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Real estate is an ever-changing market with a wealth of expansion opportunities. If you’re ready to grow your business and are looking to acquire a new company, there are several steps you’ll need to take first.
Considerations include what you’re looking to acquire (assets vs. shares) and whether you’ll be expanding to a new market. In part one of our two part series, we’ll explore the preliminary questions you should be asking before beginning an acquisition:
Who are you buying and what are you buying?
When acquiring additional real estate, it’s easy to get lost in the rush of an impressive purchase. But, according to the Harvard Business Review, over 60% of acquisitions fail, mainly because of “insufficient discipline” in the evaluation process. Essentially, buyers get so caught up in the thrill that they overlook the risks and long-term effects of the purchase.
The key to your success is contingent on performing a thorough due diligence review.
While the idea may seem alluring, the first step in this complicated process is to ensure that any potential purchase will be a good fit for your existing business. Some key questions to ask include:
- How will it contribute to your company’s financial position? Other than affecting your market share, what value will this acquisition add to your business?
- How will this acquisition affect your current clients and employees?
- How will your stakeholders be affected by this acquisition?
Once you’ve identified a target, you’ll want to decide on what exactly you’ll be purchasing – assets or the entity holding the assets. Both types of transactions have unique pros and cons. While vendors often look to sell the business entity, purchasers usually prefer asset sales. Here’s a guide to both types of acquisitions:
Asset Sales
An asset transaction means you’ll be buying par or all of a business rather than the entire company itself. Assets include real estate, equipment, inventory, other property, contracts or lease agreements. The downside to this type of sale is that it can get complicated.
Every asset needs transfer paperwork and, in some cases, transfers of assets such as leases will also require third-party permission. Even so, purchasers usually prefer this type of sale, because they’re able to cherry-pick which assets they’d like to buy instead of purchasing all the assets owned by the company, good or bad.
Asset sales also come with less risk because purchasers don’t have to assume all the businesses’ liabilities. In fact, if you go forward with an asset sale, you’ll be able to use the purchased assets to form a new company altogether, meaning you won’t inherit any issues from the old company.
Another perk of an asset sale is the ability to reset the tax base of assets acquired to the value they were on the date of purchase, allowing you more available depreciation expenses that you can write off against future profits.
Purchase Price Allocation in an asset sale
When buying assets, it’s vital to have a proper Purchase Price Allocation (PPA) in order to establish the price of all assets being purchased. This is accomplished through the Purchase and Sale Agreement (PSA), which summarizes all the terms and conditions of the sale, including the PPA.
The PPA is important because it helps determine your assets’ tax base after the acquisition is complete, which also determines the rate and extent of amortization and depreciation expenses you’ll be able to deduct from your new company’s income.
In order to set up your acquisition for success, make sure you’ve allocated enough time for your team of professionals to draft an accurate PSA with terms that work for both the seller and purchaser. Other than the purchase price, a detailed PSA usually includes:
- Transaction classification (share vs. asset)
- Financing method
- Any relevant purchase price adjustments
- Payment terms, deadlines and milestones
- Buyer’s long-term liabilities
- Representations and warranties
- Post-closing rights and obligations
- Arbitration and dispute resolution protocol
Share Sales
A share transaction means you would be buying 100% of the company’s shares. This is a less complicated process as it only requires documentation for the transfer of shares and, sometimes, the assignment of shareholder loans. This is popular with vendors because it often comes with personal income tax benefits for the seller. It also releases them of any liabilities or potential liabilities as these travel with the shares.
Shares sold through this transaction are typically taxed as capital gains. This means that qualifying small businesses can receive a capital gains exemption of approximately $892,000 (as of 2021).
It should also be noted that it might not be shares that are being sold. It could be partnership units or a interest in a joint venture.
Will this acquisition expand your company into a new market?
If you’ve decided to expand to a new market, make sure you understand the complexities that come with this type of growth. If you’re doing business in another province or country, you’ll be dealing with different regulations, employee rights, IP issues and, if you’re crossing the border, different currencies and tax jurisdictions.
If you’re interested in expanding into the US, make sure to research and consult with your financial team to fully understand the tax implications. Remember that each state will have unique regulations that can affect your acquisition.
When talking to Canadian Real Estate Magazine about Canadians investing in the US real estate market, Florida-based expert Lauren Cohen cautioned against moving fast, and alone.
“What they usually get wrong begins with professional guidance, like getting an LLC without the help of a cross-border expert, and the consequence is often that they pay a price later, like being penalized with double taxation,” Cohen said.
If you’re set on a US acquisition, it’s especially important to decide whether it’s best to form an LLC or LLP or a Corporation.
Here’s a quick guide to each option:
Limited Liability Company (LLC)
This is a separate business entity that has one or more owners (or members) and is created by filing paperwork with the secretary of state. It’s a separate entity from its owners and has its own bank account and tax identification number. An LLC provides significant liability protection.
If your company is sued, you won’t be personally responsible and will be able to protect your personal assets.
In terms of taxes, an LLC can decide to be taxed as a sole proprietorship, partnership or C corporation.
Limited Liability Partnership (LLP)
An LLP, which is a partnership formed by two or more people, doesn’t require any legal filings, only state paperwork. It is also a separate business entity, though keep in mind that liability protection differs from state to state. Some states require that at least one partner be liable in the case of a lawsuit. An LLP does not pay income taxes as income is flowed to the ultimate partners.
C Corporation
This is a typical US corporation that pays taxes at the federal and often state level. The liabilities of the entity stay in the corporation.
Understanding your new market
If your acquisition isn’t necessarily taking you to a new location, it’s still important to understand your new market. Decide whether it makes sense to build a new team once the deal is complete or to outsource talent.
If moving from residential real estate to commercial, the same advice stands: do your research and consult your financial and legal team to ensure you’re not ignoring any red flags or potential long-term issues.
Taking the leap with a team you trust
Before starting the acquisition process, it’s important to understand who your target company is and what type of sale works best for your real-estate business. It’s best to work with your financial team to decide which direction you’d like to take your company and whether or not that would mean delving into a new market. At Zeifmans, we’ve been through a variety of different real-estate M&As and are happy to take you through the preliminary process. Contact us here to get started.
Additional Insights:
How to prepare your real estate business for a successful acquisition
