Business intermediaries are not typically licensed to provide tax guidance on transactions involving the sale of a business, however, it remains important that he or she possess a working knowledge of all of the intricacies that surround a business sale. Included amongst the most critical elements of the sale of a business is the impact of federal taxes upon a transaction.

Since most business sales in which professional business intermediaries have been engaged are those of non-public entities and, as such most likely take the form of an asset sale (as opposed to a stock sale), it is this type of sale upon which we will focus. The IRS has established guidelines for the allocation of purchase price for asset based transactions under Section 1060 of the Internal Revenue Code.

Allocating the purchase price to the entity’s assets in a business sale/acquisition is both science and art. The science aspects dictate that the rules established by the Internal Revenue Service be followed, along with documenting the underlying assumptions that are used. Art comes into play in the actual identification of the intangible assets and allocating value to these intangible assets.

It is important that the seller and buyer seek direction from their tax advisors when purchase price allocation is being negotiated. Failure to do so can have a significant affect upon the economics of a sale/acquisition. The allocation of purchase price is often overlooked while price, terms and other conditions of the sale are being negotiated. It is not uncommon, in fact, for the buyer and seller to have agreed upon these terms before discussing the purchase price allocation and its corresponding tax effects. Therefore, itshould be evident that the purchase price allocation, and the potential cash implications following close of the transaction, can assume such a critical role that the inability to mutually agree upon the allocation can cause a deal to fall apart. The intermediary, knowing that the seller seeks to maximize the after tax proceeds from the sale and the buyer desires to maximize the after tax cash flow of future operations, should be prepared to bring the parties together at the appropriate time to incorporate the discussion of purchase price allocation during the discussions and negotiations of other terms.

Once the parties have agreed upon the purchase price allocation and the transaction closes then IRS Form 8594 must be filed by each of the parties. The allocation of purchase price reported on IRS Form 8594 is binding unless the IRS determines it is not appropriate.

The sale includes all the assets of the business not specifically excluded and may include equipment, inventory, work in progress, trade fixtures, leasehold improvements, contractual rights, business records, licenses, franchises, customer lists, goodwill, covenant not to compete, trade secrets, trade names, telephone numbers and supplies. Other intangibles and intellectual property could include patents, trademarks, secret formulas, etc.

The allocation discussed above is based on what is referred to as the “Residual Method” and, pursuant to IRS guidelines, must be determined in the sequence outlined below:

• Step One: Value all identifiable assets
• Step Two: Determine total amount to be allocated (certain non-specific transaction costs such as employment/non-compete agreements must be considered)
• Step Three: Assign to respective classes of assets in the following order:

o Class I – Cash
o Class II – Marketable Securities
o Class III – Accounts Receivable
o Class IV – Inventory
o Class V – Assets Not Otherwise Classified
o Class VI – Section 197 Intangibles (i.e., specifically identifiable intangible assets other than Goodwill)
o Class VII – Goodwill

The total value allocated to the assets must equal the purchase/sales price. Some tax implications of the purchase price allocation are shown below.

Amount allocated to Tangible Personal Property (e.g., buildings, leasehold improvements, trade fixtures, furniture, and equipment):

• Seller: If held more than one year, gains in excess of depreciation are long-term capital gains; otherwise ordinary income
• Buyer: Depreciates new basis per IRS schedules

Amount allocated to Covenant Not to Compete/Customer List and similar Intangibles:

• Seller: Ordinary income
• Buyer: Amortize over 15 years

Amount allocated to Training/Consulting:

• Seller: Ordinary income
• Buyer: Expense as incurred

Amount allocated to Goodwill:

• Seller: If held for more than one year, long-term capital gain
• Buyer: Amortize over 15 years

Amount allocated to Land:

• Seller: If held more than one year, long-term capital gain; otherwise ordinary income
• Buyer: No immediate tax impact

Amount allocated to Inventory:

• Seller: Ordinary income, to the extent over basis
• Buyer: Treated as cost of goods sold upon sale of inventory

In summary, Huntington Business Group, Inc. highly recommends that the seller and buyer address the allocation of purchase price in connection with negotiations of the other terms of the transaction. Licensed and/or accredited brokers, CPA’s and attorneys should be consulted.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group is the leading business brokerage firm in North Texas and the Dallas/Fort Worth Metroplex. Our firm is comprised of professional business intermediaries that specialize in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

While millions of small business owners have tucked the memories of 2009 into a distant corner, many others who have endured, and in some case prospered during the recent economic downturn, are looking to 2010 and asking “Is now the time to sell my business?” The answer is yes.

With the reinvigorated mindset of the market place and the recent announcement from the SBA about additional funding to support small business lending, it is increasingly clear that 2010 is an ideal time for business owners to sell.

The decision to sell, however, is a difficult one and is driven by a number of factors. Personal timing must be considered. Owner burn-out and a desire for change often influences the decision to sell - retirement, illness and a host of other issues can also be motivating factors. But these items should NOT be the only factors considered. Proper timing should also be considered in order to maximize the economic benefits of the sale. Although no one can advise a business owner as to the best personal time to sell their business, allowing personal issues to determine when to sell can only lower the value of a business.

Once you’ve eliminated any personal obstacles, you must then consider selling from a business standpoint. Unfortunately, few business owners decide to sell when everything is going great. However, this can be and most times is the best time to consider selling your business. It is important to recognize that this is the precise point in time that buyer interest will be at its peak and your premium price will be most achievable. On the other hand, if an owner attempts to sell their business after a period when revenue is off, after losing a key employee or losing a significant customer then the ability to sell becomes problematic at best. The best time for an owner to sell is when his or her business is efficiently staffed and growing. Businesses with these characteristics are very attractive, can be financed and are, therefore, saleable.

Now that we understand what motivates business owners to sell, what appeals to the marketplace and how timing can impact the value of one’s business during the sales process, we can now focus on why 2010 is an ideal time to sell.

Capital Gains Tax Rates Will Increase

This is an if but rather a when. Given the current state of the economy and circumstances at the national level, the federal government will need to raise additional revenue in order to finance the various governmental programs it enacted during 2009. Much of these revenues will be generated from an increase in the Capital Gains Tax rate legislated during 2010. Of concern is whether an increase in these rates will be retroactive – at a minimum it appears that effective January 2011 any taxable transaction will be subject to an increased capital gains rate. The new rate will be higher than the current rate which is approximately 15%.

The sale of a business is complicated and can require several months to finalize - some transactions require 8 to 12 months to complete. Delays can, therefore, be very costly - especially in light of an imminent tax rate increase. For example, a mere increase to 25% from the existing 15% capital gains rate could cost a business owner $100,000 per $1 million of their sales price should the sale of their business not becompleted prior to enactment of any legislation that raises the capital gains tax rate.

Buyers Are Available

There are many individuals who have been unable to survive widespread corporate downsizing. On the surface this group may not appear to be candidates to buy a business, but let us drill down a bit further. Most of the recently unemployed are members of the prolific baby boomer generation and have had the opportunity to save substantial sums of money. Much of this wealth is stored away in 401(k) plans and other savings programs that the IRS now allows one to tap into without paying taxes or penalty. These funds are available to buy a business.

Other buyers also exist. Many companies have been hoarding cash and are seeking opportunities to take advantage of this abundant level of acquisition capital. This, along with low interest rates, offers a very broad base of buyers who are seeking investment opportunities to take advantage of economies of scale and to gain market share.

Financing

Traditional financing avenues remain narrow but many SBA lenders continue to exhibit a healthy appetite for lending and, as recent statistics reveal, have provided millions of dollars for qualified buyers. SBA lending is likely to increase as the current administration undertakes previously announced efforts to increase funding for small businesses.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group is the leading business brokerage firm in North Texas and the Dallas/Fort Worth Metroplex. Our firm is comprised of professional business intermediaries that specialize in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

While there are a few good and strategic reasons for the owners of a C Corporation (“C Corp”) to maintain C Corp status (e.g., plans to take the company public, preserving health care deductions, etc.) the owners MUST prepare in advance and develop an Exit Strategy in order to avoid the shock that typically comes when they receive the tax bill following the sale of their company.

We at VR Huntington Business Group often find that business owners have very little knowledge of the tax consequences that are triggered when they sell their business. These consequences are most especially severe for the owners of C Corporations.

C Corporations pay taxes on the income earned and, if the earnings and cash levels warrant, they then distribute the after-tax earnings in the form of dividends to the shareholders who will in turn pay taxes on those dividends. This is known as “double-taxation” and is the subject of much frustration for many C Corporation owners.

When a C Corp is sold it will generally take the form of an asset sale as opposed to a stock sale, which means the buyer will purchase the assets of the corporation and the proceeds will go to the corporation. The corporation will then pay taxes on any profits from the sale. What remains is then distributed to the owners who will in turn be taxed a second time - the “double-taxation” I mentioned earlier. Tax rates vary according to earnings and capital gains rates but, of critical importance, if the C Corp owners are not careful they will pay double taxes on the sale of the company.

If owners of a C Corp are considering the sale of their company in the next few years, they should meet with professional advisors to begin developing an Exit Strategy. The owners’ CPA and a professional business intermediary should be contacted to start developing an exit strategy well in advance of the sale. For example, it may be desirable to make an S Corp election and take advantage of favorable tax strategies now available under the American Recovery and Reinvestment Act of 2009.

We, VR Huntington Business Group, have on numerous occasions advised our clients to consult with their CPA regarding how they can minimize their tax burden by classifying the sale as one that predominately includes personal goodwill. This structure may be applicable and can substantially reduce the taxes on the sale of a C Corp. In other cases the owners’ CPA or other advisors may be able to develop alternative tax strategies to substantially reduce the tax liability. There are, as noted above, advantages to C Corporations but when selling a C Corp the owners must plan carefully and well in advance.

In summary, VR has often been contacted by owners of C Corporations that it most cases should have considered converting to an S Corp many years earlier. These owners are now presented with significant hurdles that advance planning could have avoided. We find that many middle-market business owners, unfortunately, do not understand the effects that a C Corp status has, not only on the eventual price the owner will receive for the business and the taxes to be paid on the sale, but also on the challenges that a C Corp status presents in marketing the business.

Focus should be on advance planning – VR Huntington Business Group offers consultative services to ensure against the pitfalls that many C Corp business owners should avoid before selling their business.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.