Planning on buying a Business?
Starting a business from scratch has some distinct limitations, including the problem of building a client base, marketing the new business, hiring workers and establishing cash flow .As a result ,you might decide that buying an existing business that’s already generating cash flow and profits is a better fit. Moreover, bankers and investors generally feel more comfortable dealing with a business that already has a proven track record, thereby making it easier to arrange financing to buy the business.
A study by BDC reveals that close to 60% of owners of small and medium-sized businesses are aged 50 or older, and that means many will soon exit their companies.
With so many baby boomers business owners heading to retirement, the coming years are an excellent time to buy a business in Canada.
Source : BDC report
“The key to make acquisitions is being ready because you really never know when the right big one is going to come along”~James McNerney
Determining the appropriate structure –whether you are going to purchase the assets of the business, or the shares of the business entity, is critical to a successful transaction.
Advantages of buying Assets to you (buyer)
• You can pick and choose which assets to purchase and liabilities to assume, leaving unwanted assets and liabilities behind in the selling company. You can also use the purchased assets to create a new company, reducing the risk of unforeseen liabilities (to mitigate the risk of assets being subject to undisclosed pledges and collaterals for loan).
• Given that assets would sell at fair value, this can create a bump in the tax cost of assets whose fair value is higher than its current tax cost for the seller. The value of this future tax shield can be significant depending on the original tax basis of the assets when owned by the selling company.
• You are not responsible for any undisclosed liabilities/contingent liabilities.
• You are not required to assume liability for non-union employees unless you elect to offer them new contracts.
• If you pay more for the assets than the value of the assets acquired, the additional amount paid is purchased goodwill which is eligible for CCA deductions leading to tax savings.
Disadvantages of buying assets (buyer)
• The new owner can not use non-capital losses of the seller corporation.
• The seller may decide to retain certain assets he/she does not wish to sell. For example, the selling company may want to retain real estate and other non-operating assets. If you are interested in these assets, you are at a disadvantage by purchasing the net assets of a business.
Advantages of buying shares
• The legal structure of the acquired corporation can be retained, which might have certain legal or tax advantages. You can keep the company name, which makes the change of ownership less transparent to clients/customers, thereby covering the risk of lost sales .
• The new owner may use non-capital losses of the purchasing corporation under certain circumstances.
• If in future, it is determined to sell the net assets, it may be easier to sell the shares (either privately or on the open market) rather than individual assets.
• As you can acquire control by purchasing less than 100% shares, the total cost may be less than the amount to be paid for the individual assets. For example, you only need to purchase 51% the selling company’s shares to have control.
Disadvantages of buying shares
• Acquiring a companies shares outright also means inheriting all that company’s liabilities such as unpaid Income Tax, Property Taxes, GST, Provincial Sales Tax, Workers’ compensation premiums, Payroll taxes.
• You lose the ability to pick and choose between assets which you want to buy. You might not need redundant assets, and you will spend time divesting yourself of those. Besides, these assets may not realise their fair values once you sell them.
• There is no change in the tax basis of the assets purchased. The tax basis cannot be “written up” to fair market value, so you do not get any added tax shield for the added fair value.
• If you pay more for the shares than the value of the assets of the corporation, goodwill arises; however, it is not purchased goodwill, so it is not eligible for depreciation claims.
Based on the advantages and disadvantages of both the options, you might want to purchase assets. However, if you do so, be cognizant that the seller might ask you to pay more for the assets than what he/she is asking to get paid for selling the shares.
The primary reasons are:
1) The seller can not claim lifetime capital gains exemption ($848,252) on the sale of assets. On the other hand, if a capital gain arises on the sale of shares and the corporation is a qualified small business corporation, the lifetime capital gains exemption may be claimed by the seller to exempt from tax all or a significant portion of the capital gain.
2) An asset sale may activate the need to obtain more third-party consents to the transfer of assets (involving high time and money cost) such as contract, lease, license or permit.
3) There are two levels of tax for the seller when you structure the deal as an asset purchase. The first of these is at the corporate level, where the seller considers the tax consequences of the sale of assets. The seller would then have the corporation redeem his shares and would, at the second level, pay tax on the deemed dividend that occurs as a result of the share redemption, thereby resulting in a higher tax, and the complexity increases the professional fees charged by the accountant.
“Because if you are prepared and know what it takes, its not a risk. You just have to figure out how to get there . There is always a way to get there.” ~Mark Cuban
If you want to purchase assets of a business , but the seller only wants to sell shares, this situation should not be a deal breaker, there are ways to break the impasse.
You can employ specific risk management strategies to deal with the risk associated with a share purchase such as the following:
• Increased due diligence procedures, including a search for unrecorded liabilities. Clarify to the seller that if there are unknown liabilities at the time of purchase, the former shareholders should be responsible for those.
• A right to set-off contingent or unknown liabilities from the purchase price.
• A holdback of a portion of the purchase price to cover unknown liabilities.
Usually, the seller wants to allocate a lower value to depreciable assets such as building and machinery and higher value to non depreciable assets such as land to minimise recapture to pay less tax. In contrast, you might want to allocate as much of the purchase price as possible to the depreciable property so that it can ‘step up’ the value of assets to their fair value resulting in higher tax deductions for depreciation expenses in the future. Armed with the knowledge given to you by your CPA , you will be in a better position to negotiate this matter with the seller.
Your CPA does a quantitative, and qualitative analysis of after-tax cash flows from the purchased business, comparing the scenarios of buying assets versus shares to give you the advice to choose the best option along with the financial and operational review for business valuation.
Assess the reliability of the financial statements that are used to assess future profitability and establish a purchase price. Your CPA researches and suggests a suitable method of valuation, e.g. if you want to continue and expand the business in the future, the going concern method of valuation has the edge over an asset-based approach.
Your CPA wants to know if the financial statements (FS) provided by the seller have undergone an audit, If not , then, the substantive procedures performed by the CPA are more extensive.
Review industry and market potential to assess the agreed-upon value for the goodwill. Determine the future impact of the seller is leaving the operations on the goodwill of the company. The CPA usually suggests mitigating this risk by advising the new owner to keep the old owner on board for a certain length of time.
The decision to purchase assets versus shares frequently involves some negotiation between the buyer and the seller. Make sure to speak to your CPA as this can save you valuable time and money.
How to ride the coming wave of business sales | BDC.ca. https://www.bdc.ca/en/articles-tools/start-buy-business/buy-business/pages/buying-business-how-take-advantage-coming-wave-entrepreneur-retirements.aspx
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