SELLING OR BUYING A BUSINESS

Almost always, the sale of a business or the purchase of a business will be structured as either a sale/purchase of the assets of the business or a sale/purchase of the entire business entity.

It is important to note that the structure of the transaction will be a main negotiating point, because a transaction structure that is favorable for tax purposes to the seller is usually not as favorable, tax wise, for the buyer, and vice versa. Because of the taxation of the seller and the tax consequences to the buyer, a seller will typically prefer a sale of the entire entity while a buyer will typically prefer to purchase the assets of the business.

Also, for non-tax reasons a buyer will again generally prefer an asset purchase instead of purchasing the entire business entity. This is because in the purchase of the entire business entity, all liabilities, known and unknown, disclosed and undisclosed, stay with the business, while an asset purchase will avoid most liabilities of the business with some limited exceptions, such as debts and other financing arrangements that are secured by assets of the business. Unknown or undisclosed liabilities might include, for example, products liability claims, contract claims, employee lawsuits or personal injuries where such claims are being considered or prepared by as yet unknown persons but which have not yet been asserted or placed into litigation.

Sellers generally favor the sale structure of selling the entire business entity in part because it typically results in long term capital gain to the seller.

In an asset sale/purchase, each asset is treated for tax purposes as having been sold separately. The tax treatment for each may differ, depending upon the tax classification of the asset. Such tax classifications may include capital assets, depreciable property used in the business, property held for sale to customers (such as inventory), real property used in the business, and intellectual property rights. Therefore, both the buyer and the seller will need to give careful consideration to the allocation of the sale/purchase price to each asset. Also, in an asset sale, there will likely be sales tax to be paid on certain of the assets, based on the prices allocated.

In a sale/purchase of the entire business entity, all of the assets continue to be owned by the business entity and the transaction results in more of a “turn key” acquisition by the buyer. Further, the transaction results in more apparent business continuity and may well result in customers being more loyal and more likely to continue to patronize the business.

To accomplish the sale of a corporation, the buyer typically will purchase all of the outstanding shares of stock of the corporation.

The sale of a limited liability company as a business entity may be accomplished by the sale of all of the membership interests combined with the buyers becoming members themselves. This second part is important because the mere sale of a membership interest does not, by itself, make the buyer automatically a member of the LLC.

The purchase of a business (as well as the sale of a business) is all about due diligence. “Due diligence” is shorthand for knowing all about the business if you are the purchaser and preparing the business for a sale if you are the seller.

The buyer’s due diligence checklist will include such things as examining the balance sheets, income statements and cash flow statements of the business, examining the legal and corporate or LLC legal documents, minutes and statements of actions taken over the years, tax returns, agreements, mortgages, loans, financing arrangements, customer lists and judgment and lien searches, as well as other items.

A seller, knowing what will ordinarily be on the due diligence checklist of a buyer, should prepare the business accordingly, including, for example, by updating corporate and legal records, preparing balance sheets, income statements and cash flow statements in accordance with generally accepted accounting principles and making sure that all tax returns, income, sales tax and otherwise, are prepared and filed. As a seller, you do not want to be in the position of getting your house in order during the same time that you are negotiating a sale and the buyer is examining your business. Problems that arise in your business records or with your business that are discovered during the sale process may well result in the buyer arguing for a lower purchase price or even result in the buyer withdrawing from the transaction.

Also, a seller may well want to have the business appraised or at least valued informally before selling, to know what a realistic selling price should be, and to be better prepared in negotiating a price.

Also, both a seller of the business and the buyer of a business should early on meet with a tax professional to learn the taxation and tax consequences of the different ways to structure the transaction.