@0101 CHAP 3 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� � NEGOTIATING THE PURCHASE OF A BUSINESS: � � NON-COMPETE COVENANTS, PURCHASE PRICE, ETC. � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� @Q "Never trust a treacherous, conniving, thieving, @Q claim-jumping, well-poisoning, witness-suborning @Q lawyer." -- Jenkins' Seventh Law* of Business @Q Survival (by Michael D. Jenkins, CPA and Attorney) @Q @Q (*The corollary to the Seventh Law states that all @Q lawyers are treacherous, conniving, thieving, @Q claim-jumping, well-poisoning, witness-suborning @Q &!#%]^&%&*#$%es.) THE PURCHASE PRICE. Neither this program nor any book can tell you how much you should pay for the business you are about to buy. However, if you have done your homework pro- perly in investigating the business in question and talking to bankers, accountants and other people in that line of business about what the normal purchase price for a busi- ness of that size and type should be, you should have a rea- sonably good basis for determining if the purchase price is a reasonable one. For example, you may learn that small businesses of the type you are considering generally sell for about one and one-half times their annual gross sales in your market area. That could be VERY useful information if the seller is asking three times last year's gross sales. DISCLOSURE OF FINANCIAL INFORMATION. At an early stage in the negotiations, specify that you want access to tax re- turns, books of account, corporate minute books, and other financial records of the business, and make it clear that you have no interest in continuing the negotiations unless the buyer cooperates fully in this respect. Also, be sure that this condition is expressed in any kind of informal "memorandum of understanding" or letter agreement between you and the seller that is written up prior to the final contract of sale. COVENANT NOT TO COMPETE. In most states and for most kinds of businesses, it is possible to prevent the seller from competing against you for a reasonable period of time with- in specified geographic areas. (Your attorney will know what limits state law places on such a non-compete agree- ment.) This can be an extremely important provision to negotiate for from the outset, for many types of busines- ses, to prevent the seller from starting up a new business just down the street to compete with the one you are buying from him or her for good money. ALLOCATION OF PURCHASE PRICE. One very important item that is often omitted in business sale agreements, perhaps be- cause it is not absolutely necessary, is a provision in the agreement that spells out how the parties agree to allocate the purchase price between the various assets that are be- ing acquired. While this is now of somewhat lesser impor- tance for tax purposes than before the Tax Reform Act of 1986, it can still be quite important in certain situations. The '86 Act requires both the buyer and seller to abide by an allocation formula based on the fair market values of the cash, securities, and other assets such as land, im- provements, equipment, inventories, and intangible assets (such as patents, trademarks, etc.). Any excess of the purchase price over the sum of those values MUST be allo- cated to "goodwill" or "going concern" value, which is an intangible asset that cannot be deducted, depreciated or amortized by you, the buyer. This is the "zinger" in the '86 Act, as it relates to allocation agreements. Since the IRS allocation formula is based on the fair mar- ket values of the various "real" assets, you obviously can- not get around the formula by agreeing with the seller in a purchase price allocation that a $5 supply of paper clips is worth $50,000, to avoid allocating excess purchase price to "goodwill." However, you should not overlook the possi- bilities of allocating some part of the purchase price to certain types of assets that may have value, and which may be amortizable or depreciable for tax purposes. These could include any or all of the following: . Customer Lists. Courts in recent years have allowed some buyers to deduct the value of customer lists, where an allocation was made in the purchase agree- ment as to the agreed value of each customer being acquired, and any such customers were subsequently lost. . Covenant Not To Compete. Obtaining such a covenant from the seller can be an important negotiating point for non-tax reasons, as well. For tax purposes, the courts will usually uphold a reasonable value for such a covenant agreed to by the parties. Note that you can deduct or amortize the cost of the covenant over the period it remains in force. Also, the courts have held that if the parties don't agree in the contract of sale that such a covenant has a par- ticular value, then it is considered to have NO value for tax purposes. In other words, YOU LOSE, tax-wise, if you fail to include a purchase price allocation in the agreement of sale. . Other Intangible Assets. The courts have upheld simi- lar advantageous tax treatment for buyers (and possib- ly with potentially beneficial capital gains treatment to the seller as well) for purchase price allocations to various other types of intangible assets, such as blueprints or technical know how that has a limited useful life. (NOTE AS WE HEAD INTO 1993: Congress appears ready to pass new tax legislation that will require--or permit, in the case of "goodwill"--most such intangible assets to be amortized over a set period, probably 16 years.) Remember, if there is a purchase price allocation in the sale agreement, to include a provision that says that both parties will report the transaction the same way for tax purposes, in accordance with the agreed purchase price al- location between assets. IMPORTANT: Note also that new tax regulations require, any time a business is bought or sold, that both buyer and sel- ler must file Form 8594 with the IRS reporting certain in- formation about the purchase price allocation. PENALTIES FOR FAILURE TO FILE THIS FORM CAN BE EXTREMELY LARGE! Need- less to say, the information on the two Forms 8594 that are filed by you and the seller should be identical, or you will both be inviting IRS audits.