Price allocation when buying a business- How to buy a business – How to sell a business

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so Greg wants to know once you’ve actually worked out a price for buying a business how do you then break down that price amongst the different things that you’re buying or what we like to call a price allocation hey and everyone it’s a David Barnett from the YouTube channel and investlocalbook.com blog site where I talk about buying and selling businesses local investing personal finance issues for entrepreneurs and anything else that my viewers and readers want to ask me about today I have a question from Greg who wants to know once you’ve successfully negotiated the purchase price of a business what do you then do about the purchase price allocation and if you don’t know what I’m talking about pay attention I’m gonna go over it right now let me put some stuff up on the whiteboard okay I’ve written some things down here on the board and what I’ve got is different classes of assets when you buy the assets of a business you’re buying stuff whether or not that stuff is tangible or intangible so for example things like inventory less tangible equipment vehicles etc but goodwill or non-compete agreements for example they’re not tangible you can’t put your hands on them but they may represent some of the value of what you’re buying in transaction so if you agree to purchase a business as an asset sale one of the things that’s going to have to happen before the deal is done is the allocation is going to have to be worked out as to how much of that price goes for which item why is that important well from the sellers point of view and don’t forget in an asset transaction the seller is often going to be the corporation that currently runs the business is going to be selling these things to you as a buyer either to your corporation or to you personally you should watch my video on asset vs. share deals if you’re not quite sure what I’m talking about I’ll put a link down below in the show notes so the reason why asset allocation is important is from the buyer and sellers point of view different classes of assets are going to be treated differently for tax purposes so let’s use an example let’s say that we agree that we’re going to buy this business million dollars and on the balance sheet the equipment is worth $200,000 well the balance sheet will show us what’s called The Book value of the equipment so the equipment gets purchased and then the accountant will depreciate it every year and that creates a tax savings for the seller now what if though the equipment on the balance sheet is says $200,000 but in reality the fair market value of the equipment is higher than that let’s say it’s 300,000 if the seller agrees to put an allocation of 300,000 dollars for that equipment it means that he’s going to face some kind of capital cost recapture so he has depreciated down the value of the equipment to $200,000 it may actually be worth $300,000 there’s there’s no issue about you know tax evasion or anything like that but if he sells those goods for $300,000 what he’s effectively done is he’s got a capital gain he took advantage of the tax efficiency of depreciation but now he’s reversing that by recognizing that the stuff is worth more he’s going to have to pay those taxes that he was able to avoid before by using depreciation so clearly the seller is going to have an interest in putting down tangible goods like equipment and vehicles etc at their Book value instead of their fair market value now the buyer of course from the other side of the table wants to get as high a price as possible allocated to things like equipment and vehicles because they depreciate quickly and the buyer is thinking about the tax savings that are going to come from the depreciation allowance given to that type of of goods right so I have often seen in my brokerage career where people have come to an agreement on the price and then negotiations have broken down when they start to get down to the nitty-gritty about how they’re going to allocate that price different places around the world treat different classes of asset differently so for example in the United States there will often be a price allocation to the non-compete agreement whereas that’s much more rare to see in Canada although the rules be changing soon things like goodwill would be treated differently as far as capital gain in some countries than in others and things like equipment if the seller sells the equipment and allocates a price equal to what’s on the balance sheet then there’s no capital gain or loss so it’s kind of a neutral tax thing from the point of view of the actual transaction itself so different people have different interests in what’s happening the tax codes will say that things should be allocated according to their actual value but of course there’s wiggle room and anything who’s to say that you know $300,000 worth of equipment isn’t actually worth 10 percent more or 10 percent less it often can come up to the judgment call of you know the people that are talking and oftentimes people choose not to engage someone like an appraiser unless it’s required from a bank or lending institution for making loans so Greg I hope that answers your question about what’s going on with asset price allocation in my online course business buyer advantage which you can find a business buyer advantage com I teach people how to use an offer to purchase which actually includes an allocation component because what you don’t want to have happen is to agree on a price move through your due diligence and get to the end and then have a disagreement about how the asset allocation is going to work it can very much be part of the negotiation right from the very beginning and it should be talked about upfront especially if one of the two parties doesn’t really know why we’re talking about asset allocation they’re going to have to come up to speed and understand what the pros and cons are for both sides in order to properly negotiate anyway I hope you guys enjoyed this video don’t forget you can learn all kinds of stuff and sign up for my email list by going to david ceebar Netcom and if you’re considering purchasing a business you really need to educate yourself go to business buyer advantage comm and sign up for my nine hour business buyer advantage online course you don’t have to take it all in one sitting you can break it up you can redo them you get lifetime access once you purchase the course and it comes with a 3-bit day money-back guarantee so your satisfaction is guaranteed thanks and we’ll see you next time