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Purchasing A Business – The Right Way

Tax and Financial News

June 2007

Purchasing A Business – The Right Way

Strong companies are bought and sold every day. While purchasing an established business has many advantages, there are some significant disadvantages that the wary buyer should avoid. In the next few paragraphs, we will discuss some points to consider if you are planning to buy an existing business.

Should you go it alone?

Too often, potential buyers enter into negotiations with a seller before seeking expert advice. A purchaser should consult knowledgeable business professionals before agreeing to acquire a business. Ideally, you should consult with someone who has experience in purchasing established businesses or who has a broad overall knowledge of business and business finance. Particularly important will be finding someone who can help you properly value the business.

For example, an employee of an upscale clothing store once agreed to purchase the business for approximately $400,000. Prior to finalizing the deal, the potential purchaser consulted with a CPA. After analyzing the historical financial trends of the shop and the current economic environment, the professional was able to demonstrate to the seller and the purchaser that the net value of the business was $250,000. While the advice may have cost several thousand dollars, it was only a fraction of the $150,000 reduction in the purchase price. As it turned out, the shop would not have been able to support the additional debt load and the buyer would have lost her life savings.

What kind of company are you buying? Is it a corporation or a partnership? What is the best way to structure the purchase to avoid taking on any liabilities from the prior owners? If there are tax attributes of interest, how do you preserve them? These are just a few of the questions you need help answering in the course of negotiation. While you could strike a deal with the seller on your own, it’s likely he or she will use an attorney and an accountant. Shouldn’t you have the same advantages?

How much is the business worth?

Valuing a business is, at best, a rather imprecise science. There are a number of different methods to determine that value, each with its own strengths and weaknesses. The method of valuation depends on a number of factors including the industry in which the business operates, how significant hard assets are to the business versus goodwill and other intangibles and how leveraged (amount of debt) the company is.

The starting point in valuing a business is generally its historical financial statements, but that is only a starting point. How reliable are those financial statements? On what basis is income and expense reported? Are the assets being presented at realistic values? Depending on the type of business, you may need equipment and real estate appraisers in addition to business valuation assistance. Don’t be bashful about fully investigating the factors that go into valuing a potential acquisition. It is better to have too much information on the front end than be hit with surprises later on. If the current owner(s) of the business are not forthcoming with information, you need to carefully evaluate the reasons why. Generally, there is no reason for a seller to be anything less than candid.

Do you buy assets or stock?

With the advent of limited liability companies, more businesses are formed as “pass-through” entities (partnerships, etc.), but there are still numerous corporations in existence. When the owners of a corporation decide to sell the business, their general preference is to sell stock. This allows them to pay tax on their net gain at capital gains rates and avoid the double taxation inherent in the sale of an asset sale.

In limited instances, you may wish to buy stock instead of assets. This primarily occurs when the corporation has significant tax attributes the buyer wishes to retain. More often than not, however, the better route for the purchaser is to buy the assets. This is especially true when the business is purchased for a greater amount than the company’s recorded net worth.

If you purchase a company for greater than its net worth, that means you believe the assets are worth more than their recorded value. If you purchase assets rather than stock, you will be able to record them at their fair value. This will, in turn, increase their tax basis and save you needed tax dollars. Purchasing assets will also relieve you of any liabilities associated with the old corporation.

Careful consideration must be given in deciding how you will structure a business acquisition.

Conclusion

Acquiring an existing business can help you become your own boss more quickly and without the need to spend months or years building a reputation for your company. There are numerous pitfalls in structuring a purchase that a buyer might not think about until it’s too late. If you are considering acquiring a business, give us a call. Let us help you make sure to structure an agreement that is one which you and your company can live with.

Enjoy the beautiful weather that June generally brings.
 

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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