12 Dec How to buy a business
How to Buy a Business
For individuals who want to learn more about how to buy a business, consider simply buying some, or all, of the target company’s assets, as opposed to buying the company’s shares (or units, if the target company is an LLC). For the most part, when it comes to small businesses, buyers benefit when they purchase assets, and sellers benefit when they sell shares.
The benefits to buyers include avoiding being encumbered with the company’s debts and liabilities; getting a stepped-up basis on the assets purchased; and avoiding the possibility of being locked in to a closely held business with other shareholders.
This article will briefly address the benefits, from the buyer’s perspective, in purchasing a company’s assets, and will offer some initial considerations to buyers thinking about such a purchase. Buyers of small businesses, should, of course, engage in thorough due diligence before purchasing a business.
Considerations in How to Buy a Business
Debts and Liabilities
During the pendency of its existence, a company will likely have exposed itself to numerous debts and liabilities. Debts may be in the form of promissory notes or other loans. The debts will belong to the company, and, therefore, whomever owns the company will ultimately be responsible for the repayment of those debts. This is because, in a purchase of shares, the buyer will assume all of the business’s liabilities, as an operation of law. Further, depending on the nature of a business, it will likely have exposed itself to various liabilities during its lifetime. In other words, there may be a possibility that it has not yet, but could be, sued. If it is sued, the company owners are ultimately going to be responsible to pay any judgments.
Take, for example, a company that operates a store selling items to the public. If an injury occurs on the premises, the statute of limitations may not run before the sale of the company. In that case, the new owner may also buy him or herself a lawsuit. Or, as another example, a company may have outstanding contracts that it has not yet fulfilled when the company’s shares are sold. Therefore, the new owners will have to consider how they will fulfill those contracts upon purchase of the company’s shares.
These types of debts and liabilities can be avoided if the buyer chooses to purchase the assets, as opposed to purchasing the company’s shares. In an asset purchase, the buyer can choose to assume only those liabilities that are expressly agreed upon in the purchase agreement.
Stepped-up Basis
Asset purchasers get a stepped-up basis on the assets they purchase. Basis is the amount a business has invested in an asset. According to the IRS’s definition, “in most situations, the basis of an asset you purchase is its cost.”
When an asset purchaser acquires the assets of a business, he or she receives a “step-up” in basis. This means the price he or she paid for the assets is the new basis. This is beneficial to the buyer because, when the assets are eventually sold, the stepped-up basis allows the asset purchaser to reduce his or her tax liability on the sale since the taxes on the sale will be result from the difference between the sales price and the stepped-up basis.
Locked in to a Closely Held Company
Assets purchasers benefit by not having to be co-shareholders in a closely held company, which can be loosely defined as a company that has five or fewer shareholders. (A buyer could simply purchase all of the shares in the target company, avoiding this result.) However, in the case where less than all of the shares are for sale, the buyer should consider the potential problems of being such a shareholder.
Shares in closely held companies are often unmarketable since it is difficult to value them, as there is no established market. As a result, shareholders often have a difficult time selling their shares, and remain locked in to the company even during times when they no longer wish to be shareholders, or have disputes with other shareholders. Moreover, it may be difficult to establish share value in estate or gift situations. Finally, forcing other shareholders out of a company can only be done by a few methods, and they often are extremely costly, time-consuming and involve litigation.
The Asset Purchase Agreement
Buyers should ensure they conduct adequate due diligence on a company before purchasing its assets. Each deal is unique and should be structured with the assistance of a competent business attorney, as well as a thorough consideration of tax issues.
The purchase will be memorialized in an asset purchase agreement. In such an agreement, the buyer should be careful to protect him or herself with indemnification provisions. This is because, under the legal doctrine of “successor liability,” the buyer may, as an operation of law, otherwise be deemed to assume liabilities related to certain product or environmental actions.
Another consideration for buyers is to protect themselves against fraudulent conveyance claims. These claims would come from a selling company’s creditors. As part of the asset purchase agreement, a buyer should consider requiring that the sale proceeds remain with, or be used for the benefit of, the seller. Alternatively, adequate arrangements should be made to pay off the company’s creditors prior to the sale.
If you’d like to learn how to buy a business, or if you’d like to learn how our firm can assist you in such a transaction — especially if your business is in or around Portland, Oregon — please contact us.
Author: Andrew Harris
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To continue reading more about the laws that might affect your business, please see the Articles page, or to simply see a list of helpful legal resources for Oregon startups and businesses, please see the Legal Resources page.