Recently, I had a client purchase a retail business in Clarksville that had been in operation for many years. When the client initially came to discuss the matter with me, they were unsure as to the best way to go about structuring the purchase of the business. Should they buy the actual business entity or should they simply purchase the assets of the business? To be sure, these are important questions and they should be carefully examined. If you are considering buying a business, take a second and familiarize yourself with the two primary ways to buy a business.
Two Primary Ways to Purchase a Small Business
If you are purchasing a business you need to determine whether you wish to purchase the business entity itself, or just the assets of the business. Here’s what that means: Let’s say you want to purchase Burger Joint, a restaurant that sells delicious, gourmet hamburgers. Burger Joint is set up as an LLC. All you care about is owning the burger business they operate. To do that you have two options:
- Purchase the business entity itself; or
- Purchase the assets of the company
It you purchase the business entity itself then you are purchasing the ownership interest of Burger Joint, LLC. If you are purchasing the assets of the company then you are buying the hamburger stand itself, the grill, buns, meat, condiments, the name of the business, goodwill, etc. There is a substantial difference in the ways you purchase a business and there are pros and cons to both.
Purchasing the Business Entity
Understand that when you purchase the business entity – whether the stock in a corporation or the interest of an LLC or partnership – you are buying all of the assets and debts of the company. Many buyers do not want the debt of the business, especially if it is significant. For example, if the company has a million dollars worth of debt but only marginal assets, you might want to reconsider purchasing the business. On the other hand, the main advantage of purchasing the company itself is that you do not have to worry about changing titles to assets, contracts, or permits. You own the stock or interest of the business the instant you purchase the business so changing the titles and contract are not necessary. Depending on your situation, this may be an important factor to consider.
If you are considering selling your business, you’d probably want to lean towards selling the actual business entity to the buyers. The purchasers would inherit the debts of the company when they complete the purchase of the business, leaving you free and clear of those liabilities.
Purchasing the Assets
If you are a buyer, an asset purchase is probably the most favored way of buying a small business for several reasons:
- You don’t have to take the debt of the company
- You get a step up in the basis of the assets
- You can amortize goodwill for 15 years.
When you agree to purchase the assets of a company, you are not buying the business entity. Here’s an example: You want to purchase Burger Joint, but you don’t really want to own Burger Joint, LLC, you only want to own the assets of the business. So you contract with the owners of Burger Joint, LLC to purchase those assets. You buy the building, fixtures, inventory, the secret sauce recipe, the name, and the goodwill of the business. You then create a new LLC and place those assets inside it such that this new LLC owns the assets and operates the business. Because you are buying the assets only, you do not have to worry about acquiring the debt of the company. Additionally, you also get a step up in the basis of the assets. So if you sell the assets, such as the real estate, at a later date you do not have to pay high capital gains tax. Finally, a large advantage of purchasing the assets of the business is that you can amortize goodwill over a 15 year period, which can provide a significant tax advantage.
While asset purchases generally are better for the buyer, there are some disadvantages. One main disadvantage of an asset purchase agreement is dealing with current employees. Do you want to keep the employees of the business, or bring in your own? If you want to keep the current employees, that may require some renegotiation of their employment, role, and compensation. That can be difficult. Another primary disadvantage is that the buyer will likely have to change some of the current contracts of the business. If the business has supplier contracts, seller contracts, utility contracts, etc. those may have to be changed to the new company that has purchased the assets.
What About the Name of the Business?
One of the biggest concerns in an asset purchase is whether the purchaser can assume the name of the old business. Let’s say that Burger Joint is a household name. If the buyer and seller agree to sell only the assets, can the buyer purchase the name Burger Joint? Can they use it as their trade name? Absolutely. In corporate America, buying the name of a business is often very important. For example, names like Coca-Cola, Budweiser, and Apple are invaluable. While the names of small businesses likely have less intrinsic value compared to these brands their value nevertheless be significant. If you are purchasing a business, remember to include the right to use the name of the business in the agreement if that is critical to have for the future.
Do Your Due Diligence
Buying a business can be an exciting time, but its important to do your due diligence before the purchase. What are the assets? What are they worth? What about the liabilities of the business? Is the name important? What about current employees? Make sure that you have an attorney prepare or, at the very least, review any purchase agreement before signing. Do not make the mistake of assuming that the seller or their attorney has your best interests at heart.
Considering Buying a Business?
Business Attorney John Crow has extensive experience negotiating and brokering deals with small businesses and preparing purchase agreements. Give John a call today at 931-218-7800 to discuss your situation.