In micro-private equity purchases, there are a number of different ways to buy an income producing website.
The first consideration is whether you wish to purchase the entire business or just the assets. Is there a difference? You bet.
The legal and tax implications of this decision are much more critical than just the difference between profit and loss. Not understanding the difference can have massive ramifications on you, your investors, your family and the future of your investment.
An Asset Purchase
An Asset Purchase is the most common practice for purchasing a website in the micro private equity space. It is simple to execute and limits the amount of risk for the buyer. But depending the country and the specifics of the site, it is now the most tax optimized situation for the seller.
What is an Asset Purchase?
An asset purchase is when you are buying the assets of a business but not the business itself.
An asset as “a single item of ownership having exchange value”.
For the purposes of investing in online businesses, here are a few examples of assets we’re interested in:
- Domain Names,
- eMail list,
- Social media accounts,
- WordPress site,
- Patents / Intellectual Property
- eCommerce platform accounts (Amazon, eBay, Shopify, Walmart),
- Relationships with 3rd parties (Resellers, Dropshippers, Manufacturers),
- Systems / Processes / Standard Operating Procedures (SOPs)
- Account Receivables (money owed to the business)
- Real Estate
And there can be more but these are the most common ones.
When making an Asset Purchase you are agreeing to buy the assets listed in the contract but not the business itself.
Benefits of an Asset Purchase
There are a number of really solid benefits of making an Asset Purchase.
1. You do not take on any of the risk of acquiring the business
When you purchase an asset, that’s all you get. When you purchase a company, you take on the full history and risk of that company. With assets, it is a lot easier to know what you’re getting. If it’s access to systems like social media accounts, eCommerce platforms or hosting accounts, you can log in and confirm access. If it’s real estate, you get the property, if it’s a marketing or email list you get access to that list, if it’s an eBook or training course, you get copies of the files.
But when you purchase a business, you may not get visible to everything. Has the business properly paid its bills or are there account payable you’re not aware of? Has the seller properly filed taxes and is it caught up on what is owed? Has it made any promises or written contracts to other companies that have not been identified?
When you purchase a business, the entire history of that business, the good and the bad, comes with it.
When purchasing an asset, only the asset comes with it and drastically reduces your risk.
2. The Transfer of ownership is simple
With a simple asset purchase agreement, payment is made by the buyer and the asset is transferred by the seller. In online micro-private equity investing, that can be transferring files over, providing user id /Password to systems, transferring digital content, or sending over inventory.
Even complicated sites with many moving parts can be transferred in a matter of days or weeks.
Personal Note: I do recommend however putting in place a much longer transition period to ensure the transfer is smooth, well documented, that the asset are performing as expected, and that the seller provides robust training. However simple the process might be, expect challenges along the way.
3. You can depreciate the assets
You definitely want to get specific tax advice on asset depreciation, but most assets can be depreciated. The rate at which you can depreciate the asset will depend on what the asset is (inventory vs digital products vs a website), your investment strategies, your local laws and your accountant.
But it is not uncommon to see various assets depreciated between 1-5 year while others can take over a decade.
4. Seller Benefits of Asset Sales
The benefits of an asset sales are not just for the buyer. Having an asset sale also means that the process is quicker for the seller and the seller doesn’t have to worry about complicated purchase structures. Often in larger stock sales, there is a requirement for seller financing, loans, stock options, and complicated tax implications.
Selling an asset can be advantageous to a seller depending on their specific situations.
Risks of an Asset Purchase
There are little risks to making an asset purchase which is why they are such a common purchasing vehicle for website buyers.
The largest risk would be to not properly define the asset when making the purchase. If you think you’re getting a website that has an eCommerce platform and you don’t add the inventory asset to the purchase agreement, then may be left with a empty store.
It is important to have a thorough understanding what you are purchasing and be complete and detailed in your Letter of Intent and purchase agreement. This is where due diligence is critical
Some additional risks to consider are:
- The asset not performing as expected
- Not being told when an asset like a domain, an email account or a vendor contract expires
- Having a email or marketing list that has not been properly acquired and doesn’t meet GDPR, CASL or other country wide or local privacy laws. (note, I say local because California just changed it’s privacy laws in 2018 and are pretty severe. See this article by the Harvard Business Review)
- Having content such as images or other material where permission of use was not acquired.
- Having eCommerce products that don’t meet regulation or where regulation is changing on the product
Due Diligence for Asset Purchase
When conducting due diligence for an asset sale, you want to make sure you leave no stone unturned. You should completely understand all aspects of the assets. Here are just a fraction of what to consider for a simple site purchase:
- Validate domain ownership
- Get access to Google Analytics and validate traffic / user engagement / content, etc
- Get access to wordpress, shopify, amazon or what every platform and review history
- Get access to Google Search Console and insure there are no penalties
- Review site speed using GTMetric or a similar service
- Understand and validate all revenue and expenses.
- Make sure the patents / processes are unique and properly owned
- Ensure the seller is open to a non-compete and wont replicate the site
There is really a lot that should be reviewed but these are the basics to ensure you fully understand what you’re buying. For our InnerCircle members, we provide a robust due diligence list to help guide our members.
Tax Implications for Asset Ownership
This could be the most important piece of any site acquisition as taxes are such a large part of the overall profit equation.
Obviously, the benefits here are based on specific situations. Many factors impact tax consideration such as ownership (sole proprietor, corporation, partnership or LLC), country of incorporation and residence, if you’re an investor or partner, where you sell to, etc. Speak to an accountant about the impact of the purchase BEFORE you make the purchase
For example, as a seller, there are large tax benefits structuring a sale as stock purchase if you live in Canada. Having a local accountant review your specific situation can be worth its weight in gold
A stock Purchase
When making a stock purchase you’re actually buying a company, not just the assets.
Divestopedia defines a stock purchase as “the
definitive agreement that finalizes all terms and conditions related to the
purchase and sale of the shares of a company.”
This could be hugely beneficial to both the seller and the buyer if you understand the risks and benefits and are thorough in your due diligence.
Benefits of Stock Purchase
There are some key benefits that can’t be ignored when purchasing a well-run business. And although many folks are scared away from making Stock Purchases, it can be well worth the consideration
1. Business Loans based to the Age and Reputation of the Business
When buying small online businesses in general, one of the largest challenge is getting a business loan. Bankers in North America and Europe are much more comfortable with brick and mortar businesses than they are with online businesses.
Conventional lending will only provide loans to online businesses that have either very long profitable history, are sitting on large inventory assets or have well established IP. Without these, they will request that the owner provides a personal guarantee.
Acquiring a company that has been around for a long time may allow you to get to the front of the line for a business loan and get a preferred interest rate. This has real value and can allow you to take your money back out of the business after the purchase.
2. Account Receivables, Write offs, and Losses
There may be some existing assets hidden in the financials of an existing business such as account receivables, write offs, depreciations and losses.
- Some businesses are owed money from their customers for services rendered. These account receivables can become immediate cash through factoring (selling them to a 3rd party) or borrowing against them.
- The business could be sitting on write offs or deductions in the current year of purchase that can be immediately leveraged. In some countries, hiring students, home offices, or interest on business loans, can all be written off. within the deal.
- Net Operating Losses from prior years can be used as an immediate tax benefit for the buyer.
A good accountant can help identify these opportunities prior to the purchase and make the acquisition that much more valuable to a buyer.
3. Sell off assets
In some cases, the parts are more valuable than the whole. It is possible to sell off individual assets within a business for profit.
Say you have an online business that is running its eCommerce business at a loss but overall makes a profit because of its wholesale revenue and affiliate marketing revenue. Breaking up the business can allow you to flip the assets that are performing well for a profit like the affiliate portion of the business, sell off the inventory to a wholesaler separately and just shut down the eCommerce site.
Many folks know the practice of break up brick and mortar companies to sell off the assets. But the same practice can be done in online businesses as well if an aggressive deal is reached at the point of purchase
Risks of Stock Purchase
A stock purchase does come with significantly more risk. When you take on the company, you take on all the good with the bad and unfortunately, some of the risks are very hard to identify.
1. Tax Liability
This always scares everyone. It is hard to determine if taxes for a company have been properly completed over time. The IRS typically has a 10-year and CRA has a 3-year statute of limitations. If the company gets audited and has not properly filed taxes, the buyer can be on the hook and the IRS can legally seize business assets to satisfy what is owed.
You can call the IRS, CRA or local tax authority to ensure that nothing is outstanding but this doesn’t protect you from a future audit that identifies a previous issue.
It is important to get language in your purchase agreement that will protect you from this risk.
2. Financial – Account Payable and Employee Obligations
With the pros comes the cons. Understanding the financials can not only create opportunities for Account Receivable, write-offs and Losses, but can also create liabilities such as Account Payables and employee obligations (especially in more socialist learning countries).
3. Suits, Lines and Judgments
Lawsuits are a real risk to businesses. Often times that is why we create a business in the first place, to create a level of risk mitigation to ourselves personally
It is impossible to know everything that a company has done in the past that could open it up to lawsuits. And although there often are statues of limitations or limitation of liability language that can be added to buyer’s contracts, legal costs can be daunting and distracting.
And in some cases, it only takes 1 lawsuit to bankrupt a company.
At the very least, a buyer can protect themselves by researching existing suits, liens or pending judgements that a company may be involved in. A good lawyer will run through their systems to identify these and provide guidance on the level of risk.
Due Diligence for Stock Purchase
If you can identify these risks through due diligence then you can protect yourself by adding limited liability language within the purchasing contract. However, it is very difficult to find these issues. Some tips:
- Find a forensic accountant to do a robust review of the financials for the business you are about to purchase
- For online businesses consider a company like Ceturica that does due diligence on a business
- Find a solid lawyer that specializes on business acquisition that can put in the limitation of liability clauses to protect you and who can research any suits, liens and judgements that may exist on the business.
- Call tax authorities to review previously filed information and compare that with the numbers provided by the seller.
- Have your lawyer add as much language as possible to protect you from future issues arising from the company’s and seller’s past activities
Tax Implications for Stock Ownership
Again this will depend on what country you are buying and selling the business in. For example, in Canada, the CRA has a life time exemption for capital gains from the sale of a small business up to $866K in 2019. This article from CNIB explain well. This exemption doesn’t exist in the US and many other countries.
However, in the US, you can start an LLC and have profits flow through the LLC to the individual so as to remove double taxation. That doesn’t exist in Canada. And in the US the Small Business Administration is starting to offer loans to help individuals buy online businesses. That doesn’t exist in Canada (there is Bank Development Canada but that crown corporation works differently and the loans are a lot less lucrative).
All that to say that you really need a local accountant to walk you through the benefits, risk and overall tax implications. And again this is something better done prior to the purchase to ensure you can maximize the money you retain when making a purchase.
There are obviously many other risks and benefits that may force you down a path of an asset sale versus a stock purchase of a business. For example, it might be important to consider the following questions:
- Is the company’s reputation going to support or restrict your future plans?
- Are there risks in the ownership of the brand if transferred as an asset?
- Are there agreement with 3rd parties that can only be made in the name of the company and can’t be transferred in an asset sale (like territory alignment for distribution rights)?
And many more.
Get Professional Advice from your team
This may all sound daunting but this is why you need a team of professionals to support you. A buyer broker like MadX Capital, a business lawyer and a business accountant can help you avoid the pitfalls and understand what questions to consider.
It is also important to manage the risk based on reward. If you’re purchasing a site for $100K that make $40K per year in profit, it doesn’t make sense to spend $20K on legal and accounting services. However, if you’re buying a $1M business, then maybe $20K is well work cost of ensuring you have optimized the purchase agreement in your favor and limited the liability.
Now that you’re aware of the differences between an asset and stock purchase, you’re more likely to ask the right questions, surround yourself with the right experts and structure an purchase agreement that will make your acquisition a major success.