Succeeding in Your Business by Cliff Ennico

"I have been looking to buy a small business for some time. After meeting with several business brokers, I found an interesting business for sale — it's a family-owned corporation. The price is right, and the sellers seem like lovely people, but the broker is telling me I must buy the stock of the corporation, not its assets. My accountant and lawyer are both telling me I should buy the assets of this corporation, not the stock. Who is right here?"

First of all, keep in mind that when you are dealing with a business broker, he is not necessarily your friend. Like a real estate broker, a business broker represents the seller of the business — not you — and is obligated to do everything he can to get the best possible deal for the seller.

Generally, the buyer of a small business wants to buy the assets of the business, not the stock. There are several reasons for this, but two major ones. In an asset sale:

1) The buyer assumes only those liabilities of the business that he expressly agrees to assume — the seller has to deal with the rest; and

2) The buyer gets a "step up in basis" for tax purposes — this means that the value of the business will be whatever the buyer pays for it, reducing the amount of capital gains tax the buyer will have to pay when he sells the business to someone else down the road.

Buying the stock of a corporation is not as advantageous to the buyer, because:

1) The buyer assumes all of the corporation's liabilities, both known and unknown; and

2) The buyer gets a "carryover basis" for tax purposes — regardless of what he pays for the business, the stock will be valued at whatever the seller originally paid for it (if the seller started the business from scratch, this could well be zero), increasing the amount of capital gains tax the buyer will have to pay when he sells the business.

Without getting into a lot of detail (entire books have been written about this), the owners of a closely held corporation want to sell the corporation's stock, while the buyer wants to buy the corporation's assets. Whoever has the stronger bargaining position wins the "tug of war" over how the transaction will be structured. Because of the "golden rule" of business — "he who has the gold makes the rules" — that's usually the buyer.

There may, however, be some compelling reasons for doing a stock sale as opposed to an asset sale:

1) The corporation may have a license (such as a liquor permit) that cannot legally be transferred to the buyer in an asset sale — the corporation must be left intact so that the permit stays in place;

2) The corporation may have built up a substantial positive credit history under its federal tax identification number (EIN), which would be lost if the corporation sold its assets (EINs are not usually transferable);

3) The corporation may have liabilities (such as equipment leases) containing "due on sale" clauses that would be triggered by an asset sale; and

4) Most importantly, the business may have incurred net operating losses (NOLs) in prior years — under current tax law, these can be carried forward to reduce or even eliminate tax liability in up to 20 future years, but NOLs can no longer be used if there is a "change in control" of the corporation such as an asset sale.

You should ask the broker why he is insisting on structuring this transaction as a stock sale.

If he doesn't have a compelling reason for doing so, then he is merely trying to get his client (the seller) the best possible deal. You should "stick to your guns" in that case and insist that the transaction be structured as an asset sale.

If there is a compelling reason for structuring the transaction as a stock sale (such as a lot of NOLs or a nontransferable license), make sure your accountant or lawyer does thorough "due diligence" to make sure the broker's claims are accurate. The rules governing NOLs, in particular, are very complicated, and it may be possible that the broker is (unintentionally, of course) overstating your ability to carry those NOLs forward into future tax years.

Your "due diligence" shouldn't stop there. You will need to:

1) Review thoroughly the corporation's financial statements and tax returns so that you understand all of the corporation's current liabilities;

2) Prepare detailed lists (called "schedules") of every liability the seller can think of that doesn't appear on the financial statements;

3) Get the sellers to indemnify you for any liability that is not disclosed on the financial statements or the schedules; and

4) Hold back a portion of the purchase price for a few months so that you can apply it against any unexpected liability that pops up during that period.

Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com.

COPYRIGHT 2010 CLIFFORD R. ENNICO.

DISTRIBUTED BY CREATORS.COM