Some Aspects of a Purchase of a Business Out of Earnings
BY CHARLES N. WHITEHEAD Partner, San Francisco Office
Presented before the 34th Annual Conference of Certified Public Accountants of the Pacific Northwest — June 1957
My topic this afternoon concerns the purchase of a business out of earnings.
It may seem an anomaly that a business can be purchased out of earnings, but in fact many businesses are purchased with relatively small initial payments, the balance paid later from retained earnings after taxes. Since taxes are a large factor in cash dissipation, that is, cash which could be otherwise used to liquidate indebtedness incurred in the purchase, the general content of this paper will be the tax problems incident to the form of acquisition and factors which should influence the business operations thereafter.
Since a business is to be purchased it must be assumed that an existing business is already in operation which its owners wish to sell, and which its purchasers wish to buy with as little cash outlay as possible. It must be assumed for this purchase that the business is a profitable one, or one which the purchasers believe can be made profitable. If the business is profitable there may be a question as to why the owners wish to sell. Typically,
reasons for such sales can be found in the following:
• Advanced age of the owners, with lack of successor management.
• Estate tax problems faced by the principal owners.
• Realization by high-bracket-taxpayer owners that the only way in
which they can realize on their investment and still retain part of the proceeds is by a capital gains transaction; that is, by a sale.
• Realization by the operators that the business is not going well and
that they are unable to make it do well, but our prospective purchaser
believes he is in a position to do so. The typical business with which the first three sellers would be concerned
would be a corporation which has been in operation for a considerable
period, with low-cost-basis assets, very little debt, and profits which force payment of dividends because of the hazards of the accumu-