If you are just beginning to consider buying or selling a business, you may not be familiar with the terms used by brokers, attorneys or accountants in this process. We will cover more terms in future blogs, but let’s start with a basic one, deal structure. You should consult with us and your attorney or accountant for a more extensive explanation.
In buying / selling a business there are two basic structures for the transaction: an Asset Purchase or a Stock Purchase. If the seller has a sole proprietorship, then only an Asset Purchase can occur.
In an Asset Purchase certain assets are purchased out of the seller’s corporation or LLC. The money paid for these assets (this could, and normally does, include goodwill) is paid into the seller’s corporation (or LLC). Normally the buyer (company or individual) does not assume the seller’s debt (but they could if it is agreed upon). Most Asset Purchases are made with all assets (in the deal) purchased free and clear of liens, debt and liabilities.
In a Stock Purchase the buyer is actually buying the stock of the seller’s corporation (or LLC). The buyer pays the shareholders for their stock, and receives all assets and liabilities in the corporation (assuming the purchase is for all of the stock; less than 100% of the stock can be purchased).
The overwhelming majority of small to mid-market transactions are structured as “Asset Purchases”. Stock transactions may occur when the seller’s corporation is a “C-Corp” because of the tax burden that may face the seller (double taxation). As a rule-of-thumb, if the seller has an S-Corp or LLC almost all transactions will be structured as Asset Purchases.
There is a hybrid of these two methods (using a “stepped-up basis”) that in unique situations should be considered but won’t be covered here.
There are a number of advantages and disadvantages to both the buyer and seller on the structure agreed upon. Some of the more important considerations in selecting the structure are:
In an Asset Purchase, generally the buyer does not have to worry about the seller’s liabilities incurred prior to closing (debts are normally paid off at closing and any contingent liabilities follow the seller’s corporation or LLC). This is probably the number one reason for a purchase to be structured this way; also the buyer is able to depreciate or amortize the purchase price (including goodwill) over a period of years, saving taxes. From the seller’s standpoint the goodwill portion of the selling price will be treated as LT capital gains, so from a tax standpoint there will likely be little difference to the seller.
There are many other aspects in structuring a deal, including the allocation of the purchase price; depreciation recapture; rep’s & warranties; personal guarantees; etc. Expert advice is needed in these areas.
In our next newsletter we will cover terms like EBDIT (Earnings Before Depreciation, Interest, Taxes) and ACF (Adjusted Cash Flow, also called seller’s discretionary cash); how and why these are used in selling companies.