and Selling a Business and Business Assets
Buying or selling a business can be complex, and different things are important
in different industries. While it’s not remotely possible to discuss
all matters that should be considered, here are some of the major issues
to keep in mind including valuation, types of transactions, sales taxes,
allocation of asset purchase price, various contract provisions,
and bulk sales laws.
The seller should be sure to have all potential buyers sign a confidentiality
agreement before providing proprietary information.
Listing of Assets and Liabilities.
In an asset sale, the assets being purchased obviously must be
listed in a sale of assets.
A clause merely stating that the sale includes all equipment,
furniture and supplies on the premises will inevitably lead
to arguments about what was and wasn’t there.
The agreement should also list any liabilities being
assumed by the buyer and state that no other liabilities
are being assumed.
In a sale of stock, the buyer should not merely rely on
a review of the seller’s books. It also is not enough to
refer generally to the assets listed on the books. Instead, a
list of the seller’s assets and liabilities should be created
and attached to the agreement.
Valuing a business is somewhat subjective and is always the subject
of negotiations. Valuation methods include:
Market-based valuation. This is based on the sale prices
of similar businesses in that geographic area. Often business
brokers use this method, based on their experiences selling similar
businesses in the area. (Business brokers frequently ask for 10%,
but like everything else, that is negotiable.)
Asset-based valuation. This takes into account figures
such as the book value and liquidation value of the business.
Still, these are considered bare minimums in business appraisals
and are not generally used as the sole path to an asking price.
Earnings-based valuation. This takes into account historical
financial figures, including debt payments, cash flows (past,
present and projected) and revenues. Sometimes multipliers of
revenues or profits are used; these vary widely from industry
to industry. Also, sometimes this is calculated in a return-on-investment
Adjustments in Price Based on Performance.
In order to limit their risk, buyers may want to include a performance
clause in the purchase agreement.
Such a clause states that if the business’s revenues drop,
there is an adjustment in the promissory note used to pay the
remainder of the purchase price.
Faced with this, the seller may also want a provision where there
is an increase in the amount of the promissory note if the business’s
Types of Transactions.
Taxable Transactions. In taxable transactions, the seller
has to pay income tax to the extent the consideration exceeds
the tax basis of the seller’s assets or stock. The buyer
benefits from receiving a "stepped-up" (purchase price) basis
in the assets or stock acquired.
Buyers often want the deal structured as a purchase
of assets in order to try to avoid picking up unknown
liabilities. (This is not always successful.)
Buyers also prefer a purchase of assets because they don’t
want to inherit the seller’s historic low tax basis
of the assets (rather than a tax basis equal to the purchase
Corporate sellers often want the deal to be a sale
of stock, since a sale of assets results in two levels
of income tax for the seller: a corporate tax on the transaction
and a second tax, if the seller’s corporation is dissolved
after the sale, imposed on the shareholders to the extent
their portion exceeds their tax basis in the stock.
The sale of assets by an S corporation generally does
not result in this double taxation, unless the
S corporation was converted from a C corporation within
the prior 10 years.
Tax-Free Transactions. A "sale" of stock can
be tax free to the seller IF the principal consideration is not
money but stock in an acquiring corporation. (These transactions
are generally referred to as "mergers", and there are
many ways of structuring them.)
In a tax-free transaction, the seller benefits from the tax-free
treatment, but the buyer suffers detriment because it acquires
the seller’s (historically low) basis.
In asset sales (but not sales of stock), sales tax is generally imposed
on the sale of tangible personal property unless the company
being sold is a service business (where the "occasional sale"
exemption may apply).
Sales tax is imposed even if the only consideration is the buyer’s
assumption of liabilities.
Custom computer software is generally not considered tangible
In the absence of any provision in the purchase agreement to
the contrary, the seller is liable for any sales tax.
The parties should agree on the allocation of the purchase price
to various categories as part of the purchase agreement.
It is often difficult to reach agreement if this is left until
later – so decide it before the agreement is signed.
In an asset sale, if the buyer is paying all the sales taxes,
then the allocation should definitely be set to best benefit the
buyer for tax purposes.
If the seller is paying some or all of any sales tax, though,
then allocating more to tangible personal property will increase
the seller’s sales tax amount.
Typically, the buyer wants to allocate as much of the purchase
price as possible to assets with the fastest tax write-offs –
that is, those with the shortest depreciation periods.
For this reason, the buyer generally wants to attribute most
of the price to business equipment and fixtures. Usually equipment
and fixtures can be depreciated over three, five, seven or
The buyer also generally wants to assign smaller values to
intangible assets, because they have a long tax write-off
period, 15 years.
Goodwill may not be amortized, so a buyer emphatically will
want to allocate the minimum amount to goodwill.
Still, in transferring a trademark, goodwill must be
specifically transferred as well or the trademark will
be lost – so something must be allocated to goodwill.
Covenant/Agreement Not to Compete.
The buyer will almost always insist that the seller to agree
to not start or participate in a competing business.
Sales of a business are one of the rare occasions California
will uphold a covenant not to compete.
Still a specific geographic area where the business has been
carried on must be specified.
Also, sole proprietors and shareholders must specifically
be selling the goodwill of the business – and therefore
something will need to be allocated to goodwill. (There is
no such requirement when partners or members of LLC’s
Payments specifically allocated to the seller’s covenant
not to compete are taxed as ordinary income to the seller and
are deductible by the buyer.
The allocation must be reasonable in nature and amount.
The buyer must amortize the payments over a 15-year period
(like other intangible assets). That’s not as good as
an allocation to equipment and fixtures, but is still better
than a larger allocation to goodwill.
In a sale of stock, generally the seller would prefer less
or no allocation to a covenant not to compete (which represents
ordinary income tax) and more or all to any accompanying stock
sale (which is usually capital gains).
Often the buyer will want the non-competition provisions to be
in a separate agreement, so if there is some argument over adjustments
in the purchase agreement then the non-competition agreement will
still stand. The seller, of course, may well want the opposite.
Frequently the buyer wants a certain amount held back in escrow
to cover any adjustments (due to changes in inventory or accounts
receivable, or due to unpaid creditors) or pro-rations (such as
taxes, utilities or rent) based on the closing date.
The seller, of course, tries to minimize the amount of the hold-back.
Bulk Sales Law.
With sales of assets (though not sales of stock), the buyer must
be wary of the Bulk Sales Law. This law applies when:
"The seller’s principal business is the sale
of inventory from stock, including those who manufacture
what they sell, or that of a restaurant owner";
the sale is not in the ordinary course of business; and
more than half the seller’s inventory and equipment
Essentially, the Bulk Sales Law makes the buyer liable to pay
the debts of the selling company – although unless agreed
otherwise, the buyer has the right to recover these amounts against
For sales where the purchase price is $2 million or less, the
creditors must be paid from the escrow.
The buyer can limit its liability by requiring the seller to
provide a list of creditors and agreeing to pay the creditors
on the list (with an adjustment in the purchase price) or making
sure the seller has paid these debts.
If the buyer is continuing the seller’s business, the buyer
may be liable under a "successor liability" theory for any
product-liability suits brought by pre-closing customers. It’s
a good reason to have an indemnification clause running from the seller
in favor of the buyer, and to check out the business’s insurance
In addition to all the other due diligence that the buyer conducts,
the buyer should hire an accountant to examine the seller’s
books and determine if any adjustments in the purchase price are
needed. This is crucial.
The seller will want to have a specific time limit placed on
all due diligence so that if no objection is made by the specified
deadline the due diligence results are deemed satisfactory to
If the business is a California entity, buyers can see if it
is in good standing (has paid its California taxes) by going to
Buyers may want to conduct a UCC search to see if there are liens
against the business. On the Internet, try +California +"UCC
search" to get a list of companies that will provide
this service. This is recommended.
If you want to conduct a search to see what litigation has been
filed against the business, try +California +"litigation
searches" (this time make it plural) to get a list of
companies that will provide this service. Alternatively, use a
service like www.lexis.com
. (Often, though, the buyer will be satisfied with contract provisions
that state that the seller warrants there is no litigation unless
expressly listed – and that the seller will indemnify the
buyer if there is any breach of this warranty.)
Buyers may want to check with the Better Business Bureau to see
if any consumer complaints have been filed regarding the business.
If you believe that there may be environmental issues, see if
the county where the business is located has an "Environmental
Health" unit – and call them to ask if there are any
problems at the location.
Assignment of Leases and Contracts.
If existing leases are important, the buyer should include provisions
stating that closing is contingent on the landlord’s approval
of the leases using the current rents and lease provisions.
Similarly, if existing contracts are important, the buyer should
either make sure that the contracts allow assignment or include
provisions stating that closing is contingent on the other parties
to the contracts agreeing to the assignment.
Licenses & Permits.
The seller should represent that it has all licenses and permits
needed to operate the business, and that these can all be transferred
to the buyer.
The buyer should investigate if there will be any fees from the
issuing authorities for these transfers – or if the issuing
authorities will require the buyer to qualify in some way.
In addition to many other warranties (and indemnification provisions),
if intellectual property is being transferred, the buyer generally
will want the seller to warrant that the seller owns the intellectual
property and will indemnify the buyer for any third-party claims of
Pre-Closing Training & Post-Closing Consulting by
For smaller transactions in particular, if the buyer needs training
to operate the business, the purchase agreement should state precisely
how much (in hours or days) pre-closing training and post-closing
consulting will be provided by the owner and what (if any) compensation
will be paid to the owner for this. (For example, this could be
done as a maximum number of hours per week for a set number of
From the seller’s point of view, the agreement should specify
that this time is for training or consulting only, and not for
running the business.
It may also be important for the seller to limit the days and
times during which training and consulting will be provided (e.g.
9:00 to 5:00, M-F) so that the buyer does not try to have the
seller be present at unusual times.
The seller will often want to limit how far he/she must travel,
in case the new owner relocates the business.