One of the hidden and sometimes very surprising scenarios that buyers and sellers of a business experience comes when both parties need to agree on the Purchase Price Allocation. The surprise arises as most buyers and sellers are unfamiliar with the Purchase Price Allocation.
As this is another negotiation, the buyer and seller can find it emotionally challenging. This is especially true if the negotiations have been long and arduous.
What is the Purchase Price Allocation?
The Purchase Price Allocation is a tax reporting requirement for the sale of a business. Both the buyer and the seller must file their tax documents, based on their understanding of the Purchase Price Allocation, with the IRS. The IRS can and does verify that both parties report the same information.
Where does the challenge come into play?
The challenge arises because the buyer has different tax needs than the seller. The seller prefers to sell his stock of the company to the buyer as he does not need to pay back any taxes he has claimed as a deduction when operating the business. The buyer wants the opposite: they want to buy assets, not stock, to start depreciating them and lower their tax bill.
The general process involves the seller listing the business for sale at a specific price. The buyer conducts their research and makes an offer; if all goes well, both parties agree, perform due diligence, and close the sale of the business with an escrow. Just before closing escrow, the seller and buyer must agree on the Allocation of the Purchase Price.
If an escrow company is handling the transaction, it will require a written agreement specifying the Purchase Price Allocation. It’s not uncommon, but it happens when the buyer and seller have spent months working together on this transaction, only to have it fall through because they simply cannot agree on the Purchase Price Allocation. This occurs when negotiations have been stressful and challenging, and the frustrations come to a head at this point, with the Purchase Price Allocation serving as the catalyst.
Education helps prevent problems.
The solution to prevent this from happening is simply education. If the buyer and seller know what the Purchase Price Allocation requires, an agreement can be reached quickly and cleanly. There is a need for both parties to give, just like all the other items they have negotiated. One of the best places to start is with the buyer’s initial inquiry. If the seller decides to sell only their stock and not complete the transaction as an asset sale, stating this upfront can help mitigate that issue.
Many buyers are unwilling to buy a company’s stock for two reasons. The first reason is that if they purchase the company’s stock, they are liable for any previous actions of the seller. The seller can substantially reduce this liability through personal guarantees and insurance, but it still may make the buyer uneasy. The second reason is that the buyer doesn’t get to depreciate the assets from a new tax basis; they simply continue with the depreciation rates the company currently gets. The buyer gets no new tax benefit if assets have been fully depreciated.
Buying and selling a business becomes more complicated when tax costs and benefits are factored in. It’s the wrong approach to take when buying or selling a business, and there is a need to win each negotiation. By definition, a negotiation means each side giving. If goodwill to negotiate is not present, there is little likelihood that the transaction will close.
Are you thinking about selling your business in California?
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For more information, please visit my website, Business Valuation.
For more immediate help, you are welcome to send an email to Andrew Rogerson or give me a call at (Toll-Free): (844) 414-9700