This article are provided for information purposes only, and are not intended as legal advice.


Buying a business over time – tips and traps

June 5th, 2009

You have decided to buy a business from your employer or from another company but do not have the cash to purchase it all at once. Alternatively, you have a small business and you will merge that with a larger company under the premise that you will be able to acquire the other shares over a period of time.  Sounds great in theory but let’s look at the issues that you will run up against.  The larger company is owned by let’s call Mr A and the smaller company is owned by Mr B.  If Mr A is old, is he coasting or actually very active in the business?  Does he believe that you will do all the work and he will earn a large return on his capital?

 

There are two components which need to be examined.  One is salary, who is doing what job and the pay should be commensurate with the responsibilities and the amount of work that takes place.  The second component is how much of the profits are distributed between the partners.  Mr B needs the money to acquire Mr A’s shares.  He may set up a holding company and have dividends distributed to his holding company who in turn will buy some of the shares of Mr A.  When merging companies, you may want to have two classes of shares, those owned by Mr A and those owned by Mr B.  This may give flexibility in distributing cash between the shareholders.  You may want to contact your accountant for tax advise.

How do you determine a reasonable salary – that means you need to define the job responsibilities between the two owners.  Are their kids in the business which will have an impact on the allocation of salary between the owners?  Are the kids or family members active or is this just a mechanism to minimize tax.  You may want to make the new business clean and have only working people on the payroll and not non working family members. Once you buy the business and if the payroll is audited down the road, it is possible that the deduction could be challenged and the company which Mr B owns is now liable for the tax planning activities of Mr A.

 

If Mr A and B merged companies and Mr A owns say 80% of the new business and Mr B 20% then Mr B wants to start buying part of Mr A’s shares.  How do you value the company, based on individual companies before the merge, after the merge, who is paying for the costs of amalgamating the two companies?  If you are buying his shares of the company and Mr A did not have another company, this simplifies things significantly.  What happens if Mr A is a super salesman who knows lots of people.  He is able to double the sales and profit of the company.  When he buys the company, does he have to pay double the price for the shares because he has double the net worth of the company in a short period of time?

 

These are all things to negotiate.  The initial purchase price is easy to determine because there is no impact of the new addition to the business – Mr B.  What happens if Mr  B is not from the industry and needs to be trained.  He makes a mess of things and loses a major customer – who is responsible, does Mr B still pay the same goodwill, instead of bringing business, he loses business – not a good situation.  The relationship between the two owners may sour and there may be a  of friction between the two.  In this case, Mr A could be so infuriated he could say that he wants to get rid of Mr B.  Is that possible in the purchase and sale agreement?  Buying over a period of time can have pros and cons, if things go well or things go wrong, if some person does not pull their fair share of the business or if one person brings in more business than the other.


Filed under: Buy a business — Gary Landa @ 10:05 am


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