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.
Mansour Gavin’s Corporate and Business Services Group understands the complex issues that can occur in business transactions and can help you navigate the process. We offer comprehensive legal guidance on all business-related matters that you may face when buying or selling business interests. Contact us today.
