The World of Computer Software/The World of Computer Software.iso/sbadv64b.zip/F219.SBE

Text File | 1992-12-01 | 7KB | 135 lines

@0101 CHAP 3
        ┌───────────────────────────────────────────────┐
        │    NEGOTIATING THE PURCHASE OF A BUSINESS:    │
        │  NON-COMPETE COVENANTS, PURCHASE PRICE, ETC.  │
        └───────────────────────────────────────────────┘

        "Never trust a treacherous, conniving, thieving,
         claim-jumping, well-poisoning, witness-suborning
         lawyer." -- Jenkins' Seventh Law* of Business
         Survival (by Michael D. Jenkins, CPA and Attorney)

        (*The corollary to the Seventh Law states that all
          lawyers are treacherous, conniving, thieving,
          claim-jumping, well-poisoning, witness-suborning
          &!#%]^&%&*#$%es.)


THE PURCHASE PRICE.  Neither this program nor any book can
tell you how much you should pay for the business you are
about to buy.  However, if you have done your homework pro-
perly in investigating the business in question and talking
to bankers, accountants and other people in that line of
business about what the normal purchase price for a busi-
ness of that size and type should be, you should have a rea-
sonably good basis for determining if the purchase price
is a reasonable one. For example, you may learn that small
businesses of the type you are considering generally sell
for about one and one-half times their annual gross sales
in your market area.  That could be VERY useful information
if the seller is asking three times last year's gross
sales.

DISCLOSURE OF FINANCIAL INFORMATION.  At an early stage in
the negotiations, specify that you want access to tax re-
turns, books of account, corporate minute books, and other
financial records of the business, and make it clear that
you have no interest in continuing the negotiations unless
the buyer cooperates fully in this respect.  Also, be sure
that this condition is expressed in any kind of informal
"memorandum of understanding" or letter agreement between
you and the seller that is written up prior to the final
contract of sale.

COVENANT NOT TO COMPETE.  In most states and for most kinds
of businesses, it is possible to prevent the seller from
competing against you for a reasonable period of time with-
in specified geographic areas.  (Your attorney will know
what limits state law places on such a non-compete agree-
ment.)  This can be an extremely important provision to
negotiate for from the outset, for many types of busines-
ses, to prevent the seller from starting up a new business
just down the street to compete with the one you are buying
from him or her for good money.

ALLOCATION OF PURCHASE PRICE.  One very important item that
is often omitted in business sale agreements, perhaps be-
cause it is not absolutely necessary, is a provision in the
agreement that spells out how the parties agree to allocate
the purchase price between the various assets that are be-
ing acquired.  While this is now of somewhat lesser impor-
tance for tax purposes than before the Tax Reform Act of
1986, it can still be quite important in certain situations.

The '86 Act requires both the buyer and seller to abide by
an allocation formula based on the fair market values of
the cash, securities, and other assets such as land, im-
provements, equipment, inventories, and intangible assets
(such as patents, trademarks, etc.).  Any excess of the
purchase price over the sum of those values MUST be allo-
cated to "goodwill" or "going concern" value, which is an
intangible asset that cannot be deducted, depreciated or
amortized by you, the buyer.  This is the "zinger" in the
'86 Act, as it relates to allocation agreements.

Since the IRS allocation formula is based on the fair mar-
ket values of the various "real" assets, you obviously can-
not get around the formula by agreeing with the seller in
a purchase price allocation that a $5 supply of paper clips
is worth $50,000, to avoid allocating excess purchase price
to "goodwill."  However, you should not overlook the possi-
bilities of allocating some part of the purchase price to
certain types of assets that may have value, and which may
be amortizable or depreciable for tax purposes.  These
could include any or all of the following:

  .  Customer Lists.  Courts in recent years have allowed
     some buyers to deduct the value of customer lists,
     where an allocation was made in the purchase agree-
     ment as to the agreed value of each customer being
     acquired, and any such customers were subsequently
     lost.

  .  Covenant Not To Compete.  Obtaining such a covenant
     from the seller can be an important negotiating point
     for non-tax reasons, as well.  For tax purposes, the
     courts will usually uphold a reasonable value for
     such a covenant agreed to by the parties.  Note that
     you can deduct or amortize the cost of the covenant
     over the period it remains in force.   Also, the
     courts have held that if the parties don't agree in
     the contract of sale that such a covenant has a par-
     ticular value, then it is considered to have NO value
     for tax purposes.  In other words, YOU LOSE, tax-wise,
     if you fail to include a purchase price allocation in
     the agreement of sale.

  .  Other Intangible Assets.  The courts have upheld simi-
     lar advantageous tax treatment for buyers (and possib-
     ly with potentially beneficial capital gains treatment
     to the seller as well) for purchase price allocations
     to various other types of intangible assets, such as
     blueprints or technical know how that has a limited
     useful life.  (NOTE AS WE HEAD INTO 1992 FALL ELECTION
     SEASON:  Congress appears ready to pass new tax legis-
     lation that will require--or permit, in the case of
     "goodwill"--most such intangible assets to be amor-
     tized over a 16-year period.)

Remember, if there is a purchase price allocation in the
sale agreement, to include a provision that says that both
parties will report the transaction the same way for tax
purposes, in accordance with the agreed purchase price al-
location between assets.

IMPORTANT:  Note also that new tax regulations require, any
time a business is bought or sold, that both buyer and sel-
ler must file Form 8594 with the IRS reporting certain in-
formation about the purchase price allocation.  PENALTIES
FOR FAILURE TO FILE THIS FORM CAN BE EXTREMELY LARGE!  Need-
less to say, the information on the two Forms 8594 that are
filed by you and the seller should be identical, or you
will both be inviting IRS audits.