Buying and Selling a Business

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1 let s talk about Buying and Selling a Business Tea in Wonderland Youngs The Matthews Group Phone: (403) Fax: (403) Netvisit us at: Suite 404 Mount Royal Village th Street SW Calgary, Alberta T2R 1K1

2 A FEW CASUAL WORDS This is a quick take on buying or selling a business. So, take it for what it is - a notso-serious look at things to look at before you do the deal. Get help before you go ahead. A client says, I ve bought a business. We wince, and ask Did you buy shares or assets? POINT You can buy the assets the business uses or you can buy the company that owns those assets. If you buy the assets you usually get inventories, equipment and goodwill. You don t get the company. If you buy the shares you get the company that owns the assets. Client replies Who cares? We bought the business - What s the problem? No problem, just different deals. You buy shares, you take over a corporation that carries on that business. That company is not you. It has it s own rights and responsibilities. It s been around a while, so it may have misbehaved. It may have lied to the tax people; a truck may have run over an old gent. It may have dropped oil somewhere. No matter. You now own it. You may have a bag of trouble. Buying assets is usually less risky because you buy things some trucks, some goodwill, those inventories, and you don t take responsibility for the seller s past sins. Shares and assets are two different deals - with different taxes, prices, and risks. Right for the Time Roger Wood You accountants complicate things. I bought the shares. That s the business, right? No, you own the company, the company owns the business, and you may inherit its past sins. We ll go in with your lawyers to do due diligence - look around. Other consultants may have to provide environmental certificates - your bank will ask for them. We ll all spend a lot of time - and we ll make sure you can t sue us later if anything bad shows up later. No matter how good we are we can t know all the things a company has done. We ll do our best, but it takes time, it s costly and you won t get 100% certainty. Hey, I said keep it simple we bought shares. That s simple. Wrong. It only looks simple. Buy assets and you can kick a few tires, get experts to look at the assets, check titles and look for liens. Assets can often be bought on a bill of sale. Buy shares and you already know you take over the company s past sins. You still have to choose what assets you re buying. You ll find you may have to take on their liabilities too like trade payables. These things affect what you pay. That seldom happens when you buy assets.

3 OK, The seller wants to sell shares. Why? Unlike you, he got advice before he tried to deal. Most sellers want to sell shares of a small business to use the Enhanced Capital Gains Exemption less tax. You also take over responsibility for their past sins we ve said that before. You, the buyer, usually (there are always exceptions) want to buy assets. You want different things but you re both talking about the business so it s easy to get confused. In truth, we see few share deals. Most buyers won t bite. That s OK he says he ll indemnify me. No problem. Of course he will. It s a normal part of the deal. But the problems may show up years down the road. You ll have to prove loss and liability, and try to collect from someone lazing on a Cayman beach. Indemnities are fine short term (if funds are escrowed) later they re good for papering your closet. I trust the seller. I ve known him for years. Your choice. Let s look at how a share purchase might work. You normally try to buy the shares of a company that has been stripped of all the assets but the ones you want inventories, supplies, fixed assets, and goodwill. The seller takes the cash, receivables, cars, cottages etc, and pays off all the creditors. You re get a clean company with just the assets you want and no known debts. Dog Daze Hugh Block But, let s look at that balance sheet. The assets you ve paid a million for are on the books at $150,000 $50,000 inventories and $100,000 equipment. What happened to your other $850,000? Maybe the inventories are really worth $100,000 and the fixed assets $600,000, so that the other $300,000 is goodwill. Here s the bad news. It doesn t matter what those assets are really worth for tax purposes you take over the residual values he used. For example, if you sell those fixed assets for $600,000 you ll pay tax on the recapture of depreciation or gain in excess of the $100,000 book value. You picked up the seller s tax bill. Also, you can only claim depreciation from where he left off, and you ll get no goodwill write-off. So, if you have high earnings from that expensive goodwill you ll not get much to write off.

4 What about the inventories? Good question. Some people mis-state their inventories to avoid tax. You could be paying that bill too on that difference between the fair value of the inventory and what s in the books. Let s go back to blue sky a catchy name for goodwill. Often it s the biggest asset you bought. It s the difference between the fair value of the assets you can touch or measure and the total price you paid. If you buy shares that goodwill won t appear on your balance sheet. You ll get no tax write-off. Its cost is buried in the cost of your shares with no tax benefit to you unless you sell the shares again. So, lots of disadvantages to buying shares. Don t forget the potential liability that could be out there. OK! A share sale usually looks good for the seller. Bingo. You ve got it. He may pay no tax on the sale and you re picking up extra tax in the company. Nice situation - walk away from past sins AND pay no taxes. It s a pardon with treats. We don t need those problems. We ll buy assets. You re probably wise however we said USUALLY. You could be the exception. Buying shares sometimes makes sense share purchases do happen. Sometimes you have to buy shares or walk away from the deal. That happens. Potential buyers for small businesses often outnumber sellers. So, you may have competition. Then too, sometimes it just makes no difference. We run across very clean companies where the book value of the assets is close to the price asked for the shares. Or, you may be willing to do a share deal if you re paying with the shares of your company. Public companies do this. Each case is different. Haight-Ashbury Christina Luck It s just that normally you ll want to buy assets, and sell shares That can be a problem. The seller wants to sell you shares, you want to buy the company s assets. You re on different planets. Now, let s look at another common problem the million dollar business. Most sellers overvalue their businesses. They ll sell out if they get their price. That price moves up to a nice round figure. Whether it be coffee shop or superstore - it s the starting point. The problem is bridging the gap between their million and the thirty five thousand you think it s worth. Often you wonder how much you can offer without deadly insult.

5 Shares or assets and the million dollar business two big problems, and you usually haven t started the game yet. You just contradicted yourself. We can buy shares and the business is worth a lot of money because we can cut a lot of costs. No. We re talking usuallys. You ll usually buy assets and you need to know exactly what you re buying before you decide the price is right. More on price and value in a minute. OK, what about buying assets? It s simple in theory, but it also has its own dangers. You ll fit this new business somewhere in your organization. Often you ll set up a new company to buy the assets. Sometimes you ll use one of your existing companies. The choice depends on where that business fits in your organization. We can help you decide. Your company borrows the money from your sock, bank, relatives, or the Godfather. It buys the inventories, supplies, small tools, fixed assets, leases, patents, customer lists, and goodwill. Goodwill is what s left after you ve assigned values to all the tangible or measurable assets. For example, if you buy a business for $1 million and the inventories are $300,000, the supplies & small tools $50,000, and the fixed assets $250,000, the client list $100,000, the goodwill will be $300,000. How do you decide on those values? Most times after a lot of hassle between you and the seller. You ll agree on the total price, and then scrap over the allocation to inventories, fixed assets, goodwill etc. You ll want high values on inventories and supplies (100% tax deductible), high values on fast depreciating equipment like trucks and computers, and low values on land (0% depreciable) and goodwill (depreciable at a snail s pace). Just Ducky Ray Matthews The seller prefers the reverse a high value to goodwill (only 50% taxable), and to items that will result in a capital gain such as land. That s easy. What else should I know about buying assets? Asset deals are usually easier to put together and easier to finance. You have a clean company with no history. You do less due diligence, pay less in legal and accounting. The assets have serial numbers and histories, or you can assign them a value like goodwill. The guy with the flat dog can t sue. Your friendly tax authorities are no worry. You re not going to pay the seller s old liabilities unless you don t check for liens.

6 Of course you ll check for liens and encumbrances against the assets but that s routine. GST can be an issue but you can elect out of it. Normally no GST is paid on a sale of all the assets of a business. This makes it simpler to paper an asset deal - your professional fees will be less (alas!). You ll also find you can borrow money more easily for the deal. Your bankers can take direct security on the assets. Bankers understand asset purchases. Share deals are often beyond many of them. Tips Samantha Blue Let me understand this. It s easier to borrow to buy assets? Most times yes. But, it s always hard to borrow for goodwill. Bankers dislike goodwill. Goodwill has no serial number. It evaporates at the first whiff of trouble. They can t corral it or sell it, so expect problems borrowing if you buy a lot of blue sky. You ll need plenty of your own money in the deal or a lot of security. Bankers know blue sky generates income, but they can t dab a rope on it if you misbehave. So far so good. What are the problems with buying assets? It s more difficult to protect your goodwill. How do you make sure it belongs to you, and it stays with you. You need to control the name, location, process, people, or whatever it is that protects your goodwill. You can get ownership of the name. You can make sure you have a good lease if it s location. You can truss up individuals with contracts and non-compete agreements. You pin down anything which might have a hint of goodwill, and you ll always get the seller s company to change its name. You have to make sure you get good title to the assets you buy. All provinces have laws to protect creditors when assets are sold. You should know if these exist. In some provinces the seller has to comply with a Bulk Sales Act for you to get good title to the assets you bought. You must get a clearance certificate. Fail and you could be handing over those shiny new assets to the seller s creditors. Not a problem in Alberta now. But a factor other places. Worth repeating. The seller can not sell assets without considering debts - so creditors have to be paid out or agree to the sale. If not they ll have a claim against your new assets.

7 Sounds boring. How much is a business worth? Before we go there, we should finish with asset purchases. Before we get to value, don t forget you ll want protection against misrepresentation, and competition from the seller. You ll want indemnities and non-compete agreements. That s standard. You may also want to hold back part of the price for a while in case anything shows up. Now let s go back to the two problems we talked about earlier. The seller wants to SELL SHARES for ONE MILLION DOLLARS. Well, what should I pay for assets? How long is a piece of string? What s the business worth to you? Price and value are not the same. Price is what you pay after you ve finished negotiating. Value is either what is is worth to you in dollar terms, or it s an airy-fairy amount dreamt up by valuators. Don t confuse the two. Valuators, well there is no deal and they can t know all the factors that affect price what one will sell for and the other pay. They do their best. But don t let them tell you what to pay you re a smart buyer. Trust your instincts. Do your arithmetic. Listen to your advisors. Price is negotiable. One side is always stronger, smarter, more knowledgeable, richer, etc. Be on that side. The price you pay is affected by taxes, timing, the structure and a zillion other factors. Price is often less important than how the deal is structured. Look more at cash flow! See if the seller will carry part of the price. Make part of it contingent on business performance. Good deals fall apart on price but structure is more important. What about the difference in what we think it s worth? Urge the seller to get expert advice before the million dollar syndrome sets in. It ll save hassle later. Understand that the business may be worth more to the seller than it is to you. The seller is there. You have to borrow to buy it, and hope you ll be able to run it. Negotiate hard, take your time, don t be panicked by other buyers. Pavarti Susan Crompton

8 Above all know how much it s worth to you on what terms. Don t go past this you re not at an auction. Buying and selling businesses is an art not a science. So, a few last cautions beware overconfidence, you may not be able to run it better. Avoid a business that s reached its full potential unless you can slash joint overhead. Structure the deal to work for you make part of the price contingent on results, make part of the price as tax deductible consulting fees. Look at assuming existing debt. Hold back an amount for snake protection. Focus on cashflow - the business may pay for itself. Don t bring in the squints and scriveners too early we kill deals and get paid for it. But don t go in unarmed. Get the best advice you can from people who ve been there many time before. Grizzly Bear Maureen Enns

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