At James Law Firm, we have over 20 years of experience helping clients navigate the purchase of a business.  This article gives a general overview of the steps you should take in the purchase of a business.  No steps are necessarily sequential, as the steps may be going on simultaneously. 
You have decided to “become your own boss,” hopefully to obtain time and financial freedom.  Thus, you have already decided to purchase, and you probably already have decided “what” to purchase, meaning the type of business, such as manufacturing or service oriented.  This article discusses what to do after that step.  When you have located a potential target, you should consult a lawyer, because many clients think that they should work out their terms of the deal and provide it to a lawyer to document it—at the tail end of the process.  This approach does not use the lawyer’s experience in dealmaking and does increase transaction risk of a bad deal.  Being a scrivener is not the lawyer’s only task! In fact, most, if not all businesspersons, do not consider all the terms and due diligence items to examine in the purchase of a business by the time that buyer discusses pricing with seller. 

Get Your Team Involved

First, when you have identified that target, you should discuss the target with your commercial banker or seek a referral from your lawyer if you do not have one.  Even if you decide to buy the business with cash, getting insight into from the banker could help, and you might want to establish a line of credit as a contingency for your business.  You should also consult with your lawyer, banker, and financial experts, if you need assistance in pricing the business.  Pricing the business is part art and part science and outside the scope of this article.

The Big Question: Asset Purchase or Stock Purchase?

Second, your attorney should focus your attention on the correct deal points.  Most importantly, when you locate the target business, are you going to purchase the assets of the business with a new legal entity that will operate as the name of the target business, or will you acquire the stock or membership interest of the target and take over the exact same entity?  These two options present different risk assessments and pricing differences.  Most importantly, the pricing difference is huge!  You would not buy the assets of the business for $x or the stock of the company for $x, the same price!  When you buy the assets of the business, the buyer can depreciate the hard assets over a few years, or, better, expense the assets under Section 179 or under a bonus depreciation method in year one or over two years.  In addition, any amount paid over the hard assets of the business and receivables gets allocated to goodwill, and this asset is expensed (amortized) over 15 years.  In contrast, when buying stock, membership interest, or partnership interest, there is generally nothing to depreciation or amortize (there are some nuanced exceptions such as buying 100% LLC interest classified as a partnership).  The expense deductions should be discounted to present value to determine the current value of these tax benefits.  As a result, a buyer might determine to buy the assets of the business for $1,000,000, but buy the stock of the company for $700,000, after taking into account the present value of the tax benefits over 15 years. 

The second difference between a stock purchase and an asset purchase is the assumption of liabilities.  An asset purchase should have a carefully crafted provision regarding the purchase of the assets and a limited and specific liability assumption, such as liabilities arising under assumed contracts for obligations to provide services or goods after closing.  The asset purchase agreement does not assume all liabilities.  In contrast, a stock purchase results in the purchase of the corporation (or LLC) with all its known and unknown liabilities in it.  Thus, representations and warranties (basically, promises regarding what is getting sold) are more crucial, and buyer should want assurances that seller will be on the hook for unknown and unexpected liabilities or for any shortcomings in promises.  In summary, the risk assessment and pricing are much different in a stock or membership interest purchase than an asset purchase.

The most important aspect of the negotiation with seller over price is what you are paying AND what you are getting.  Nothing is more cringy when asking the client who answers that he does not know the answer to the question, “So are you paying $3,000,000 for the assets or for the stock?”  How do you have an agreement in principle without knowing what you are buying?  Unfortunately, this problem requires backwards negotiation.

On the Road to Buying: Letter of Intent

In negotiations with seller, seller will often ask for a Non-Disclosure Agreement.  This document should be reviewed by buyer’s counsel, to ensure that its obligations are not overburdensome or laden with liquidated damages for the breach of the agreement.

Seller should ask for certain items in the investigation of the business; this investigation is called “due diligence.”  Due diligence concerns not only financial aspects and performance of the business, but also the corporate or LLC charter and authorization to do business, ownership, assets, liabilities, employees, employee benefit plans, laws and compliance with laws and regulations, environmental, safety, employees legally authorized to work in the country, condition of assets and real estate (if any), existence of brokers, contracts, customer and vendor relationships, liens, lawsuits and investigations, and more.  Buyer should work with buyer’s counsel in the review of due diligence documents. 

Ideally, buyer should collect as much information and analyze it before entering a contract.  However, sellers are sometimes wary about providing all the access before such point, particularly identity of customers.  An option is to offer a letter of intent.  A letter of intent is supposed to be just what it sounds: an expression of intent (or interest) in buying seller’s business.  It is not supposed to be binding, but it will have a few binding obligations, such as confidentiality.  Poorly drafted letters of intent, specifically the DIY documents, lead to lawsuits, because the heading “letter of intent” is not binding on whether some document is a binding contract.

Contract Drafting and Closing

At some point, buyer becomes ready to make an offer.  Generally, purchase price and payment method are worked out, and hopefully, an asset purchase or stock purchase is agreed.  A buyer could also mention that buyer would not pay the same price for the stock as for the assets—just to set an expectation.  A seller who sells the stock at a lower price may come out with more money after income tax, depending on seller’s other income and stock basis.  Ideally, Seller will have counsel or a CPA who can explain this dynamic.

When the offer is made, contract drafting should start.  I like the idea that any kind of agreement in principle should include the agreement with such representations and warranties regarding the business as the buyer and seller may agree.  The best place to state this goal is in the letter of intent.
In the contract drafting, buyer should discuss with buyer’s counsel whether the deal will be a “sign and close,” whereby the parties sign the agreement and immediately close, or an “executory contract,” whereby the parties sign one day and close later.  Purchases with real estate will most likely consist of the executory contract.  If buyer needs certain contingencies or further due diligence review, then the executory contract should be used.  That way, seller is bound to the contract, while buyer works out buyer’s contingencies on financing and due diligence completion.  If buyer has ready financing, no real estate is involved, and closing document preparation is in process, a sign and close deal is doable.  I have done each one.
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The above process is a general overview, and it should be considered legal advice.

Finally, it is time to comply with the Corporate Transparency Act (the "CTA").  The CTA was passed over President Trump's veto as part of the National Defense Authorization Act in January 2021.  We had to wait until the Treasury developed implementing regulations and the website structure and database to comply.  That date was extended until this year.

What does that mean for business owners and, well, everyone ?  If you create a company, you need to know about the CTA.  The CTA requires for all LLC, corporations, and limited partnerships to file a Beneficial Ownership Information Report (a "BOIR") with FinCEN unless the company is exempt.  What companies are exempt?  Mainly, insurance companies, insurance agencies, banks, securities dealers, companies with a threshold revenue and employee number, and "inactive" companies are exempt.  These companies already report beneficial ownership to the Treasury in the federal tax return or to another agency as a part of federal regulation.

Neither the large company threshold or the inactive company exceptions apply to new companies.  The large company exception is for a company with more than 20 employees, an office in the U.S., and at least $5M in gross receipts derived in the U.S. for the previous year.  Upon formation, a new company does not have employees or revenue in the prior year. 

An inactive company is a company that (A) was in existence on or before January 1, 2020, (B) is not engaged in active business, (C) is not owned by a foreign person, whether directly or indirectly, wholly or partially, (D) has not experienced any change in ownership in the preceding twelve month period; (E) has not sent or received any funds in an amount greater than $1,000, either directly or through any financial account in which the entity or affiliate had an interest, in the preceding 12 month period; and (F) does not otherwise hold any kind or type of assets, whether in or out of the U.S., including interests in other corporations, LLC, or similar entities.  As you can see, this exception does NOT apply to new entities, probably because all entities are "inactive" at the moment of formation.

Thus, you cannot create a company to hold an acre of land or some money inherited or whatever innocuous, non-business purpose.

For 2024, an entity has 90 days to file the report after formation, so hopefully, an entity can finalize all its owners by such time.  In 2025, the deadline is 30 days after formation!  What if all the planned investors have not joined the ownership group by the deadline?  Before the deadline, the entity should file the BOIR, and upon any changes, it must consider whether it must file an updated report.

We have had this issue many times over the years.  Sometimes, it is known who owns the land, but nothing had been done to prove it.  Other time, families know that they own the land, but they have no idea in what percentages.  How does this problem happen?  Simply, it comes from a lack of planning.  People die without Wills, and no probate is ever done.  A second reason is that people refuse to probate a Will, even if it exists.  Generations pass without a probate process.

What do you do?  There are some options.  You have to research back to the source of the problem--who was the last person or persons to acquire record title to the property?  

Then, it's time to construct that family tree!   You have to construct the family tree and then apply the intestacy laws in existence at the time someone died.  Then you move your way forward.  Often, a genealogist is required to research records.  It's a fun process, but a time consuming one.  Time consumption means money, so make sure the property is worth the expense.

Each time you determine a deceased person's heirs, you have to consider how do you prove that to a title examiner at a title company, if you were to sell the property, even if you never "plan" to sell the property (that's another issue...if you have many owners of one property,  a sale is likely inevitable).  You can prove a deceased person's heirs via affidavits of heirship recorded in the deed records.  A second option is to determine the heirs in court in a determination of heirship proceeding authorized by the Estates Code.

The effort to determine who owns property could require multiple sets of affidavits or determinations of heirship. 

Another idea is a trespass to try title action to determine who owns property.  Under the Property Code a trespass to try title action is the method for determining ownership of property.  This approach should be used when there is a dispute over ownership of property.  

What if multiple owners are determined to own certain property, but the owners do not want to sell?  How do you know if your work on ownership determination is complete and adequate?  You could create your own sale by transferring the property to a limited liability company.  This transfer could close at a title company, with a value determined for the property's transfer, and with a title policy.  That idea will place the ownership work to the test.  Further, holding the property in an LLC will provide a management structure and protection from creditors.

Often, some parties will want to sell and some will not.  Some owners will often buy out other owners.  These sales could close a title company too, with a title policy.  This closing will put to the test the work to determine owners.  Sometimes, there has to be a forced sale, and a partition action is required.  One option is the Texas Uniform Partition of Heirs' Property Act of Chapter 23A of the Property Code.

Let's consider a real example.  Client is selling his 255 acre farm he inherited from dad.  A small portion of the property, 45.43 acres came from the Walker family, via one Walker heir who purportedly acquired all the Walker heirs' interests.  A husband and wife, the Walkers, owned a 545.16 acre farm, and the survivor died in the 1940's.  They had 12 children.  Neither Walker had a Will or estate probated.  One of the children, Walker Jr., died in 1960, leaving 11 children.  In 1975, the family wanted to divide up the 545.16 acres, and 11 of the 12 are still alive.  They knew the last record owners, the Walkers, their parents.  One child, Walker Jr., was already deceased, having died in 1960, so they had to make a family tree for him.  The family tree was known; he had 11 children.

Affidavits of Heirship were recorded, along with a partition deed.  Each of the living children received 545.16 acres/12, or 45.43 acres.  Walker Jr's 45.43 acres were divided among his 11 children, but there was a wrinkle!  Walker Jr.'s wife also received an equal share, instead of a life estate.  Normally, a surviving spouse would only inherit a 1/3 life estate in separate real property, but for some reason, she received an equal share, meaning 1/12 of the 45.43 acre tract.  Perhaps, the law in 1960 required the surviving spouse to get an equal share--again the law in 1960 was relevant, but the partition deed required her to get an equal share, so knowing the law then was not necessary in this real example.  Ms. Walker died in 1983.  Guess what?  Research regarding Ms. Walker showed that she also had either 2 or 3 children (perhaps one was a stepchild) from previous marriage(s) or relationship(s) or subsequent ones after Mr. Walker Jr.'s death in 1960.  Because these children were not Mr. Walker's, some additional heirs inherited her 1/12 share; the 1/12 share did not get inherited in total by Mr. Walker's 11 children.  If there were three other children, then her 1/12 got divided among all her children, 14 of them!  So that is her 1/12 * 1/14 for each child, or 1/168 for each, with 3/168 going to other children who did not sell to the Walker heir who sold to Client's dad.  So that is 3/168*45.43 acres out of 255 that is the problem!

If you were to track down these 2 or 3 additional children and prove ownership, you would have to complete an Affidavit of Heirship or a Determination of Heirship for Ms. Walker and then these 2 or 3 children if they were not living and then so on, if one of these heirs had died.  Another option: since one Walker heir had acquired all the other heirs' interests (other than these 2 or 3) and then sold the property to client, client could file a trespass to try title action to determine a superior title to the property, including via adverse possession, or a partition action to acquire these two or three heirs out of their interest.  That would have been much work!  Fortunately, in client's 255 acre property sale, only a portion of the property (45.43 acres) came from the Walker family, and seller was able to work with buyer and title company for an exception from the warranty for any property claimed by Ms. Walker's two or three other children.  In summary, the problems arose because two generations of heirs had no Wills or estates probated, and the problem was not discovered when client's dad acquired the property, because the sale occurred outside a title company!

Do you have a business that is expanding and succeeding, and you want to acquire your own real estate for it--such as for an office building, warehouse, machine shop, or fabrication shop?

How do you undertake this purchase?  First, you need advisors.  You need a good business attorney who has knowledge not only in business law, but tax law and real estate law.  Some firms have someone who has knowledge in all three areas.  Sometimes, you will need a firm with multiple attorneys.  You should also have a good accountant who can perform financial analysis on purchase versus lease, with the after-tax cost of each.  You also need a good commercial real estate agent.  Finally, if you are to build, then you need a good construction management consultant and/or an engineer to help with the design and build.

You should also be in contact with your banker on the financing, and you should start the discussions before you start looking.

For the main point in this article, how do you setup the real estate ownership?  You should setup a separate company to own the real estate, and nearly every time, the separate company should be an LLC classified as a partnership for income tax purposes (for high value real estate, an LP may be used).  The operating company's business liabilities should be held separate from the ownership of the real estate.  The operating company should enter into a long-term lease with the real estate company and pay rent.  The real estate company then pays the bank.  You are not obligated to "put all your eggs into one basket" when you are in business.  Accordingly, you are not obligated to place a valuable property into your company and risk losing the business and real estate.  

Your banker should want you to place the real estate in a separate company.  Bankers will act like it such a problem to change the loan underwriting package, because the owner will be different.  Separate ownership is very common, and the banker's concern is just a lack of knowledge.  A banker should want the real estate in a separate company.  If the operating company tanks, the banker should want its collateral separate from the disaster!  Also, the bank will require the operating company to have liability on the loan anyway, along with any principals who generally own 20% or more of the company.  Instead of the operating company being the borrower, it will be a guarantor.  Big deal, there is no way around that.

There are other reasons to keep the real estate separate.  First, there are tax reasons.  Operating companies are often s-corporations.  An s-corporation should not own real estate.  If you transfer real estate outside a corporation to the shareholders (a distribution), the transfer is treated as a sale of the real estate for fair market value (even if the shareholder owns 100% of the s-corporation--would you expect that?).  If the corporation borrows money and distributes the money to the shareholders, you might create a capital gain if the stock basis is less than the amount of the distribution.  Would you expect "paying tax on borrowed money?" These are terrible tax results.  Partnerships, including LLC classified as partnerships, do not have these problems.

Second, there are business reasons, other than liability risks, to keep the operating business separate than the real estate. Do you have a key employee?  Perhaps, you want to award key employees with ownership in the business.  If the business owns the real estate, then you will also be granting the key employee ownership in the real estate too.  By keeping the two separate, you can award key people with ownership in the business and still own the real estate 100%.  Third, sometimes, only certain owners have the money and creditworthiness to invest in the real estate.  In this case, separate companies makes the ownership much more feasible.

A second business reason occurs upon the retirement or sale of the business.  If the two are separate, then you could just sell the business and keep the real estate.  Sometimes, a seller will "sell" the "stock" or "membership interest," especially if there are key contracts to keep in place.  If the real estate is outside this entity, then it is easier to sell the company and keep the real estate.  Keeping the real estate can make it cheaper for the buyer to acquire the business, and the real estate can provide retirement income--rent!

Subtitle: How to Avoid Making a $400 Will into a Court Case!

Early in my practice, I saw a Will prepared by a husband and wife for the husband, as he was very ill.  It was one of those "internet based" Wills.  It was drafted poorly and signed improperly.  The Will is considered a separate instrument from the self-proving affidavit.  Unlike today's Wills--which allow the testator and witnesses to sign only once--the prior Wills required two signatures for a self-proved Will.  The testator and witnesses only signed the self-proving affidavit.  In addition to this problem, the self-proving affidavit's language was butchered.

Oh, we cannot leave out the fact that the marriage was common law, and surviving spouse had a stepchild!  

Result: lawsuit!  Over $20,000 was spent to defend the Will and get it admitted to probate.  

What was the real problem?  The refusal or, perhaps, fear of going to see an attorney to draft an estate plan.  Many clients just need a "simple Will," a durable power of attorney, and a medical power of attorney with directive to physicians (a "living Will").  These documents are not complicated, but the client gets the opportunity to ask questions and gain some knowledge and assurance that he has an adequate and effective estate plan.

Believe me, do not let your Google search make you think that you can practice law!

LLC or S-Corporation?  This question is a common one.  However, it is not even the right question!  LLCs and S-corporations are apples to oranges.  You can have both.

An LLC is a state law entity, a limited liability company.  It is governed by the Texas Business Organizations Code, a state law.  

An S-corporation is a federal income tax election made by filing Form 2553.  The "S" stands for Subchapter S of the Internal Revenue Code, the federal tax law.  You do not create an s-corporation by filing a document with the Texas Secretary of State.  Technically, you do not even "create" an S-corporation.  You make an S-corporation election.

The proper question is, "Should I create an LLC and make the S-corporation election?"  A state law corporation (filed by filing a formation document with the Texas Secretary of State), an LLC, and even a limited partnership can make an s-corporation election.  Yes, a limited partnership can be an S-corporation, because this status is an election.  An LLC and LP are eligible entities that can make an s-corporation election, if the requirements for an s-election are met.  This law is known as the "check-the-box regulations," and these regulations were actually implemented in the late 1990's!  Amazingly, the regulations still trip up other lawyers and even accountants today.

An LLC is the most common operating entity today.  An S-corporation is preferable for many small businesses, particularly those with a sole owner and employees.  An LLC with a sole member that makes an s-corporation election will then treat that sole member as an employee, if such employee is providing services on behalf of the LLC.  

Most of the time forming an LLC is the preferable entity.  Your next question is determining whether to make that s-corporation election for the LLC. 

Probate in Texas, compared to other states, particularly New York, California, and even Florida, is not as expensive and time consuming as one would think, IF you have a properly drafted Will with an independent executor.  Most estates will have some sort of probate involved with the process of transferring assets.

Let's take a step back and say what probate is.  Probate comes from a Latin word meaning "to prove."  With a Will, the applicant is offering a document to prove that it is the Last Will and Testament.  Without a Will, one has to prove who the heirs are.  A Will has no legal effect until the testator dies (yes, there is a statute that says that) and until the Will is admitted to probate.  That does not mean a Will must be probated.  There are two types of assets: probate assets and non-probate assets.

Probate assets are those that pass through the Will, or if there is no Will, then through the intestacy laws.  Probate assets include stocks, bonds, bank accounts, privately held company stock and businesses, real estate, vehicles, and other tangible assets.  Non-probate assets include life insurance and retirement accounts; each of these allow for the designation of a beneficiary for those assets.  Further, almost any probate asset can be made into a non-probate assets.  For example, stocks in an account and money in the bank can have payable on death beneficiaries or joint tenants with rights of survivorship.  Even real estate can get transferred by a transfer on death deed or a life estate deed.  Finally, a person can create a revocable living trust and transfer assets to it.  Any assets titled in the trust at death do not need to go through probate.

Now, should you arrange your estate to avoid probate?  For most of my clients, the answer is no.  For some clients, I do create living trusts and transfer the probate assets to it.  Who are these clients?

(1) Elderly clients who have no one to manage their affairs upon incapacity
(2) High net worth clients with assets and business to manage--beneficiaries should not have to wait until a court appoints an executor to manage these assets.
(3) Clients with real estate held out of state.
(4) Clients who want privacy in the administration of their estate.  Trust assets need not get reported on a probate inventory.

Of course, with the best of plans of men, invariably, a person with a living trust plan will have an asset not held in the trust at death.  To transfer that asset, what is required?  Probate!