect a legitimate business interest and go no further than necessary.
If a court decides a clause is too broad, they will usually strike it out completely. They will not rewrite it to make it reasonable. If your contract says "10 years" and the judge thinks 10 years is excessive, you end up with zero years. The seller is then free to compete immediately.
Factors courts consider include:
- Geography: Does the business really draw customers from across the state, or just the local suburb? A cafe might justify a 5km radius; a specialised manufacturing plant might justify a national restraint.
- Duration: How long does it take to replace the seller's influence? Three years is common for business sales; anything longer attracts scrutiny.
- Scope: Are you stopping them from working in the industry entirely, or just a specific role?
This principle applies broadly. For those looking at Business Agreement Review: A Pre-Signing Checklist for Small Business Sales, assessing the reasonableness of restraints is a priority item.
The Solution: Cascading Clauses
Because it is difficult to predict exactly what a judge will consider "reasonable" years down the track, competent lawyers use "cascading" or "ladder" clauses.
These clauses list multiple options for distance and time, which are treated as separate and independent provisions. For example, the restraint applies for:
- 5 years; or if that is invalid,
- 3 years; or if that is invalid,
- 2 years.
And covers a radius of:
- 20 kilometres; or if that is invalid,
- 10 kilometres; or if that is invalid,
- 5 kilometres.
If a dispute arises, the court can cross out the unreasonable options (e.g., 5 years) and enforce the reasonable ones (e.g., 3 years). Without this structure, you risk losing all protection.
Franchise Specifics
Buying a franchise adds another layer of complexity. You are dealing with two distinct agreements: the sale contract with the outgoing franchisee and the franchise agreement with the head office.
A franchise contract review must check that the outgoing franchisee is restrained. The franchisor cares about protecting their brand, but they may not care if the old franchisee steals clients from you, as long as the royalties keep coming. You must ensure the sale contract specifically prevents the former owner from competing with your specific territory.
Furthermore, academic research into the use of the written contract in long-lasting business relationships suggests that detailed contracts reduce conflict by managing expectations early. Relying on a handshake or the generic terms in a standard franchise deed is rarely sufficient to protect your local market share.
The "Related Entity" Loophole
A common trick involves the seller agreeing not to compete, but then funding their spouse, child, or a separate company to open a competing business. Technically, the seller isn't competing—their wife or family trust is.
A robust sale of business contract review ensures the definition of "Restrained Party" includes related entities, associates, and anyone acting in concert with the seller. It should also prevent the seller from being an employee, consultant, or financier of a competitor.
Due Diligence Beyond the Contract
While the contract is the primary shield, due diligence provides the armour. You must investigate the seller’s future plans. Why are they selling? If they are "retiring" at 45, be sceptical.
In other sectors, such as property, transparency is improving. For instance, Navigating Queensland’s New Property Disclosure Laws highlights a shift towards mandatory disclosure to protect buyers. In business sales, however, the principle of caveat emptor (buyer beware) remains dominant. You must ask the hard questions before signing.
Government Reporting and Transparency
For businesses that contract with government entities, different rules apply regarding transparency. If you are buying a business that relies on government tenders, be aware that contract details are often public.
According to federal guidelines on contracting & reporting, entities must report contracts on AusTender within 42 days. This transparency allows you to verify the revenue streams the seller claims to have. Further data on Australian Government Procurement Contract Reporting can help you assess if the seller’s government contracts are nearing expiration—a risk a standard restraint clause won't fix.
Commercial Leases and Premises
Often, the location is the business. If the seller owns the freehold and grants you a lease, you need to ensure the lease does not contain hidden termination clauses that allow them to kick you out and restart the business themselves.
Even if the premises are new, physical issues can disrupt trade. While residential buyers worry about Building Contract Review: When the 10-Year Defects Clock Actually Starts Ticking, commercial buyers must check that the lease clearly defines who pays for structural repairs. A business that cannot operate due to a leaking roof is just as dangerous as one losing clients to a competitor.
Summary of Risks
When reviewing a contract for the purchase of a business, pay close attention to:
- The Definition of Business: Is it defined broadly enough to cover all activities you intend to continue?
- The Restraint Area: Is it a reasonable radius based on where customers actually live?
- The Restraint Period: Is it long enough to secure the goodwill, but short enough to be enforceable?
- Cascading Clauses: Does the contract use a "ladder" structure to save the clause if a court finds the primary restraint excessive?
The cost of a proper legal review is a fraction of the potential loss if the seller takes their clients with them. Do not leave your investment exposed.
This information is general in nature. Contact us for advice specific to your situation.
