There are a handful of key asset categories in allocating or breaking down the purchase price of a business during the sale process. In many instances buyers and sellers have different desires in how to “chop up” the purchase price. The allocation in required to complete the transaction. Below are the most common used asset allocation classes.
In my opinion the actual asset value of each category is not so important here. For instance, many times buyers and seller try to really figure out what the Fixtures and Equipment are really worth and plug that real value into the allocation. Don’t lose sight on the bigger, more important picture here. What is most important about the allocation is the tax ramifications involved not actual values. For a buyer you are setting up you initial book values in these categories for future depreciation purposes. For a seller (who is selling for a gain) they may have different tax rates; ordinary income vs. capital gains.
This is no place to lose a deal over, but if planed well it should be most beneficial tax wise for you. I always tell my buyer and seller to consult their CPA over this issue, but I also want to stay in the loop on this one so the sale doesn’t get away from me. If both sides understand the ramifications to each other properly, they always come to agreement. Be involved in this stag. It is important.
Fixtures and Equipment: This asset class has the most to discuss. There is generally a 7 year life to depreciate the assigned value over. There are some equipment classifications that still depreciate over 5 years, but in general for a sale purpose it will be a 7 year life. This means that if I allocate $35,000 of the total purchase price towards Fixtures and Equipment I can write off this amount against my taxable income over the 7 year period. If your Accountant uses straight line depreciation (equal amount each year) it would equate to a $5,000 write off each of the 7 years. This is the shortest life of all classifications in the allocation which means the fastest write off.
Because of that, as a buyer your Accountant usually will tell you to allocate a large amount on this one. Keep in mind that as a buyer you will pay a 1 time sales tax on this amount prior to closing escrow. The amount of sales tax will be according to the tax rate per the county the business is located in. Most Counties are running Sales Tax rate of 8.75 – 9.25%. Take your County rate multiplied by the value allocated to get your sales tax due. No other asset class requires tax paid upon purchase.
Accountants like a large amount here for depreciation, Buyers like a small amount here because of the sales tax due on the amount. Our wonderful taxing agency, The State Board of Equalization has a minimum formula they like to use. They want to see the value to be a minimum of the Sellers current Depreciated Book Value. This can be found on the Sellers federal tax return under pages titled “Federal Depreciation Schedule”. In many cases the State Board of Equalization will ask the Seller for a copy of his Depreciation Schedule in order to close out the Sellers account and issue the Buyer a Buyers Tax Release.
Leasehold Improvements: Leasehold Improvements have a life from 29.5 to 39 years. You will get both of these numbers from various accountants. Personally if I use a Leasehold Improvement in my allocation I would want to use the 29.5 year life as the longer the life the less per year depreciation write off you will obtain.
This is the longest life of the asset classes.
Covenant Not To Compete: A Covenant Not To Compete has a 15 year life. In the past this used to get depreciated over the length of the Covenant. In other words a 5 year 5 mile Covenant Not To Compete used to get written off in 5 years. That made sense but the tax code changed this regardless of the actual Covenant life to where all Covenants are depreciated over a 15 year life.
Goodwill: Goodwill also has a 15 year life.
Liquor License: If your business has a Liquor License (full liquor) you should allocate some value to it, but it is a NON Depreciable item. Therefore I don’t like to add the full or real value here, but like to allocate something here so that I don’t get questioned by any taxing agency on my overall allocation.
I like to use the fastest depreciation allowed. I will generally only use Fixtures and Equipment, Goodwill and Covenant Not To Compete. I don’t see any value in allocating anything to Leasehold Improvements. It is such a long life, and you don’t get much “bang for you buck” on it.
About The Author: Lee Petsas has been selling businesses with UBI Business Brokers in Southern California since 1981. In 1999 he became the Owner and Broker for UBI. He is still active daily in Listing and Selling businesses. He has been approved multiple times by Courts as an Expert Witness in the area of Business Valuations. UBI has been in Southern California selling businesses since 1965. You can reach Lee direct at 714-363-0440.
|Helpful Resources To Assist In Selling And Buying California Businesses|
|Timothy Cunha, J.D., Business Broker, Northern California
Having managed and sold several businesses of his own, Tim offers business sellers extensive personal experience and professional expertise in building business value, planning a successful exit strategy, "packaging" and promoting the sale, and coordinating a successful sale. 844-237-6487 Toll Free.
|Ron Hottes, Broker - Serving LA, Orange, Inland Empire Area
LINK Business is a business brokerage team of 28 highly skilled and seasoned professionals. Our business brokers have over 100 years of cumulative experience & the expertise to help you buy or sell a business in the LA County, Orange, Inland Empire areas. Call Ron for a consultation at 310-539-8300.
|Ryan Clark, Business Broker, Southern California
The Veld Group provides a refreshing approach to Business Brokerage, Mergers & Acquisitions and Business Consulting and Valuations. From Your Street to Wall Street, we cater to Main Street Businesses as well as more complex Strategic Firms and Start-Ups. Phone Ryan at 310-652-8353.
|Lee Petsas, Business Broker - Orange, San Diego Counties, Inland Empire
UBI Business Brokers has been successfully selling businesses in Southern California since 1965. Our Agents have over 100 years of experience in selling small to medium size businesses throughout Southern California. We service Orange County, Inland Empire, San Diego. Phone Lee at 714-363-0440.
|Steve Zimmerman: Restaurant Broker Specialist
Steve founded Restaurant Realty in 1996. He has personally sold/leased over 900 restaurants, bars & clubs, & completed over 3000 valuations. The author of "Restaurant Dealmaker - An Insider's Trade Secrets For Buying a Restaurant, Bar or Club" available on Amazon. Reach Steve direct at 415-945-9701.
|Joanne Weber, Broker - Preschool Specialist - Southern California
The Ryan Craig Company is in its 35th year as the recognized expert in Southern California, dealing exclusively in the sale of preschools, Montessori schools, day care centers, and private schools. Our extensive list of references speaks for itself. Phone Joanne at 818-760-3684 for more info.
|William Park, Business Broker - Southern California
Highest Volume Broker in California, Simply Check our HUNDREDS of Listings! Over 25 Associates, Speaking Dozen Languages, Helping Buyers and Sellers of Small Business since 1982, Centrally Located between Los Angeles and Orange Counties, while Riverside & San Bernardino Counties are Very Accessible.
|Prabhjot Randhawa, Broker: SF Bay Area, Northern Central Valley
I'm a Business Advisor at Liberty Business Advisors of San Fransisco. I have over 20 years of experience in all phases of entrepreneurship. During the past 15 years my concentration has been in business of mergers and consulting. I have owned and operated over 10 businesses.
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