Important things to consider when purchasing a new business
Generally speaking there are two ways to go about purchasing a business. When buying a business that is formed as a limited liability company, or a corporation, a prospective entrepreneur may buy the business’s assets or the entrepreneur can buy the business itself (which includes all the businesses assets and debts, and the business entity itself). Note that when buying a sole proprietorship, there is no transfer of business entity because no business entity was ever formed; the sale of a sole proprietorship is therefore treated as an asset purchase. In the case where the sellers are selling specific assets of the business, the business entity itself is not transferred; this important difference can have large ramifications.
When buying a business, as opposed to buying the business’s assets, you are essentially purchasing all the shares or interests in that particular business entity. For an LLC, the buyer purchases all the membership interests from all the LLCs members. Similarly, with a corporation, the buyer purchases all the shares of the corporation from the shareholders of that corporation. Once you have control of the business by virtue of owning all the shares or interests, then you can control what to do with the business’s assets, but the business will remain liable for past debts. Being liable for the business’s outstanding debts makes an asset purchase agreement an attractive alternative to purchasing the entire business.
Doing an asset purchase usually benefits the buyer and can impose negative tax consequences to the seller; this fact should be accounted for in the purchase price set by the sellers of assets. Selling of the entire business entity is usually more favorable for the Seller because the proceeds can usually be treated as long term capital gains. Buying assets of a particular business is also beneficial for tax reasons to the new business owner, because the buying business can start receiving depreciation benefits. Sometimes however it is not always possible to buy just the assets of a business.
If you are able to structure a purchase of a business’s assets, you should consider forming a business entity (LLC, or corporation) to receive the assets and operating business under. If you take the assets individual and operate as a sole proprietor you will be liable for the business’s debts. It is important when drafting an asset purchase agreement that the items purchased and the items not purchased be clearly outlined. This is one area where it pays to have a business or contract lawyer assisting you; failure to include/exclude a particular item can have disastrous consequences.