Tips for Newcomers on Buying a Business
by Jack Zwicker BA, LL,B., LL,M.
If you have recently arrived in Canada and are interested in investing in an existing small business, there are a number of stepping stones which you need to know about that are indispensable to your success. As is always the case, knowledge is power, and attaining critical information takes both time and preparation.
The first thing you should be aware of is that investing in any existing small business carries a certain degree of risk. Small Canadian businesses are generally managed and financed by the owner and no matter how you choose to go about buying such a business, seller’s financial statements will be generally be unaudited. This means that financial statements will be based solely on information the seller provides to his accountant. As a result, the financial statements that are handed over to you may not accurately reflect the correct asset, and liability values nor the correct income and expenses for the business you are interested in buying.
That’s why it is vital for you to work with a licensed accountant who can help you evaluate the financial information any seller provides to you in the course of a business sale transaction. A vital part of the process involves your reviewing the seller’s original records such as purchase orders, invoices, deposit books, journals, and general ledger with your accountant so as to ensure that the seller’s financial representations are accurate. You also need to work with an experienced lawyer who can assist in drafting an agreement that allows you to end a deal and get your deposit money back if it turns out that the seller’s financial representations are untrue.
– 2 – The second point you should be aware of is that acquiring an existing business can be done in one of two ways. You can buy either the assets of the business, or if the business is incorporated, the common shares issued to a majority of the shareholders. Should you choose to buy the assets of an existing business, you are not liable for the debts of the business. In addition you get to choose which assets you want to buy and which you do not. This can be important especially if some of the assets consist of aging equipment, which carry no manufacturer’s warranties.
There is one important income tax consideration, that is both good news and bad news for anyone buying the assets of an existing business. Any buyer who acquires the assets of an existing business has the right to deduct depreciation on a yearly basis from the portion of the purchase price represented by any equipment, fixtures or other hard assets along with that portion of the price relating to goodwill. Goodwill is the part of a business ‘s value that measures the loyalty of its customers. Because the total price of business assets which are sold is made up of these different components, experienced lawyers working with sellers and buyers are careful to ensure that asset sale agreements contain a provision setting out the dollar values of each item.
While deducting depreciation is good news for buyers of business assets, the bad news is that sellers have to pay income tax on the portion of the selling price for equipment and fixtures that exceeds their depreciated value. As well, a portion of the goodwill after sale may also be taxable. Your accountant can pre-calculate these numbers for you. So it is important for you to work with both an experienced lawyer and accountant before making an offer to buy an existing business.
– 3 – I mentioned that there is a second option for buying an incorporated business. And that involves buying a majority of the common shares held by the controlling shareholders of the company. Once again, this kind of transaction cannot be successfully attempted or completed without an experienced lawyer and accountant. When buying a majority of the common shares in a corporation, the buyer takes over all of the assets and liabilities of the company. This exposure to liability makes it all the more important for buyers to work with an experienced lawyer in preparing a detailed purchase agreement that allows the buyer to get his deposit money back and to end the transaction should the seller’s financial representations turn out to be false or inaccurate. For those who acquire controlling shares in Canadian companies, the Canada Income Tax Act allows them on a sale of those shares to exempt the first $500,000.00 from capital gains tax under certain conditions. One of those conditions is that the company engage in active business, and not merely hold passive investments. Once again your accountant can assist you in pre-calculating any applicable income tax.
So if you are thinking of buying an existing business, remember to leave yourself enough time to work with both a lawyer and an accountant who can assist you in preparing a proper purchase agreement and in verifying vital financial information. Only by dotting all of the ‘i’s’ and crossing all of the ‘t’s’ can you protect yourself from unscrupulous sellers.
Jack Zwicker is a business and real estate lawyer, negotiator, and lecturer, and practises in Markham, Ontario.