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Text File | 1992-04-30 | 6KB | 113 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 properly 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 business of
that size and type should be, you should have a reasonably 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 negotia-
tions, specify that you want access to tax returns, 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 negotia-
tions 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 busi-
nesses, it is possible to prevent the seller from competing against
you for a reasonable period of time within specified geographic areas.
(Your attorney will know what limits state law places on such a non-
compete agreement.)  This can be an extremely important provision to
negotiate for from the outset, for many types of businesses, 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 because it is not abso-
lutely 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 being acquired.  While this is now of somewhat lesser
importance 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 alloca-
tion formula based on the fair market values of the cash, securities,
and other assets such as land, improvements, equipment, inventories,
and intangible assets (such as patents, trademarks, etc.).  Any excess
of the purchase price over the sum of those values MUST be allocated 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 market values of
the various "real" assets, you obviously cannot 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
possibilities 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 agreement 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 particular 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 similar
       advantageous tax treatment for buyers (and possibly 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 knowhow
       that has a limited useful life.

Remember, if there is a purchase price allocation in the sale agree-
ment, 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 allocation between assets.

IMPORTANT:  Note also that new tax regulations require, any time a
business is bought or sold, that both buyer and seller must file Form
8594 with the IRS reporting certain information about the purchase
price allocation.  PENALTIES FOR FAILURE TO FILE THIS FORM CAN BE
EXTREMELY LARGE!  Needless 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.