goodwill

How to Drastically Reduce Taxes by Allocating Goodwill

You may hear the word “Goodwill”  thrown around a lot, especially during business valuation and/or buying and selling a business, but what does it really mean?  When it comes to selling your business, the term refers to all the “sweat equity” that the seller put into a business during his/her ownership tenure. Goodwill can be thought of as the difference between the various tangible assets that a business has and the overall purchase price.

The M&A Dictionary defines goodwill in the following way, “An intangible fixed asset that is carried as an asset on the balance sheet, such as a recognizable brand, product name, or strong reputation. When one company pays more than the net book value for another, the former is typically paying for goodwill. Goodwill is often viewed as an approximation of the value of a company’s brand names, reputation, or long-term relationships that cannot otherwise be represented financially.”

Goodwill vs. Going-Concern

Now, it is important not to confuse goodwill value with “going-concern value,” as the two are definitely not the same. Going-concern value is typically defined by experts, as the fact that the business will continue to operate in a manner that is consistent with its intended purpose as opposed to failing or being liquidated. For most business owners, goodwill is seen as good service, products and reputation, all of which, of course, matters greatly.

Below is a list of some of the items that can be listed under the term “goodwill.” As you will notice, the list is surprisingly diverse.

42 Examples of Goodwill Items that Drive Core Value

  • Phantom Assets
  • Local Economy
  • Industry Ratios
  • Custom-Built Factory
  • Management
  • Loyal Customer Base
  • Supplier List
  • Reputation
  • Delivery Systems
  • Location
  • Experienced Design Staff
  • Growing Industry
  • Recession Resistant Industry
  • Low Employee Turnover
  • Skilled Employees
  • Trade Secrets
  • Licenses
  • Mailing List
  • Royalty Agreements
  • Tooling
  • Technologically Advanced Equipment
  • Advertising Campaigns
  • Advertising Materials
  • Backlog
  • Computer Databases
  • Computer Designs
  • Contracts
  • Copyrights
  • Credit Files
  • Distributorships
  • Engineering Drawings
  • Favorable Financing
  • Franchises
  • Government Programs
  • Know-How
  • Training Procedures
  • Proprietary Designs
  • Systems and Procedures
  • Trademarks
  • Employee Manual
  • Location
  • Name Recognition

As you can tell, goodwill, as it pertains to a business, is not an easily defined term. It is also very important to keep in mind that what goodwill is and how it is represented on a company’s financial statements are two different things.

Here is an example: a company sells for $2 million dollars but has only $1 million in tangible assets. The balance of $1 million dollars was considered goodwill and goodwill can be amortized by the acquirer over a 15-year period. All of this was especially impactful on public companies as an acquisition could negatively impact earnings which, in turn, negatively impacted stock price, so public companies were often reluctant to acquire firms in which goodwill was a large part of the purchase price. On the flip side of the coin, purchasers of non-public firms received a tax break due to amortization.

The Federal Accounting Standards Board (FASB) created new rules and standards pertaining to goodwill and those rules and standards were implemented on July 1, 2001. Upon the implementation of these rules and standards, goodwill may not have to be written off, unless the goodwill is carried at a value that is in excess of its real value. Now, the standards require companies to have intangible assets, which include goodwill, valued by an outside expert on an annual basis. These new rules work to define the difference between goodwill and other intangible assets as well as how they are to be treated in terms of accounting and tax reporting.

Before you buy a business or put a business up for sale, it is a good idea to talk to the professionals. The bottom line is that goodwill can still represent all the hard work a seller put into a business; however, that hard work must be accounted for differently than in years past and with more detail.

Generally speaking when you purchase another business, you are only buying the assets of that business. In other words, you are not buying the entity. Why not? Well, the entity could have a lot of skeletons in the closet. If the previous owner had made a mistake on a tax return and that mistake led to $100,000 in damages for the client, as the new owner do you want that responsibility or exposure? Nope.

There are circumstances where an asset sale is NOT ideal. At times the entity holds a license that is non-transferrable such as a liquor license or the entity has a contract with the government that took 7 years to bid and be awarded, and is also non-transferrable. But for most transactions, you will be executing an asset sale.

Within that asset sale is allocation of assets. Buyers and sellers have competing interests on price of course, but they also have competing interests on tax consequences. And to add to the complication, based on each party’s unique circumstances, a buyer and seller’s interests might be in concert with each other. In other words, an asset allocation might provide a favorable tax position for the buyer because of his or her own tax world, while still providing a favorable or at least neutral tax position for the seller. And these issues can affect the purchase price as well.

As business consultants, the Business Acquisition Experts is very aware of these competing interests and how they interplay with price negotiations. Let us help!

Let’s review some basics.

Asset Priority Buyer Seller
Cash Class I NA NA
Investments Class II NA NA
Accounts Receivable* Class III NA Ordinary Income
Inventory, Book Value Class IV NA None
Fixed Assets Class V Amortized, Varies Recapture / Gain
Intangibles Class VI Amortized, 15 Years Capital Gain
Goodwill Class VII Amortized, 15 Years Capital Gain
Non-Compete NA Amortized, 15 Years Ordinary Income
Consulting Agreements NA Expensed Income + SE Tax

* Sellers using an accrual method of accounting would not recognize income for the sale of their Accounts Receivable

The IRS breaks assets into classes, and essentially once you’ve allocated everything to Class I thru Class VI, whatever is left over is then considered Goodwill. So if the price is $200,000 and all your assets add up to $150,000, then you are also purchasing $50,000 in Goodwill.

 

For more on selling your business and how to negotiate the many parameters of a deal contact Business Acquisition Experts today!

 

Copyright: Business Acquisition Experts, Inc.

 

Why Seller Financing is Important when Selling Your Business?

Buying a business requires a good deal of capital and/or willingness from the current owner to offer Seller Financing. The bottom line is that a large percentage of buyers don’t have the necessary capital or lender resources to pay cash and that is where seller financing comes into play. The fact is that seller financing is quite common. In this article, we will take a deeper look at some of the key points to remember.

Is Seller Financing a Good Idea?

Many buyers feel that a seller’s reluctance to provide seller financing is a “red flag.” The notion is that if a business is truly as good as the seller claims it to be, then providing financing shouldn’t be a “scary” proposition. The truth is that this notion does carry some weight in reality. The primary reason that many sellers are reluctant to provide seller financing is that they are concerned that the buyer will be unsuccessful. This, of course, means that if the buyer fails to make payments, that the seller could be forced to take the business back or even forfeit the balance of the note.

However, it is important for sellers to look at the facts. Sellers who sell for all cash receive approximately 70% of the asking price; however, sellers receive approximately 86% of the asking price when they offer terms!

Seller Financing has a Range of Benefits

Here are a few of the most important benefits associated with seller financing: the seller receives a considerably higher price, sellers can get a much higher interest rate from a buyer than they can receive from a financial institution, the interest on a seller-financed deal will add significantly to the actual selling price, there are tax benefits to seller financing versus an all-cash sale and, finally, financing the sale serves as a vote of confidence in the buyer.

Clearly there are no guarantees that the buyer will be successful in operating the business. Yet, it is key that sellers remember that in most situations the buyers are putting a large percentage of their personal wealth into the purchase of the business. In other words, in most situations, the buyer is heavily invested even if financing is involved.

Business brokers excel in helping buyers and sellers discover creative ways to finance the sale of a business. Your broker can recommend a range of payment options and plans that can, in the end, often make the difference between a successful sale and failure.

Copyright: Business Acquisition Experts

www.acquisitionspro.com

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Citations:

www.bizbuysell.com

https://www.entrepreneur.com/article/244610

SBA Loans Fact Sheet- Everything You Need to Know to Buy a Business

If you are seeking financing to buy a business this is a must read! If you have
any questions following this please call Cody Weaver (646)737-5273

Buying and Financing a Business can be difficult but it doesnt have to be. Business Acquisition Expertss has the experince you need to make and acquisition with the most favorable terms.

SBA SOP 5010 5 (E) – as it relates to SBA Loans for BUSINESS ACQUISITIONS p. 81 – Acceptable Use of Loan Proceeds: Business Acquisition, Working Capital, Furniture, Fixtures, Machinery, Equipment, Real Estate, Refinance Business Debt

p.153 – Loan Maturity: Maximum Maturity is 10 years unless largest % of assets financed is Real Estate then maturity may be up to 25 years p.

139 – 141 – Change of Ownership “rules”: 1. Change must result in small business applicant purchasing or acquiring 100% ownership interest in business; Non-owner cannot purchase a partial ownership from seller, and existing owner cannot purchase ownership from a partner if transaction does not result in 100% ownership by purchaser;

2. Seller may not remain as officer, director, stockholder or key employee of the business; may contract as a consultant for no longer than 12 months after purchase;

3. Loan applicant must be a business, not an individual;

4. Lender must verify with IRS the last 3 years tax returns of business being sold;

5. Any Real Estate that is part of a change of ownership cannot be financed separately with a non-SBA guaranteed loan unless SBA loan receives a shared lien position on the real property. (Does not apply to SBA 504 program);

6. SBA considers change of ownership to be a “new” business. Lender is required to: a. Obtain a business valuation (*see valuation below) b. Make a site visit of assets being acquired c. Obtain a Real Estate appraisal for any real property acquired d. Analyze how the change of ownership will benefit the business being purchased (not buyer or seller);

7. SBA loan can finance intangible assets (goodwill, client/customer lists, patents, copyrights, trademarks and agreements not to compete, etc.)

a. If purchase price of business includes intangible assets in excess of $500,000, the borrower and/or seller must provide an equity injection (**see equity requirements below) of at least 25% of the purchase price – or a lender cannot process the application using PLP, and the application must be approved through SBA.

b. “Purchase Price of Business” includes all assets being acquired, including any real property, equipment, and intangible assets.

c. Value of intangible assets is determined by either i) book value reflected on business’s balance sheet, ii) separate appraisal for the particular asset, or iii) the business valuation minus the sum of working capital assets and fixed assets being purchased. Susan Kite /

SBA SOP 5010 5 (E) – as it relates to BUSINESS ACQUISITIONS p. 187 – 188 – Equity Requirements:

1. Lender must determine and document adequacy of equity injection.

2. Source of Equity Injection: a) Cash that is NOT borrowed (can be backed by a gift letter if supported by documentation in 3 below);

b) Cash from a personal loan IF repayment of that loan can be demonstrated from sources other than cash flow of business or owner salary from business;

c) Personal assets, other than cash, injected by owners where value is supported by an outside appraisal, not part of business valuation;

d) Debt that is on FULL STANDBY (no payments during term of SBA loan) or debt on PARTIAL STANDBY (interest-only payments being made). Partial Standby debt can only be considered as equity when there is adequate historical business cash flow available to make the interest payments.

3. Lenders must document and verify all equity injection prior to disbursement of loan proceeds. Borrower must provide: a) copy of a check or wire transfer along with evidence that the check or wire was processed showing the funds were moved into the borrower’s account or escrow; b) copy of the statements of account from which the funds are being withdrawn for each of the two most recent months prior to disbursement showing that the funds were available; and c) subsequent statement of the borrower’s account showing that the funds were deposited or a copy of an escrow settlement statement showing the use of the cash.

p. 194–195 – Business Valuation for Change of Ownership: Lender must determine the value of the business in addition to any real estate, which is valued separately through an appraisal.

1. If total amount being financed, minus appraised value of real estate and/or equipment being financed is under $251,000, lender may perform their own valuation;

2. If GREATER than $250,000 or if there is a close relationship between buyer and seller, then lender must request an independent valuation from a “qualified source” that regularly receives pay for business valuations and is either CPA or accredited by a recognized organization listed on page 194 of SOP.

3. Lender may use a going concern appraisal to meet valuation requirement if i) loan is used to purchase a special use property, ii) appraiser is either a “qualified source” or has completed a specific Appraisal Institute course, and iii) appraisal allocates separate values to land, building, equipment and intangible assets.

4. Any amount in excess of business valuation may NOT be financed with the SBA guaranteed loan.

Cody Weaver M&A Adviser at Busines Acquisition Experts
www.acquisitionspro.com

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What Do Buyers Really Want to Know?

Before answering the question, it makes sense to first ask why people want to be in business for themselves. What are their motives? There have been many surveys addressing this question. The words may be different, but the idea behind them and the order in which they are listed are almost always the same.

  1. Want to do their own thing; to control their own destiny, so to speak.
  2. Do not want to work for anyone else.
  3. Want to make better use of their skills and abilities.
  4. Want to make money.

These surveys indicate that by far the biggest reason people want to be in business for themselves is to be their own boss. The first three reasons listed revolve around this theme. Some may be frustrated in their current job or position. Others may not like their current boss or employer, while still others feel that their abilities are not being used properly or sufficiently.

The important item to note is that money is reason number four. Although making money is certainly important and necessary, it is not the primary issue. Once a person decides to go into business for himself or herself, he or she has to explore the options. Starting a business is certainly one option, but it is an option fraught with risk. Buying an existing business is the method most people prefer. Purchasing a known entity reduces the risks substantially.

There are some key questions buyers want, or should want, answers to, once the decision to purchase an existing business has been made. Below are the primary ones; although a prospective buyer may not want answers to all of them, the seller should be prepared to respond to each one.

  • How much is the down payment?  Most buyers are limited in the amount of cash they have for a down payment on a business. After all, if cash were not an issue, they probably wouldn’t be looking to purchase a business in the first place.
  • Will the seller finance the sale of the business?  It can be difficult to finance the sale of a business; therefore, if the seller isn’t willing, he or she must find a buyer who is prepared to pay all cash. This is very difficult to do.
  • Why is the seller selling?  This is a very important question. Buyers want assurance that the reason is legitimate and not because of the business itself.
  • Will the owner stay and train or work with a new owner?  Many people buy a franchise because of the assistance offered. A seller who is willing, at no cost, to stay and to help with the transition is a big plus.
  • How much income can a new owner expect?  This may not be the main criterion, but it is obviously an important issue. A new owner has to be able to pay the bills – both business-wise and personally. And just as important as the income is the seller’s ability to substantiate it with financial statements or tax returns.
  • What makes the business different, unique or special?  Most buyers want to take pride in the business they purchase.
  • How can the business grow?  New owners are full of enthusiasm and want to increase the business. Some buyers are willing to buy a business that is currently only marginal if they feel there is a real opportunity for growth.
  • What doesn’t the buyer know?  Buyers, and sellers too, don’t like surprises. They want to know the good – and the bad – out front. Buyers understand, or should understand, that there is no such thing as a perfect business.

Years ago, it could be said that prospective buyers of businesses had only four questions:

  1. Where is the business?
  2. How much is it?
  3. How much can I make?
  4. Why is it for sale?

In addition to asking basic questions, today’s buyer wants to know much more before investing in his or her own business. Sellers have to able to answer not only the four basic questions, but also be able to address the wider range of questions outlined above.

Despite all of the questions and answers, what most buyers really want is an opportunity to achieve the Great American Dream – owning one’s own business!

Key Factors on the Acquirer’s Side

There are several key factors on the acquirer’s side of a sale, most of which are necessary to achieve a successful closing. Just as a seller has to deal with quite a few factors, the acquirer must also. Some of the more important ones on the acquisition side are:

  • Sufficient financial resources to complete the deal as specified.
  • Depth of capable staff to run the existing business and also execute an acquisition at the same time.
  • A rational approach to the type, size and geographic location of target companies.
  • The willingness to “pay-up” for acquisitions such as 6x EBITDA and, if necessary, the willingness to pay 100% cash, whether the sale is one of assets or a stock transaction.
  • Assuming the acquisition search generates satisfactory deal flow, a willingness to stay the course for 6 to 12 months in the search process.
  • A confirmation by the board of directors of their commitment to complete a deal.
  • A “point person” in the search process, preferably the CEO, CFO or Director of Development who is reachable on a daily basis to discuss relevant matters.
  • Complete access to sales manager and others by the business intermediary to discuss suggestions of target companies.

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Questions to Consider for the Serious Buyer

A serious buyer should have the answers to the following questions:

  • Why are you considering the purchase of a business at this time?
  • What is your time frame to find a suitable business?
  • Are you open-minded about different opportunities, or are you looking for a specific business?
  • Have you set aside an amount of capital that you are willing to invest?
  • Do you really want to be in business for yourself?
  • Are you currently employed or unemployed?
  • Are you the decision maker, or are there others involved?

The real key to being a serious buyer, however, is whether the individual can make that “leap of faith” so necessary to the purchase of a business. No matter how much due diligence a buyer performs, no matter how many advisors there are to advise the buyer, at some point, the buyer has to make a leap of faith to purchase the business. There are no “sure things” and there are no guarantees. If a buyer is not comfortable being in business, he or she should not even contemplate buying one.

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Advantages of Buying an Existing Business

1. Established.

An existing business is a known entity. It has an established and historical track record. It has a customer or client base, established vendors, and suppliers. It has a physical location and has furniture, fixtures, and equipment all in place.  The term “turnkey operation” is overused, but an existing business is just that, plus everything else. New franchises may offer a so-called turnkey business, but it ends there. Start-ups are starting from scratch.

2. Business Relationships. 

In addition to the existing relationships with customers or clients, vendors, and suppliers, most businesses also have experienced employees who are a valuable asset. Buyers may already have established relationships with banks, insurance companies, printers, advertisers, professional advisors, etc., but if not, the existing owner does have these relationships, and they can readily be transferred.

3. Not “A Pig in a Poke”. 

Starting a new business is just that: “a pig in a poke.” No matter how much research, time, and money are invested, there is still a big risk in starting a business from scratch.  The existing business has a financial track record and established policies and procedures. A prospective buyer can see the financial history of the business — when sales are the highest and lowest, what the real expenses of the business are, how much money an owner can make, etc. Also, in almost all cases, a seller is more than willing to stay to teach and work with the new owner — sometimes free of charge.

4. Price and Terms.  

The seller has everything in place. The business is in operation and a price is established. Opening a new business from scratch can be the proverbial “money pit.”  When purchasing an established business, the buyer knows exactly what he or she is getting for his money. In most cases, the seller is also willing to take a reasonable down payment and then finance the balance of the purchase price.

5. The “Unwritten” Guarantee.

By financing the purchase price, the seller is saying that he or she is confident that the business will be able to pay its bills, support the new owner, plus make any required payments to the seller.

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