The allocation of purchase price in asset sale is an important step in selling a business. Correctly allocating a purchase price can be very complicated, relying on several factors such as what the asset is worth and what potential buyers would be willing to pay.

Purchase Price Allocation

When selling a business, it's important to allocate a purchase price for the business's assets. Allocating a purchase price occurs with both stock sales and non-stock sales. In most cases, selling a business either involves selling the business's stock or selling the assets of the corporation.

Before allocating a purchase price, you must consider whether the sale will be strictly a stock sale, or if it will be a non-stock sale, meaning you will only offer your company's assets. An asset sale is another name for a non-stock sale.

The term “asset sale” can refer to two different types of sale. The first type of asset sale involves the tangible and intangible assets of an ongoing company. The second type of asset sale focuses on the sale of a business's fixed assets. This type of sale can include all of a business's assets or only a set of assets. Often referred to as liquidation, this type of asset sale usually takes place after a business has closed.

Allocating a purchase price for business assets can be extremely complex, even for the most experienced business owners. For example, when allocating purchase price, you must consider rules put in place by the IRS. The value of a business's intangible assets is also an important factor to consider.

To comply with IRS rules for allocation, there are three issues to keep in mind:

  • The tangible assets of the business
  • The business's intangible assets
  • Real world factors such as the negotiated purchase price and the value later given to the assets

Both buyers and sellers need to consult a tax lawyer when negotiating the allocation of purchase price. Negotiating allocation of purchase price can take place after a buyer and seller have agreed to the sale. Tax implications make the allocation of purchase price very important.

Typically, all of the assets of a business will be sold, whether the business is sold through a stock sale or a non-stock sale. Those assets can include:

  • Contract rights
  • Equipment
  • Lease holds
  • Customer lists

Non-stock sales can exclude certain business assets:

  • Accounts receivable
  • Business bank accounts
  • Business liabilities
  • Cash
  • Deposits

Allocation of Purchase Price in a Stock Sale

Selling a company through a stock sale allows the business to completely allocate the purchase price to the sale of company stocks. If the stock sale involves a private corporation, however, the price allocation can include service agreements and service contracts, including:

  • The stock's value
  • The value of training
  • The value of the covenant not to compete

Sellers usually will request that all of the allocation of purchase price be to the stock's value. The reason that sellers prefer this form of allocation is that it can lower their tax burden resulting from the sale. Generally, the sale of stock is subject to the lower capital gains tax rate than the much higher income tax rate.

Buyers, on the other hand, prefer more value placed on Transition and Training and the covenant not to compete. Lowering the value of the stocks and placing more value on these other items provides the buyer with beneficial tax write-offs.

Allocation of Purchase Price in a Non-Stock Sale

In a non-stock sale, the usual principle is that the purchase price of the company's assets should be allocated based on fair market value. The buyer and the seller will negotiate the allocation of purchase price for these assets so that neither party is disadvantaged by the sale. Each party involved in the sale will need to consider several factors. The buyer, for example, must take into account the taxes they will pay once the sale closes and should also think about how to decrease future taxes for their new business.

If the seller realizes a gain from selling their business, they will need to determine how much capital gains tax they will need to pay and if any income taxes are required.

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