Thinking About Buying a Business? Some Things to Consider
When clients first come to KKC to discuss their intended purchase of a business, the conversation usually starts with the following question from the attorney that they are meeting with: “Are you buying the ownership interest in the business (i.e. the stock for a corporation or the LLC membership interest for an LLC), or are you buying the assets of the business?” For many clients the response is a somewhat confused look on their face because the difference between purchasing the assets of the business as opposed to purchasing the business entity is not something that they had considered. The reality is that whether the purchaser is buying the business assets or the business entity itself is a critical first question that should be discussed with an attorney and a CPA as early on in the process as possible. For the purpose of this newsletter, the purchase of the business entity will be referred to as a “Stock Purchase” (although it could also apply to the purchase of an ownership interest in an LLC), and the purchase of a business’ assets will be referred to as an “Asset Purchase.”
Whether the transaction is structured as a Stock Purchase versus an Asset Purchase will likely have significant tax implications for the buyer and the seller. As a result, the purchase price that the seller is willing to accept may be different for a Stock Purchase than for an Asset Purchase. For example, a seller of a business may be able to have the sale proceeds taxed at a lower capital gains rate if the transaction is structured as a Stock Purchase as opposed to an Asset Purchase. For this reason, sellers often prefer Stock Purchases over Asset Purchases.
Although a Stock Purchase may provide some tax benefits to the seller, that structure can create issues for the buyer. With a Stock Purchase, the buyer inherits all of the liabilities of the seller’s business including those that arise from the operation of the business prior to the buyer owning the business. This could include liability for unpaid debts or state and federal taxes as well as liability for any third-party claims. Third-party claims could include a wide variety of claims, such as claims by employees for discrimination, claims by individuals injured on the business premises, product liability claims for products sold by the business, or even claims of infringement of intellectual property rights, just to name a few. Although some of the risks associated with these claims can be mitigated through proper insurance coverage, obtaining tax clearance letters from the State of Connecticut, and a proper due diligence investigation of the business being purchased, the risks that remain often outweigh the tax benefits for a seller, and for that reason the majority of transactions are structured as Asset Purchases. Additionally, with an Asset Purchase there may be some tax benefits to the buyer, such as the ability to further depreciate the acquired assets, that may not be available with a Stock Purchase.
In addition to the potential tax and liability considerations, a purchaser of a business will also need to determine what, if any, licenses or permits are required for the operation of the business that is intended to be purchased. Very often these licenses are not transferable from the seller to the buyer if the transaction is structured as an Asset Purchase, and therefore the buyer may have to weigh the potential risks of a Stock Purchase and the costs and delay in obtaining new licenses and permits for the business. An attorney can assist in determining what licenses and permits the business needs to operate as well as assist in obtaining those licenses and permits.
Some additional considerations for the buyer of a business that we discuss with our clients are:
- Does the business operate out of a leased space? If so, will you need a new lease, or can you (do you want to) assume the existing lease? How much time is remaining on the existing lease term? If the lease is to be assumed, are there any options to extend the term of the lease?
- Are there any “key” employees of the business that is being acquired? If so, how will those employees be retained after the business is purchased?
- Are there any “key” customers of the business, and is there anything that can be done to ensure that those customers remain customers of the business after it is acquired?
- Does the business receive a substantial amount of its revenue from government contracts or set-aside programs (small or minority-owned businesses, for example) and if so, will the buyer be able to retain those contracts after the purchase?
- Will there be any financing involved in the purchase transaction and if so, what are the bank’s requirements for financing the transaction?
- Has your CPA reviewed the target company’s financial statements and advised you as to the value of the business?
These are just a few of the things that need to be contemplated and addressed when thinking about buying a business. If you are considering buying a business, speak to your accountant and an attorney in KKC’s business department.