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Buying a business? The following are some considerations about buying a business.
Each situation is very different and merits deeper consideration of the complex
issues involved before any action is taken. The following are very general points
with which to start consideration of the purchase of a business and are not intended
to be final answers to a potential purchaser's questions.
Issue - Is there a broad brush approach to valuing a business that does not include
much property or equipment?
Consideration - A common approach to estimating an initial value of a business is to
work backwards to value using the potential investment return the buyer could expect
from the business' available cash flows. This capitalization of earnings approach can
be roughly done as follows:
- Determine the buyer's required cash return on investment considering the
degree of risk of an investment in this particular company (compared to a possible
15% return in the stock market or 7% in Treasury bills, a buyer may want a 25%
return for the risk of the target business, for example).
- Divide 1 by the desired return (if 25% return, then 1 / 25% = 4) to get a multiple figure.
- Multiply the result by the business' available annual cash flow.
- See if the result makes sense.
This approach to value arrives at an estimate of going concern value, or the
value of both the business' tangible and intangible assets.
Issue - Should a buyer buy the company's stock or the company's assets?
Consideration - The seller usually get the best tax benefits from selling
his/her company's stock to the new buyer, as the seller generally gets capital
gains treatment. However, the buyer usually can get the best tax treatment from
buying a company's assets. Instead of buying stock, an asset purchaser usually
can write off the entire purchase price over a period of years. For example,
intangibles that are purchased (goodwill, customer list, etc.) can be written
off for taxes over 15 years. Also, the buyer of assets generally does not assume
any of the seller's potential corporate liabilities (if the assets are not
collateral for a loan or other vendor credit arrangement).
Issue - If I buy the assets, does it matter how much I pay for which assets?
Consideration - The allocation of the purchase price of assets and structure
of the whole purchase transaction can be the most negotiated part of a business
purchase, as different allocations can strike very different tax benefits and costs
for the buyer versus the seller. Considerations for the differences in buyer's and
seller's tax treatments of such items as a seller-financed installment sale,
goodwill, non-compete, consulting contracts, equipment, real estate, and other
assets are important in the structuring of the deal.
From a buyer's perspective, the range of best to worst tax treatment usually follows:
consulting payments, accounts receivable, inventory, equipment, non-compete, goodwill
or other intangible assets, and real estate.
Issue - If I want to buy a company's assets, where should I consider starting?
Consideration - If the equipment and real estate in a business are a good part
of the value, a common first step is to get appraisals of those tangible assets (real
estate, equipment, inventory, etc.). These appraisals are often required before any
financial institution would even consider financing part of the purchase. The appraised
value of tangible assets is often a starting point for value considerations, and is
often the lowest value considered. To the tangible asset value, you may consider
adding for goodwill, non-compete or other intangible asset value.
For more information, please
contact us.
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