Allocation of Purchase Price for Buyers and Sellers

There are a handful of key asset categories in allocating or breaking down the purchase price of a business during the sale process. This allocation will be required by the escrow officer.  In many instances buyers and sellers have different desires in how to “chop up” the purchase price. The allocation is required to complete the transaction. Below are the most common used asset allocation classes.


Fixtures and Equipment:

This asset class has the most to discuss. There is generally a 7 year life to depreciate the assigned value over. There are some equipment classifications that still depreciate over 5 years, but in general for a sale purpose it will be a 7 year life.  This means that if you allocate $35,000 of the total purchase price towards Fixtures and Equipment you can write off this amount against your taxable income over the 7 year period. If your Accountant uses straight line depreciation (equal amount each year) it would equate to a $5,000 write off each of the 7 years. This is the shortest life of all classifications in the allocation which means the fastest write off.

Because of that, as a buyer your accountant usually will tell you to allocate a large amount on this one. Keep in mind that as a buyer you will pay a one-time sales tax on this amount prior to closing escrow. The amount of sales tax will be according to the tax rate per the county the business is located in. Most counties are running Sales Tax rates of 8.25 – 9.25%. Take your county rate multiplied by the value allocated to get your sales tax due. No other asset class requires tax paid upon purchase.

Accountants like a large amount here for depreciation, Buyers like a small amount here because of the sales tax due on the amount. Our wonderful taxing agency, The State Board of Equalization has a minimum formula they like to use. They want to see the value to be a minimum of the Sellers current Depreciated Book Value. This can be found on the Sellers federal tax return under pages titled “Federal Depreciation Schedule”. In many cases the State Board of Equalization will ask the Seller for a copy of his Depreciation Schedule in order to close out the Sellers account and issue the Buyer a Buyers Tax Release.

Leasehold Improvements: Leasehold Improvements have a life from 29.5 to 39 years. You will get both of these numbers from various accountants. Personally if I use a Leasehold Improvement in my allocation I would want to use the 29.5 year life as the longer the life the less per year depreciation write off you will obtain. This is the longest life of the asset classes.

Covenant Not To Compete:  A Covenant Not To Compete has a 15 year life. In the past this used to get depreciated over the length of the Covenant. In other words a 5 year 5 mile Covenant Not To Compete used to get written off in 5 years. That made sense but the tax code changed this regardless of the actual Covenant life to where all Covenants are depreciated over a 15 year life.

Goodwill: Goodwill also has a 15 year life.

Liquor License: If the business has a Liquor License (full liquor) you should allocate some value to it, but it is a NON Depreciable item. Therefore I don’t like to add the full or real value here, but like to allocate something here so that I don’t get questioned by any taxing agency on my overall allocation.

I like to use the fastest depreciation allowed. I will generally only use Fixtures and Equipment, Goodwill and Covenant Not To Compete. I don’t see any value in allocating anything to Leasehold Improvements. It is such a long life, and you don’t get much “bang for your buck” on it.

In my opinion the actual asset value of each category is not so important here.  For instance, many times buyers and sellers try to really figure out what the Fixtures and Equipment are really worth and plug that real value into the allocation. Don’t lose sight on the bigger, more important picture here. What is most important about the allocation is the tax ramifications involved for both parties. For a buyer you are setting up your initial book values in these categories for future depreciation purposes. For a seller (who is selling for a gain) they may have different tax rates to consider; ordinary income vs. capital gains.

 I always encourage my buyer and seller to consult their CPA over this issue, but I also want to stay in the loop on this one so the sale doesn’t get away from me. If both sides understand the ramifications to each other properly, they always come to agreement. Be involved in this stage. It is important.

Preparing to Sell Part 5- Qualify, Site Visit, Negotiate

Qualifying Buyers

If you don't have a process to qualify prospects, you may find yourself dealing with tire-kickers, wasting lots of time and resources trying to sell them your business. There’s no bigger waste of time than working with a buyer who will not be able to complete a transaction.

In addition, you should require buyers to submit some basic information:

·        Name and all contact information.

·        Previous employment and business ownership.

·        Educational background.

·        Funds available to invest and sources of financing.

·        Minimum monthly income requirement.

·        Intended timeframe for completing a transaction.

·        Reason for interest in your business.

Your business broker should have a process in place for qualifying buyers.

Site Visit

Once a buyer has been qualified, signed a confidentiality agreement, reviewed your business profile, and shows continued interest; the next step is typically a site visit.

I suggest that these visits be scheduled after hours for confidentiality and to allow you to focus on the buyer. This is your one chance to "sell your business" so it is imperative that you be on top of your game. A tour is usually the best way to start the site visit as it will generate a lot of good questions and give you an opportunity to present your business in a favorable light.

It is highly recommended that your business broker be there to document disclosures made between seller and buyer and to answer any questions relating to terms and conditions and the process should it continue.

Negotiating the Deal

After you’ve found a qualified buyer, provided a business profile and had an initial site visit, it is time to stop the flow of information and ask that an offer be presented. This can take the form of a nonbinding letter of intent or a written offer. It should spell out the terms of the deal so that all parties can move forward in good faith.

All sellers hope to get a full-price cash offer for their business. But in the real world this rarely happens. More often buyers will make a down payment and pay the remainder in installments to either you or a lender. Don’t be disappointed by an offer that doesn’t meet your expectations. It is not uncommon to counter-offer the original offer. A willingness to be creative with the terms of a transaction can go a long way toward a successful sale. Your business broker can be the creative "glue" that holds the deal together. Also, be sure to enlist your accountant to help you assess the tax consequences of the terms you accept.

Once the terms have been agreed upon by both parties (offer and acceptance) it is time to open an escrow account. Your business broker can walk you through the escrow process, costs, and timeline. Depending on the complexities of the deal, plan on allowing approximately 30 to 60 days to close escrow.

Navigating the escrow closing process takes careful attention and daily follow up.  This is where a skilled business intermediary or broker can really help.  As the say goes: ‘Nothing happens until the sale is final.”  Business sale transactions can easily fall apart during the escrow period unless momentum to close the transaction is sustained by careful attention to detail

Preparing to Sell Part 4 Marketing

Prepare Your Marketing Package

There are two primary marketing materials that are used to describe your business to potential buyers. The first is a one-page document that offers highlights of the business without revealing its identity and is sometimes referred to as a “blind ad.” These "blind ads" are used to generate interest without creating any possible negative consequences with employees, suppliers, customers, or competitors.

 The second is a comprehensive selling prospectus or business profile to be sent to serious buyers who have signed a confidentiality agreement. It is important to include photos (a picture is worth 1,000 words) of major assets, buildings, products, etc. The business profile should provide a comprehensive overview of the business including structure of the business, opportunities for growth, competitive advantages, personnel summaries, requirements for licensing,  financial results, an equipment list, licensing requirements, reasons for selling, terms and conditions of the sale, seller financing, and potential buyer profiles.

Marketing Plan

After your marketing package is complete, you and your broker should set up a process to target and qualify buyer prospects.

Advertising on Websites- Fewer than 5% of the general population are prospective business buyers, so focus only on the established 'business for sale' advertising venues that this 5% is following. There are a number of websites that cater to these buyers. Don't expect your broker to run a massive ad campaign. It isn't required or effective. Ads should be tested carefully and slowly. They should be "blind ads" where the identity of the company is protected.

Targeted Campaigns- Often times the buyer may be a competitor, supplier, or customer. There are several ways to approach these potential buyers. A direct mail or email campaign targeting these business owners/leaders can be an effective method to "get the word out".  Again, be careful to use "blind ads" to protect  the identity of the company until a confidentiality agreement is in place.

For additional information contact Ron Schwab at 530.269.1143.