BUYING AND SELLING A BUSINESS
By: R. Scott Alagood
A qualified tax advisor (CPA or tax attorney) should be consulted to determine the tax consequences resulting from the transaction. The tax advisor may assist in determining how to structure the sale. The seller needs to consider (1) how much, if any, gain or loss will be recognized by the seller; and (2) the character of the gain or loss as ordinary or capital. For the buyer, it is important that the purchase price be properly allocated among the assets or ownership interest purchased. An allocation will establish the purchaser’s cost basis in the asset or ownership interest used for future taxable events such as determining gain or loss and depreciation deductions and recaptures.
The type of sales transaction must be evaluated in order to determine the tax consequences and structure of the sale. Sales of sole proprietorships involve the transfer of assets and the allocation of existing and future liabilities of the business. With business organizations, the transaction may be structured as an asset purchase (similar to the sole proprietorship) or a sale of the ownership interest in the business entity (such as stock, membership interests, and partnership interests). When a sale involves an ownership interest, careful consideration should be paid to the governing documents and public filings to ensure that the sale is allowed and does not trigger other agreements or restrictions which may interfere with the intended sale, such as superior rights of purchase by the entity or other owners of the entity.
For sales involving entities, the governing documents should be reviewed to determine who has the authority to approve the sale. Financial records should be analyzed to determine what, if any, liabilities of the business that the purchaser will assume as well as valuing the business’ assets or intrinsic value. A purchaser should carefully consider how an entity adheres (or fails to adhere) to the formalities associated with operating as a business organization. In some instances, failure to adhere to these formalities may be used by a court to disregard the entity to place liability directly with the owner.
The purchaser may want a covenant by the seller not to compete in the same type of business being sold for a stated time and area following the sale. There are strict limitations on the enforcement of “covenants not to compete”. Parties are well advised to retain a qualified attorney to document the agreement. If the purchaser wants to retain any of the seller’s employees following the sale, then employment agreements and retirement plans must also be addressed, particularly for key employees. It may be important to negotiate covenants not to compete with key employees as well. For certain businesses, intangible property rights may be a significant reason that the business is being acquired. These include copyrights, trademarks, service marks, and trade names.
The parties may use contractual indemnification provisions to allocate liabilities of the business. However, without assurance that there is any funding underlying the contractual promises, such provisions may not provide the parties with any meaningful remedy. A percentage of the purchase price may be withheld or additional sums placed in escrow for a specified period of time following closing to provide security for the parties’ indemnification promises.
Governmental regulations, private restrictions, and real estate issues must be considered. Securities and antitrust laws may have to be addressed. Franchise laws may apply to businesses which are subject to franchise agreements. Businesses such as bars and restaurants must deal with licensing and permitting issues with the Texas Alcoholic Beverage Commission and local health departments. Unemployment compensation, insurance, and workman’s compensation may also need to be addressed. Additional regulations or requirements associated with the purchase of a professional business to legally operate the business will have to be considered.
In short, there are numerous and sometimes complicated issues which may arise with the sale of a business. Both sellers and purchasers should ensure that well qualified consultants are used to assist them with the transaction.
R. Scott Alagood is board certified in Commercial and Residential Real Estate Law by the Texas Board of Specialization and can be reached at firstname.lastname@example.org.