Understanding Leave Entitlements and Your Business Sale.
When it comes to selling your business, the management of leave entitlements can be a factor that impacts your outcome.
This often overlooked aspect can be the difference between a smooth transaction and a protracted and bumpy process.
Dive into the intricacies of handling leave entitlements, an area where attention to detail can dramatically sway your business sale's success or failure.
Leave Entitlements and Their Impact
During the due diligence phase of business exits, one of the topics that usually attracts attention is unused leave entitlements.
This can be a melting pot of conditions and rules involving Fair Work Australia, the National Employments Standards, pre-modern awards and modern awards, Enterprise Agreements and Individual Agreements.
National Employment Standards (NES): A Foundation
The National Employment Standards (NES) sets minimum employment standards and entitlements that have to be provided to ALL employees – including leave entitlements, which are listed below.
The list is separated into 2 groups – the first group includes paid leave entitlements that accumulate if not used (based on the employee’s ordinary hours of work) and the second group which includes paid or unpaid leave entitlements that are available when certain circumstances and criteria are met, however, do not carry over or accumulate from year to year.
Accumulating Leave Entitlements
- Annual leave - 20 days paid leave per year *
- Long service leave (based on State or Territory regulations)
- Personal/carer’s leave - 10 days paid leave per year *
* for full time employees so on a prorated basis for part time employees
Special Leave Entitlements - Non-Accumulating Leave Entitlements
- Compassionate leave – 2 days paid leave each time
- Family and domestic violence leave – 10 days paid leave per year
- Parental leave – up to 20 weeks leave with related entitlements
- Community service leave – unlimited unpaid leave except for Jury Duty
- Public holidays – as declared and gazetted by each State government *
Note: Bereavement leave is not included in the NES standards, so practices or policies vary from business to business. [ All details of leave entitlements are valid as of February 2024. ]
Leave Entitlements For Casual Employees
Casual employees are entitled to a limited number of paid entitlements as follows:
- Long service leave – eligibility is subject to State legislation
- Family and domestic violence leave
The Financial Implications of Inaccurate Leave Entitlements Liabilities
Leave entitlements attract a lot of attention when it comes to due diligence and negotiations on an offer.
The greatest concern is the full and accurate recognition of the financial liabilities for unused leave in the business’s accounts.
Besides recognising the liability, another concern is whether the earnings or profitability of the business is accurate if leave entitlements have not been expensed each month and year as they are being incurred.
Strategic Management of Leave Entitlements
Annual Leave: A Delicate Balance
It is common for most businesses to monitor annual leave entitlements and record the liability.
In highly demanding workplaces many employees don’t take their full annual leave entitlement, so balances build up.
Employees can see these balances as a form of bank account which increases in value every time their compensation increases.
Not only does the cost increase so does the risk of burn out and other health conditions.
Long Service Leave: An Overlooked Aspect
Depending upon the age of the business and the turnover of staff, it is less common for businesses to monitor and record the long service leave cost and liability, as it builds up.
In the minds of many business owners, long service leave entitlements don’t materialise until the employee has 10 years continuous service, so it is given little or no attention.
Interestingly, in certain structures, owners are not employees or in other cases, they don’t see themselves as employees, so the entitlement can be overlooked.
A pro-rata long service leave entitlement becomes a factor in terminations and redundancies (in a number of States) once the employee’s tenure reaches 5 or 7 years.
Long Services Leave (LSL) is payable to casuals, which is recognition how many people in the economy are employed on this basis over the long term.
Prudent Approach For Long Service Leave
Consider monitoring and recording long service leave entitlements for all employment categories once the employee reaches 5 years continuous service.
This provides the management and owner of the business visibility into the costs and how the liability accumulates.
Personal / Carer’s Leave: Hidden Complexities
It is rare to see businesses record their Personal / Carer’s leave expense and liability even though it is often monitored for productivity reasons or for employee patterns and potential abuse.
Unlike annual leave, it is not an entitlement that is paid out upon termination (voluntary or involuntary) – which may explain why it is not recorded in the accounts.
Prudent Approach For Personal / Carer's Leave
Due to the fact that the entitlement accumulates, and the liability increases in value in line with compensation reviews, it is prudent to understand the quantity of hours and value that could be payable if employees have a prolonged illness or recovery period.
Leveraging Technology for Transparency and Accuracy
Most payroll systems or SME business accounting packages such as Xero and MYOB have capabilities to process your payroll and track, quantify and report all of the leave entitlements, costs and liabilities.
The steps and time to journal the expenses (as provisions) and leave liabilities are quite simple.
So why don’t bookkeepers or accountants do so every time there is a pay run or alternatively, on a monthly basis?
One reason is it doesn’t have a tax consequence, so including them in the accounts doesn’t seem to add any value – until it comes time to sell your business.
Legal Considerations and Compliance For Leave Entitlements And Your Business Sale
Share Sale vs. Asset Sale: Understanding the Impact on Employee Entitlements
- Employer Liability in Share Sales
When a company owns a business and it is sold by way of sale of its shares, there is no change of employer and the liability for employee entitlements remains with the company. - Asset Sales and Employee Transfers
On the other hand, when a buyer acquires certain assets of a business and takes over its staff, the employer changes and in the process, employment contracts are terminated and new ones entered into.
Navigating Entitlements in Contract Negotiations
Legal representatives from both sides will meticulously examine each entitlement during the negotiation and preparation of the sales contract .
They will assess the cash adjustment to be made on the purchase price at settlement, to adequately cover employee entitlement payouts.
Financial Adjustments and Tax Considerations
The Interplay Between Buyer Liability and Seller Reimbursement
Typically, employee entitlements are paid out by the buyer unless the employee is being made redundant, which is the seller’s responsibility to pay.
When the buyer takes on a liability it is generally agreed to reduce the amount of the cash adjustment on the agreed price to reflect an after-tax position.
In other words, when the buyer pays an employee entitlement, they will receive a tax deduction for that payment.
The seller reimburses the buyer for the amount paid less the tax deduction or benefit received.
This provides the management and owner of the business visibility into the costs and how the liability accumulates.
Leave Entitlements and Purchase Price Adjustments Example
As an example – if the buyer’s tax rate is 25%, the seller’s adjustment will be 75% of the entitlement amount to be paid. Actual tax rates will be applied to vary the adjustment.
Background
- Leave entitlement amount = $100,000 (Buyer Liability)
- Buyer's tax rate is 25%
Settlement Adjustment
- Sale proceeds reduced by $75,000
- Seller's tax deduction $25,000
It is common for the parties to agree to deduct the full amount of the employee’s annual leave entitlements from the value of the purchase price for this reason.
Special Considerations for Personal and Long Service Leave
Personal Leave: A Unique Negotiation Point
Personal leave is not paid out to an employee when they are terminated. Although some employees have personal leave accrued, they may never take that leave. Accordingly, personal leave becomes a negotiation point between the parties.
Long Service Leave Entitlements: Navigating Pro-Rata Adjustments
In most States and Territories, employees can only take long service leave if they have worked in the same business for over 10 years.
An employee may, however, receive a pro-rata payment of their entitlement to long service leave if they have been an employee in the business for at least five years or seven years.
Accordingly, many standard contracts include an adjustment to the price for the accrued value of long service leave for employees who have at least five years’ service - figures the owner should be aware of.
Leave Entitlements And Your Business Sale Preparation
Having confidence that you are on top of these numbers and costs goes a long way in moving your discussions forward.
If the buyer or their legal representatives have to ask you, and then wait while you construct the current status of these costs and liabilities, it will more than likely undermine their confidence in you and your business. And could impact what they offer.
Furthermore, your earnings numbers will be adjusted downwards by the buyer once these costs are understood and deducted from your profit and loss figures.
It is better to include these costs in your profit and loss, so everyone is well informed at the outset and the process moves forward more quickly and with greater confidence.
Buyers will want to see at least 3 years of your profit and loss statements – make sure all 3 years account for these costs.
That is why the best time to start is now!
Another reason to get in front of the adjustments and the impact on the price is to ensure you can plan with confidence and be more relaxed throughout the process.
The best time to plant a tree was 20 years ago. The second-best time is NOW! ~ Chinese Proverb
Key Takeaway: Proactive Leave Management Pays Dividends
In the complex journey of preparing your business for sale, understanding and strategically managing leave entitlements are crucial.
This not only ensures compliance and financial accuracy but significantly enhances your negotiating position.
By proactively addressing the potential make-or-break factor of leave entitlements, you position your business as a more attractive and valuable proposition to potential buyers.
What steps will you take today to turn this potential challenge into a strategic advantage for your business sale?