Guide To Buying a Business

Continued Employment

Often a business owner will want to remain employed by the company after the sale. The buyer may also want the former owner on payroll so to ease transition. Especially if much of the business's operating procedures are undocumented or there are close personal relationships between the owner and the company's clients having the owner present may be crucial to the continued success of the business.

Even if you do not foresee any role for the seller in the business post closing, as a buyer you may want to structure the transaction to provide the seller with some income as salary or consulting revenue after the sale. Having the old owner engaged in an employment contract allows you to get help from the owner if you were wrong and need advice. For tax purposes, you are allowed to deduct the expense from income in the year that it is paid.

Stock vs. Asset Sale

As a buyer, you will want to structure the sale as an asset sale. Structuring the deal as an asset sale has several advantages for you. The most important advantage to an asset sale is that most liabilities of the corporation are not automatically transferred to you in an asset sale. This insulates you from hidden liabilities. For example, if the company you're buying buried toxic chemicals at a former location 20 years ago. You have no way of knowing about the potential liability. In a stock sale, the company you just bought could find itself liable for the cost of cleanup.

There are a few exceptions where liabilities can follow assets. If the sale was done as a means of trying to avoid paying debts to creditors you may find that the sale will be held by a court to be a fraudulent conveyance. In some states, for businesses where the sale price is between $10 million and $25 million the sale may be subject to the bulk sales act to prevent the use of a sale as a way to avoid paying creditors. In some cases, tax liabilities can also follow the assets. Consult a lawyer to make sure that you don't inherit liabilities with your purchase.

The seller would probably prefer a stock sale, not only because the liabilities pass to the new owner, but also because in a stock sale the seller will pay capital gains taxes on the purchase price, which can be significantly lower than ordinary income rates. In most small to mid-sized transactions, the buyer almost always wins this particular battle.

Allocation for tax purposes

When you structure the purchase of a business as an asset sale you and the buyer need to agree on how the purchase price is allocated for tax purposes. It is advantageous to you to allocate as much as the purchase price as possible to assets that can be depreciated quickly, because every dollar of depreciation is a dollar of cash flow that is untaxed. From the seller's perspective, however, there is a preference to limit the amount that is allocated to depreciating assets. If an asset is valued at the time of sale for more than the book value, the seller pays ordinary income tax rates on the difference between the book value and the amount allocated to the asset (depreciation recapture). The seller would like to pay long term capital gains rates, which are significantly lower. The compromise is often to allocate a large portion of the purchase price to section 197 intangibles, such as goodwill that can be amortized over 15 years by the buyeer and qualify for capital gains tax treatment for the seller.

Due Diligence

As part of the offer, you will reserve the right to examine the business to make sure that anything you have been told about it is substantially correct. While I don't advocate worrying if $20 is missing out of petty cash, you need to verify that sales figures, expenses, and profits were all accurately portrayed. If you do not have an accounting background make sure that you have a competent accountant help you. Do not rely on the seller's accountant.

You will need to decide how long you need to satisfy yourself that everything was accurately disclosed before you made your offer. Generally a due diligence period lasts for 30 to 90 days , usually 30-45 days for a smaller business. It is better to err on the side of caution and make sure you have enough time to examine everything thoroughly.

Previous, Crafting An Offer
Next, Final Steps In Purchasing a Business