Have you been thinking about buying your own business? You may already have begun researching industries, numbers, risks and other aspects of being a business owner. But when you finally find an exciting business to buy, the question most likely to pop into your head is “What exactly am I buying?” Interestingly enough, the converse question often pops into the seller’s head at the same time. And guess what? In most cases, your idea of what you are buying and the seller’s idea of what he is selling are very different.
So, what exactly is bought and sold in a small business transaction?
There is more than one way to skin a cat…
There are generally two ways to acquire a business. You can acquire all of the equity interests in a company (e.g., its stock) from the company’s owners. Alternatively, you can acquire all or substantially all of the company’s assets (called an “asset sale”). Each options involves different tax, legal and business risks, benefits and consequences. Below, we highlight the major considerations. Before you make a decision, it is important to understand and evaluate the positives and negatives of each option. While most small business acquisitions are structured as asset sales, it’s important to understand the fundamentals of each option in order to make an informed decision.
EQUITY SALES: TAKING STOCK OF YOUR STOCK
It is generally somewhat simpler to buy a company outright through a stock sale because you acquire an already functioning framework with all of the processes, relationships and systems defined, established and working; however, a stock sale can involve legal risks. Most importantly, a stock sale transfers liabilities, as well as assets (possibly even if they are specifically excluded in a contract). Detailed legal due diligence is required to ensure you do not acquire existing or threatened lawsuits, investigations, criminal liability, environmental responsibilities or significant debts. If the benefits of a stock sale outweigh the risks, then you will need to work with your attorney to ensure that all of the risks are properly carved out or scheduled, and that you get proper indemnification (including possibly through a post-closing escrow. You also should ensure that you have well-crafted and thorough representations and warranties from the seller.
For a seller, it’s often more advantageous to structure a transaction as a stock sale because a stock sale can generate a gain taxed at a lower capital gains rate, rather than a higher ordinary income rate. For a buyer, however, a stock sale is often less beneficial because, for example, assets are already partially or fully depreciated and any prior goodwill is already partially or fully amortized, and the buyer will accordingly have less ability to offset his business profits for tax purposes.
Why should I consider a stock sale at all?
There many situations in which a stock sale will nevertheless make the most sense for a buyer as well as a seller. For example, acquisition of a business with a significant number of non-transferrable contracts and/or licenses through an asset sale may not be practicable or even possible.
There are many other matters that require your attention, as well, such as monetary assets and liabilities (e.g., cash, accounts receivables and payables, debt). Would you like the owner to pay off all of the liabilities and collect all the cash at closing? Are you buying accounts receivable, and, if so, at what price? Are you taking over accounts payable and/or debt service? All of these matters will affect the final price you should pay, and need to be thought through and clearly communicated in your offering letter.
ASSET SALES: ASSESSING YOUR ASSETS
What I am buying?
An asset sale typically includes all or most of the following items, as applicable: business equipment, fixtures and machinery, office furniture and computer systems, delivery or other business vehicles, goodwill, trade name, supplier, customer and employee records, a covenant not to compete, training from the seller and inventory (inventory is typically priced at wholesale cost and added to the purchase price). Monetary assets such as cash, deposits, accounts receivable and payable and debt are typically not included in the transaction.
The principal advantage of an asset sale is that you set up your own company and transfer assets there, which shields you from any pre-existing risks and liabilities the company could have. The principal risk of an asset sale is that the existing company will have a non-transferable contract or license that is required to effectively run the business, and you may not be able to obtain the license or negotiate similarly favorable contract terms.
For a buyer, it’s often more advantageous to structure a transaction as an asset sale. The transaction price will be allocated between the assets bought and the goodwill acquired. The buyer can then start depreciating the assets and amortizing the goodwill based on the allocated amounts. Depreciation and amortization will generally constitute tax deductible expenses going forward.
In general, sellers benefit more from a stock sale and buyers benefit more from an asset sale, but there are numerous considerations and risks, and a competent business broker can help you make an informed and well-reasoned decision, setting you up for success.
COMER BUSINESS BROKERS is ready and able to assist you with the exciting process of buying your dream business. We can help you to find it, structure a deal that makes sense, and close efficiently and with confidence, all while maintaining the strictest confidentiality of your personal and commercial information. We hope that this adds to your understanding of the process, and we look forward to hearing from you when you decide to take the plunge. Best of luck!