As an accountant, you may find that one of your small to midsize business clients comes to you for advice about buying a business — especially regarding the tax and accounting implications. So what advice should you give them? As their trusted advisor, what do you look for when scanning a potential transaction?
When acquiring a business, your client will need to think about what industry and business model to opt for. Thanks to the internet, there’s been a huge proliferation in the number of online businesses, which is something to take into consideration.
Ecommerce, in particular, has become a popular choice for first-time business owners, who can buy existing stores from the likes of Exchange or Flippa. Whether they’re buying an offline or online business, here’s what you need to know to give your clients the best advice.
Related reading: How to Build a Successful Ecommerce Business.
Asset vs. Stock Purchase
If your client has decided to buy a business, they need to understand whether they’re purchasing the assets or the stock. One is not necessarily better than the other – it depends on the situation.
With an asset purchase, the buyer receives the business’ full assets (as the name would suggest), including any equipment, inventory, vehicles, etc. With a stock purchase, they receive only the stock. Each option has its advantages and disadvantages.
Your client should consider the following:
With an asset purchase:
- Fewer issues with minority shareholders refusing to sell shares
- Less complicated from a securities law perspective
With a stock purchase:
- Less complicated if the selling company has a small number of shareholders
- Means you can avoid some (or all) asset transaction taxes
With purchasing a business of any kind, there is always due diligence involved. This should include an in-depth review of the business’ financials – for the last three years at least. Your client should look to get hold of:
- Bank statements
- Balance sheets
- Sales records
- Tax returns
- Profit rates
These financial records must be carefully analyzed to ensure that the business is a viable prospect with good growth potential. If the records haven’t been well-kept, this could be a red flag. Your client should take the time to observe sales figures across the last several years to identify any patterns.
With good records, they will be able to project the future cash flow and profitability of the business, helping them to decide whether it’ll be a good investment. Another thing to bear in mind is whether they will be buying the accounts receivable – and if so, how this could affect cash flow.
Legal & Tax Considerations
There are several important legal and tax questions your client will need to answer as part of the due diligence process. These are broken down as follows:
Your client will likely come to you for advice on how to value assets for the best possible tax advantage. Be sure to make your client aware that when they buy a business, they are purchasing an asset – one that they may at some point want to sell. You will therefore need to ensure that they understand their position with regard to capital gains tax law and the implications of selling within one year of ownership.
Further, if restructuring or purchasing assets, there could be stamp duty to consider. You will also want to take into account Goods and Services Tax, if it applies to them.
Before entering into buying a business, you and your client should know the answers to each of the following questions:
- What are their obligations with regard to the business’ legal structure?
- Are there any legal proceedings pending against the business or current owner?
- What are the terms and conditions of any lease agreements?
- Are there any health, water or sewage notices that need attention?
This is something your client will certainly need to consider if they’re seeking any kind of financial help for their business. If they’re operating as a sole trader, then they will need to look to their personal credit history to check that everything’s above board. If others are involved, then the histories of these additional directors and partners must be looked at as well.
Poor credit history can be especially damaging to a new business owner, whether they’re starting a business or buying an existing one, since this pose a greater risk to lenders. Therefore, it’s worth advising your client to start looking into this right away, to see whether their credit score could impact their business plans, and if so, how they can implement some damage control.
There are options available for those without a strong credit history: bad credit loans, startup schemes and alternative banking, for example. It’s not necessarily the end, it just means thinking outside of traditional lending routes.
When business ownership is transferred to your client, they may need to look into the transfer of relevant intellectual property. For this, there needs to be a carefully worded written agreement – without such a document, your client may not get the essential rights they’re paying for.
Whether they’re buying rights, a trademark, or a patent, it’s worth advising your client to get an experienced intellectual property expert involved, if they can. Guidance throughout the transfer process can help to overcome much greater problems further down the line.
For example, if your client is buying the rights to a piece of software, they will want to ensure the contract is watertight. Otherwise, the seller could go away and recreate another version of the software with the same functionality, which could then be sold to a rival business.
Buying a business is a big decision for anyone. It takes time, research, cash, and confidence. It’s also essential to dot the i’s and cross the t’s. If your client comes across any of the following red flags in the process of buying their business, encourage them to exercise caution before signing their money away.
- The taxes aren’t up-to-date – Your client should review all of the new business’ tax returns before making a decision. If the business hasn’t been paying its taxes, your client could be held responsible.
- The financial records don’t add up – Advise your client to look over financial records for the last 3-5 years to check everything is above board, and to compare these statements with their corresponding tax documents.
- The owner seems shady – If the existing business owner glosses over the finer details of the business’ performance and downplays important information, there may be something going on. Always ask the business owner why they’re selling – have there been any recent developments that your client should be aware of?
- Poor equipment – If it’s an asset purchase, your client may be taking on business equipment. Advise them to have an expert check the equipment over, if they don’t know much about it themselves. Replacing failing equipment can be costly.
Buying an existing business over starting from scratch can have many benefits: an established customer base, pre-existing business records to help drive future decisions, and the knowledge and expertise of former staff. But it can also be a tricky road to navigate, fraught with potential financial burdens if things aren’t handled correctly. Be sure to guide your client in the right direction, so they can make the most from their new business venture.