Volume 7 Issue 1
Buying a Business: Tips for the Unwary
© by Tax & Business Professionals
Buying a business? Too often not enough thought goes into
exactly what you are buying. Let's say "Howard" has an incorporated garage that
he started years ago as Howard & Sons, Inc. Now after twenty years of hard work and
success, Howard wants to sell the business.
You, a mechanic in the area, want to show the world, and your
old supervisor at the Ford dealership, that you know cars and can run your own garage
The typical pattern in this situation is to have a discussion
with Howard about how much the business is worth. There may even be extensive price
negotiations before it is decided what you will pay.
Unfortunately, often little, if any, consideration is given to
one of the most basic issues: Will you buy Howard's stock or the assets of the business?
Does it make any difference whether you buy Howard's stock or
the assets of the business? The answer, emphatically, is YES.
If you buy Howard's stock here's what you may get, in addition
to the assets of the business:
- Any lawsuits and other types of claims which could or may be
filed against Howard & Sons, Inc. based on things that happened long before you bought
- Potential Federal and State tax deficiencies which may come from
a tax audit in the future and relate back to years before you purchased the stock.
- Hidden claims for back wages, OSHA audits, creditor's claims,
and yet to be discovered mistakes for cars repaired.
When you buy "stock," all of the corporate
attributes, history, and choices are delivered at your feet. As far as government
agencies, creditors, and injured parties are concerned, Howard & Sons, Inc. is
continuing on, even if you change the name after you purchase the stock.
In short, when you buy the stock of an incorporated business
you get all the assets and any number of surprise packages that you might prefer to leave
unopened in the attic. Unfortunately, when and if these packages are opened (by a tax
audit for example) is beyond your control.
While the nature of these surprises will probably vary somewhat
from business to business, fortunately there is a way to avoid these hidden claims: an
"asset purchase." Why?
- In an asset purchase you buy only the assets you select, and not
the hidden claims.
- When you buy the assets of Howard & Sons, Inc., you get only
the items described in the bill of sale tools, trucks, inventory of parts, customer
lists and the garage. (Generally, putting real estate in such corporations is a bad idea.
This will be discussed in a future edition.)
Thus when you buy assets, you are generally free of hidden
claims of creditors, former customers and government agencies. If you buy all of the
assets of a business "in bulk" it is sometimes necessary to contact creditors
and tell them whether you (the buyer) or the seller will pay outstanding bills.
When you purchase physical assets like tools, you qualify for a
tax deduction called "depreciation." Usually assets are depreciated over their
For example, if $10,000 is paid for a machine, you, as an
"asset purchaser," would be able to depreciate the machine over its useful life,
10 years, and claim a deduction of $1,000 in each of the 10 succeeding years.
But if you had purchased Howard's stock, you could only deduct
the depreciation Howard & Sons, Inc. could have claimed. If the machine was 15 years
old and fully depreciated when you purchased the stock, then no more tax depreciation
could be claimed.
Should I Ever Consider Buying Stock?
Occasionally, a business will own an asset or license that
cannot be easily or lawfully purchased or obtained independently of the present corporate
entity. Sometimes, there may be unused tax benefits that would be lost if the corporation
goes out of business.
For example, let's say that the corporation has a valuable
lease from the local airport authority. Perhaps the only way you can do business at that
valuable location is to purchase the stock so that the corporation can continue operations
there. Often such leases have special provisions limiting their transfer.
Where an important asset can only be obtained by buying the
stock, then a stock purchase is the only alternative. In such situations, you should
consider a variety of other protections, such as cash escrows and warranties, to insulate
you from the consequences of unknown claims.
In the next newsletter we will
look at this same problem from the Sellers perspective and consider other aspects of
selling and buying a business.
List of Articles by Tax & Business Professionals
Published jointly by The Tax & Business Professionals, Inc. and the law firm of Newland & Associates as a service to their clients.
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