Purchasing a business is one of the most important financial decisions you make. Buyers-to-be are often asking us questions outlined below, which we hope will help guide you when considering a new business acquisition. Please note that every situation is different, and we cannot provide you with uniform advice that will work in every situation.
Should I purchase equity or assets?
Buyers generally prefer to purchase assets over equity for
liability and tax considerations. In an equity transaction (by
purchasing stock or membership/partnership interest), a buyer is
acquiring all of the liabilities of the seller-entity, whether
known or unknown. While including indemnification provisions in the
purchase agreement can impose such liability on seller, in most
situations, an asset deal is the preferred option. An asset deal is
also beneficial to a buyer from a tax perspective. The purchase
price paid for stock is not deductible by a buyer on his or her
taxes. The buyer will be limited to deducting depreciation and
amortization based on the adjusted tax basis in the
corporation's assets immediately prior to the sale. This rule
applies to corporate deals. If you purchase assets or a
partnership/membership interest, then the sale will be taxed based
on the underlying assets purchased. The allocation of the purchase
price between the purchased assets is always a key issue. The
purchase price paid for tangible assets will be deducted by a buyer
over 5-7 years (and often entirely in the year of such purchase).
The purchase price paid for goodwill will be deductible over a
longer 15-year period. A buyer always prefers a bigger allocation
to tangible assets over intangible assets.
In some situations, notwithstanding obvious benefits of an asset
deal, buyers go with an equity purchase. This usually happens when
a seller has unique corporate goodwill, such as a special
relationship with clients or a famous corporate name. Prior to
committing to an equity deal, discuss with your counsel whether you
can acquire the rights for this unique goodwill through an asset
acquisition.
Do I need my own valuation?
It is a good idea for buyers to do their own valuation of the
business being considered for purchase. If such valuation is not
available for time or cost reasons, then buyers should at least
review the valuation prepared for a seller with the buyer's
financial advisors.
Should I form an entity prior to the
purchase?
Yes, to shield a buyer personally from any potential liability, a
new entity should be formed in all asset deals. We recommend
forming an entity even if you have an existing business to protect
said business from any potential liability. Forming a limited
liability company or a corporation is fast and easy to do under
Ohio law. The choice of the entity depends on each situation and
may be contingent on whether the business has employees, the type
of business, business goals, and so on.
What if I am purchasing a new business with a
partner?
If you plan on purchasing a new business with a partner, it is
critical to spell out the terms of such partnership in an agreement
(i.e., an operating agreement, partnership agreement, or a
shareholder agreement). This agreement should include such key
terms as a day-to-day governance of the new business, how you will
make big decisions with your partner, or what happens if one of the
partners dies, retires, or decides to sell.
How should the purchase price be paid?
Buyers prefer to pay later, paying the entire (or a portion) of the
purchase price by a promissory note. However, if the purchase price
is being paid over a period of time, then a seller most likely will
request some security for that, such as placing a lien over the
purchased assets, pledging stock, or buyer-owners personal
guaranties and other forms of security.
Do I need a letter of intent?
In most circumstances, yes. The goal of the letter is to spell out
the key terms of the future transaction. A good letter should
contain basic major terms. Letters of intent are generally not
binding or enforceable; provided; however, such terms as
confidentiality and exclusivity should be made binding. While the
letter of intent is not binding, it will be difficult to
renegotiate the key terms set forth in the letter, such as a
purchase price or restrictive covenants. Therefore, the
recommendation is to include in the letter only the basic terms
what you are not looking to renegotiate, such as a price, the stock
or assets that will be sold, treatment of accounts receivable, the
manner of payment, restrictive covenants, and a closing date. It is
a good idea to include exclusive dealing terms so while a buyer is
engaged in getting financing or due diligence, a seller will not be
looking for a better offer.
Do I need to conduct due diligence?
Yes, due diligence is crucial for a buyer, especially, when a buyer
is considering an equity purchase. Legal and accounting
professionals should assist you in this process. You should review
all of the seller's financial and business records, including
existing vendors and client agreements, licenses, and permits. The
goal of such review is to make sure that the purchased assets or
interest have no encumbrances and that a seller is in compliance
with all applicable laws, including, without limitations,
environmental, zoning, and employment laws.
What are other considerations?
It is important to review all existing agreements with vendors,
clients, and customers to make sure they are assignable to a buyer.
If the purchase of the real estate is not contemplated by the
parties, a lease agreement becomes a key consideration as a buyer
needs to make sure that the business can remain on the premises for
an agreed upon period of time. Also, if you are purchasing an
existing franchise, then this adds a list of additional conditions,
including the assignability of the existing franchise agreement
with a franchisor.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.