Common Pitfalls in Buying a Business – Structure of the Deal ©

Note: The following article is not legal advice. Competent legal, tax, and financial counsel should be obtained before doing a deal.

Common Pitfalls in Buying a Business – Structure of the Deal ©

By: Dennis J. Gerschick, Attorney, CPA, CFA

This is the third in a series of articles that will address the mistakes that are commonly made by purchasers of a business. When a buyer is considering the purchase of a business, the buyer can either: (1) buy selected assets from the selling entity; (2) buy the entire selling entity; or (3) merge the selling entity into either the buying entity, the buyer’s subsidiary, or vice versa. Each option has advantages and disadvantages. The structure that is selected has many consequences – legal, tax, and practical.

Buying selected assets from the seller has several advantages. First, the buyer can “cherry pick” the assets it wants. The buyer does not have to purchase all of the seller’s assets, some of which may not be wanted or needed. Second, the purchase price paid must be allocated among the purchased assets. Technical rules provided by the Internal Revenue Code and tax regulations must be followed in this area. The key advantage is that the buyer may be entitled to an immediate deduction for part of the purchase price paid. Further, the buyer will be able to “step-up” the tax basis of the purchased assets, and may be entitled to depreciation deductions for some of them. This is true even if the seller had already fully depreciated the assets sold. Third, the buyer’s fear of taking on liability for undisclosed liabilities causes many buyers to structure their purchase as a purchase of assets. The selling entity remains liable for its liabilities, and the buyer only assumes responsibility for the seller’s debts and liabilities that it agrees to assume.

Buying selected assets from the seller also has several disadvantages. First, buying assets is a taxable event for the seller. The seller’s tax liability should be considered. Many buyers and sellers do not consider the tax consequences until after the deal is done. This is a big mistake. Second, buying assets may cause sales taxes to be owed; the applicable state law should be considered. Third, the buyer should consider what is to be done to document the transfer of title of the purchased assets. If the buyer is purchasing many vehicles, title to each vehicle must be transferred. If real estate is involved, a real estate closing is needed. You should consider whether state transfer taxes will be owed. Generally, a purchase of assets is more cumbersome and time consuming than a stock purchase so legal fees may be higher. However, the advantages of an asset purchase often outweigh the disadvantages. Consequently, the overwhelming majority of purchases of closely-held businesses are structured as an asset purchase.

In contrast, if the buyer purchases all of the stock of the selling entity, there is no need to transfer title to the entity’s assets. The selling entity continues to own its assets and it remains liable for all of its obligations and debts. The only thing that has changed is the ownership of the entity. The buyer of the entire entity is, in effect, buying all of the selling entity’s assets and liabilities, whether they are disclosed or not. Generally, the due diligence should be much more extensive if the buyer is purchasing an entity. Sellers often prefer to sell their stock because they will usually get capital gain treatment and only one level of tax is incurred. Again, the tax consequences should be considered before the deal is completed.

© 2007 Dennis J. Gerschick All Rights Reserved

Author:.

Dennis J. Gerschick, Attorney, CPA, CFA 2691 Blairsden Place Kennesaw, Georgia 30144 dennis@gerschick.com www.Gerschick.com Dennis Gerschick is a CPA, Attorney,Chartered Financial Analyst, and Venture Capitalist. He started a venture capital fund in 1999 and continues to manage it. As an attorney, he represents both purchasers and sellers of businsesses. He also represents companies seeking capital and investors making a capital infusion either as a loan or the purchase of an equity pos...

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