THE PURCHASE PRICE - No one individual, book or computer program can tell you exactly how much you should pay for the business. However, if you have been investigating the business in question and have talked to a business broker or accountant about the purchase price you should have a reasonably good basis for determining the right price. For example, you may learn that small businesses of the type you are considering generally sell for about one and one-half times their annual gross sales in your market area. That could be VERY useful information if the seller is asking three times last year's gross sales.
DISCLOSURE OF FINANCIAL INFORMATION - At an early stage in the negotiations, specify that you want access to tax returns, books of account, corporate minutes books, and other financial records of the business.
Make it clear that you have no interest in continuing the negotiations unless the buyer cooperates fully in this respect. Also, be sure that this condition is expressed in any kind of informal "memorandum of understanding" or letter agreement between you and the seller that is drafted prior to the final contract of sale.
COVENANT NOT TO COMPETE - In most states and for most businesses, it is possible to prevent the seller from competing against you for a reasonable period of time within specified geographical areas. This is an extremely important provision to negotiate. You must prevent the seller from starting up a new business within a reasonable time and area. Although this is a very unscrupulous and vicious act on the part of the seller, there have been cases where a buyer did not obtain a covenant not to compete from the seller and the seller simply opened a similar business, taking all of the old customers, buying from all the same suppliers and stealing all his former employees and began competing against the buyer, right next store.
RIGHT TO SET OFF - The "Right to Set-Off" clause is used frequently when the seller finances a part of the selling price of the business. This is often used when the buyer and seller agree to "Waive the Bulk Sale Act". The Bulk Sale Act requires that the buyer notify all known creditors of the seller advising them that the business is being sold. The creditors now have a chance to make a claim, if any, for amounts owed to them by the seller. This can often take a long period of time. In many cases, the buyer may not want to alert the creditors that a sale is in the works, not because there is any intention of not paying the creditors but simply because they do not want to upset any relationships and credit lines they may have established. Therefore, more often than not in small business transactions, the Bulk Sale provision is usually waived or not complied by the parties. If there is no compliance, it could prove extremely fatal for the buyer since he will be responsible for the debts left behind or overlooked by the seller. To protect the buyer against such claims, the right to set off is used.
Here is an example of how a bulk sale waiver would work. Let's assume that, after the sale is consummated, a creditor asserts a claim against the business, and that claim was determined to be due during the time it was owned by the seller. Technically, the buyer would be responsible to pay the creditor, but because the buyer has the right to set off, the buyer will use the sellers note payment and pay the creditor with the sellers money. Without this provision, the buyer will have to sue the seller to recover any monies.
ALLOCATION OF PURCHASE PRICE - One item that is often omitted in business sale agreements, perhaps because it is not absolutely necessary, is a provision in the agreement that spells out how the parties agree to allocate the purchase price between the various acquired assets. While this is now of a somewhat lesser importance for tax purposes than before the Tax Reform Act of 1986, it can still be quite important in certain situations.
The '86 Act requires both the buyer and seller to abide by an allocation formula based on the fair market values of the cash, securities, and other assets such as land, improvements, equipment, inventories, and intangible assets (such as patents, trademarks etc.). Any excess of the purchase price over the sum of those values MUST be allocated to "goodwill" or "going concern" value, which is an intangible asset that cannot be deducted, depreciated or amortized by the buyer. Seek to minimize allocations to land value, and Liquor or beer licenses, since these are also not deductible for income tax purposes.
Furniture, Fixtures & Equipment - Usually, this item will have the most allocated to it. As of this writing, these assets can be depreciated over a 5 year period.
Inventory and Supplies - This item can usually be written off in the first year therefore should be given the most consideration.
Customer Lists - Courts in recent years have allowed some buyers to deduct the value of customer lists, where an allocation was made in the purchase agreement as to the agreed value of each customer being acquired, and any such customers are subsequently lost. That aside, customer lists are written off over a 15 year period.
Covenant Not To Compete - Obtaining such a covenant from the seller can be an important negotiating point for non-tax reasons, as well. For tax purposes, the courts will usually uphold a reasonable value for such a covenant agreed to by the parties. Note that you can deduct or amortize the cost of the covenant over 15 years, regardless of the period of the covenant. Also, the courts have held that if the parties don't agree in the contract of sale that such a covenant has a particular value, then it is considered to have NO value for tax purposes, In other words, YOU LOSE, tax-wise, if you fail to include a purchase price allocation in the agreement of sale.
Other Intangible Assets - The courts have upheld similar tax treatment for buyers (and possibly with potentially beneficial capital gains treatment to the seller as well) for purchase price allocations to various other types of intangible assets. The tax life is 15 years as well.
Employment Contracts or Consulting Agreements - Often, the seller may agree to stay on, either as an employee or consultant to the buyer. The purchase price may include some type of remuneration.
Purchase Options - A buyer and seller can agree to allocate part of the purchase price to the option granted by the seller on a piece of real estate or adjacent or supplemental land that is not being sold in the transaction but for which the buyer can purchase in the future. If a value is assigned to this option, its value can be written off over the life of the option.
TAX NOTE: New tax regulations require that, whenever a business is bought or sold, both buyer and seller must file Form 8594 with the IRS reporting certain information about the purchase price allocation. Remember, if there is a purchase price allocation in the sale agreement, include a provision that requires both parties to report the transaction the same way for tax purposes, in accordance with the agreed purchase price allocation. Penalties for failure to file this form can be significant. The information on the two Forms 8594 should be identical, or you will both be inviting IRS audit.
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