What is Purchase Price Allocation when selling a business or buying a business?
One of the hidden and sometimes very surprising scenarios that buyers and sellers of a business experience comes when there is a need for both parties to agree on the Purchase Price Allocation. The surprise comes into play as most buyers and sellers have not heard of the Purchase Price Allocation. When it needs to be agreed upon, both buyer and seller can find it emotionally challenging, especially if the negotiations have been long and difficult.
So, 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 report their own understanding of the Purchase Price Allocation, and the IRS can and does check to make sure both parties report the same information.
So, where does the challenge come into play?
The challenge comes into play because the buyer has a different tax need 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, lowering their tax bill.
The general process is for the seller to list the business for sale at a specific price. The buyer does their research and makes an offer, and if all goes well, both parties agree, perform due diligence, and close escrow. Just before closing escrow, the Purchase Price Allocation must be agreed upon.
If an escrow company is handling the transaction for both parties, they will require an agreement from both parties on what the Purchase Price Allocation should be. It’s not too common, but it happens when the buyer and seller have spent months working together on this transaction, and then it falls over because they simply cannot agree on the Purchase Price Allocation. This happens when the negotiations have been stressful and difficult, and the frustrations simply come to a head at this point, with the Purchase Price Allocation being 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, it can be handled 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 only sell their stock and not do the transaction as an asset sale, stating this upfront can lessen that problem.
Many buyers are unwilling to buy a company’s stock for two reasons. The first reason is that if they buy the stock of the company, they are liable for any previous actions of the seller. This liability can be mitigated through the seller’s personal guarantees and insurance, but it still makes a 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 is more complicated when the tax costs and benefits come into play. 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 the goodwill to negotiate is not there, there is little likelihood the transaction will close.
Are you thinking about selling your business?
Would you like to know the value of your business?
For more information, please visit my website, Business Valuation.
For more immediate help, you can email Andrew Rogerson or call me at 916 570-2674.
