What’s involved in buying a business? It may be as simple as purchasing a truck, inventory, and equipment or as much as purchasing all the shares of a corporation.
One way to proceed with the purchase of a business is to buy all the assets related to the operation of that business. This is often referred to as an Asset Purchase. For an agreed-to purchase price, the seller conveys to the buyer the inventory, equipment, tools, and other stuff or tangible assets that are used in the operation of the business. Additional assets would include such things as customer lists and files, supplier lists, and potentially other business permits, licenses, or records. A buyer would also want to include the intellectual property rights related to the business, such as the trade name, logos, website address and content, phone number, and other aspects of the business that make its brand unique and identifiable.
In an Asset Purchase, real estate may or may not be involved. A buyer may be interested in purchasing the land and building on which the business sits or the buyer may seek an assignment of a favorable lease agreement that’s in place. For new business owners, purchasing the underlying real estate may be too expensive or present too much risk. Sellers of a business might find it better to split the two – real estate and assets – and either lease the building and land to the buyer of the business or find another buyer for the real estate.
Another concern of a buyer when purchasing a business is to protect the investment. A buyer in an asset purchase should include a non-compete agreement, non-solicitation agreement, and sometimes a confidentiality agreement with the seller. It would be detrimental to a buyer, if the seller went down the road and set up the same business in competition with the buyer. These additional agreements of an Asset Purchase make up a portion of the value paid by the buyer.
When purchasing a business, a buyer may purchase the whole entity that makes up the business whether a partnership, corporation, or limited liability company (LLC). This is often referred to as an Entity Purchase. The seller or sellers may sell all of the stock, all interests in the partnership, or all of their membership interests in the LLC. (The types of transactions described here would be private sales, of course, and not sales of stock of publicly-traded companies). The entity operating the business continues on, and the buyer simply replaces the seller or sellers as the new owner.
The biggest difference between an Asset Purchase and an Entity Purchase is the liability assumed. In an Entity Purchase, the business entity remains intact bringing with it all of the good and all of the bad. The good may be existing contracts with suppliers or customers, licenses or other authorizations, favorable leases or locations, key employees, patents, trademarks and other IP assets. The bad may include past liabilities either known or unknown, debt, and tax implications that may be less favorable to the buyer. In an Asset Purchase, the buyer typically forms a new entity and uses the assets to start operations of that new business.
Another difference between an Asset Purchase and Entity Purchase is that the latter may allow for smoother succession planning for entities involving more than one owner. For example, if there are three shareholders in a closely-held corporation and one shareholder wants to sell her interest, a buyer could be found for those shares. The buyer would not be buying certain assets of the business, she would be buying a one-third interest in the whole. Thus, allowing the business to remain intact and continue operating.
In both an Asset Purchase and an Entity Purchase, there are many tax considerations, of course, and the parties involved have opposing interests. Buyers and sellers of businesses should consult with their accountant prior to entering into a purchase agreement. Tax issues may include the allocation of the purchase price, capital gain / capital losses, applicable tax rate, depreciation recapture, and more. This is not an exhaustive list. In addition, if financing is involved, lenders will be part of the determination of what a business may be worth. For both buyers and sellers in a transaction, the attorney, lender and accountant play important roles, so it’s important to consult with them early and often.
Although we cannot give you legal advice through the column, we can provide some general information that may be helpful for you to know. Our purpose is to educate and we hope that you can take something new away from this column each time you read it.