Buying a business

Overview

To acquire a business which is being carried on by a company, the purchaser must decide whether to acquire some or all of the shares in the company that carries on the business (the target business); or the individual business assets and liabilities of the company that carries on the target business.

Each option has different commercial, accounting and tax-related implications which vary according to whether the purchaser is an individual or a company.

In the case of a business that is to be acquired from an individual or a partnership, there is no alternative but to buy the individual assets and liabilities of the business. A purchaser who is an individual does however have the choice of buying the individual assets and liabilities of the business in their own name, or of incorporating a company to do so. In such cases, the choice is essentially one of whether to trade as a sole trader or through a company.

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Share purchase

A method of acquiring a business in which a purchaser acquires the whole (or a substantial part) of the existing shareholdings in a company which already carries on the target business. The shareholding will be purchased from the existing shareholders of the company that undertakes the target business.

Asset purchase

A method of acquiring a business in which a purchaser acquires the individual assets and liabilities of the target business. The individual assets and liabilities of the business will be acquired directly from the company that undertakes the target business.

EBITDA

Earnings before interest, tax, depreciation and amortisation.

Negotiating the Purchase Price

The vendor and purchaser must agree on a purchase price for the business and this process will generally start with a valuation of the whole business. Business valuations based on an EBITDA multiple are a common approach in relation to the valuation of businesses with mainly tangible assets. Valuations are generally based on a debt-free/cash-free concept, with the buyer wishing to acquire, and the vendor expected to deliver, the business on that basis. Any debt acquired with the business would typically be deducted from the purchase price, and cash would generally only be paid for if it could be extracted without cost (including tax) from the business

Having agreed on a whole business valuation on a debt-free/cash-free basis, the purchaser is now in a position to evaluate whether a share purchase or an asset purchase would be best means of acquiring the business. From a tax and economic perspective, absent other commercial factors, this should be done by comparing the net present value of the post-tax cashflows arising under each purchase method. The method that produces a higher forecast net present value should be the preferred option. In practice, tax and economic factors often do not always prevail, and greater weight must sometimes be given to other commercial factors.

The same principle applies, of course, to the vendor who should also evaluate whether it would be better to sell the business at the agreed valuation by way of share sale or asset sale. Once again, from a tax and economic perspective only, absent other commercial factors, this should also be done by comparing the net present value of the post-tax cashflows arising under each disposals method with the higher value determining the preferred option. Again, other commercial factors sometimes prevail.

The final determination of the acquisition method and price will depend on the outcome of a negotiation between vendor and purchaser having regard to their respective preferences for a share or asset transaction. It is not at all inconceivable that the vendor may prefer a share sale (because of the availability of business asset disposal relief (formerly entrepreneurs’ relief), for example) and the purchaser may prefer an asset sale (to avoid inheriting unprovided liabilities of a company, for example).

The final position will ultimately depend on the relative bargaining power of each of the parties. In a seller’s market, for example, the seller’s preferences are more likely to prevail and the reverse will be true in a buyer’s market. In between these two extremes, the permutations and combinations are endless.

Franchising

A business may be purchased under a business system franchise agreement. This involves the grant by an existing business (the franchiser) to another person (the franchisee) of the right to distribute products or perform services using the name, branding and systems developed by the franchiser in relation to an existing business. Franchise agreements may cover a wide variety of different activities and the terms may vary considerably. The franchisee generally acquires a right to use the system and to obtain management support from the franchisor for a specified period.

The franchisee normally pays a payment fee; and ongoing payments throughout the duration of the agreement, often a percentage of turnover, a mark-up on purchases from the franchiser or a regular fixed payment per outlet.