KEN KIRSCHENBAUM, ESQ
ALARM - SECURITY INDUSTRY LEGAL EMAIL NEWSLETTER / THE ALARM EXCHANGE
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How to allocate the purchase price on an APA
/ webinar registration

October 25, 2021
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Webinar - financing options - sign up today for 10/26 webinar
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Title: Today's Financing Options in the Alarm Industry
When: October 26, 2021 12 PM Eastern Time
Topic: various options alarm dealers have today for obtaining financing such as traditional dealer programs, consumer finance, leasing companies, specialty lenders, and your local bank to name a few. There are financial and legal ramifications that dealers should know about when considering how to raise money to sustain or grow their company.
Presented by: Jim Wooster Jr., president of Alarm Financial Services Inc, and Ken Kirschenbaum,Esq.
Who should attend: owners, CFOs, managers
Register here: https://attendee.gotowebinar.com/register/3991307891496375563
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How to allocate the purchase price on an APA
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          Asset Purchase Agreements [APA] will typically include an allocation of the purchase price.  Allocation is important because assets are [historically and presently] taxed differently.  There are two categories in just about all APA, covenant not to compete and good will.  The covenant not to compete is taxed as ordinary income and good will is taxed as a capital asset [capital gain].  Other categories would include hard assets like inventory and vehicles, which would normally be subject to sales tax [in most jurisdictions] but not likely to result in a taxable gain. 
          I am not an expert in accounting or taxes, and I won’t provide tax advice in any transaction where I am representing you as a buyer or seller of accounts.  My retainer agreement tells you that and advises that you seek other professionals for tax advice.  My “go to guy” has been Mitch Reitman so when I started wondering if “good will” was the proper category for the “alarm contracts with RMR” I was expecting a “yes” but got a detailed explanation.  Turns out the contracts are properly called “agreements with customers for services to be provided in the future” and that is provided for in Internal Revenue Code section 197.   I won’t bore you with a synopsis; instead here is Mitch’s opinion, and if you need more on this, call him. 
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Ken
          When I see someone trying to allocate some of a purchase price in an alarm company transaction to goodwill it is usually a non-industry CPA.  Goodwill is defined as the excess of purchase price over the value of assets received.  They just don’t believe that he accounts have value, and it is hard to convince them that it is 35x RMR or more.  You and both know that they are worth that much.
          Almost all alarm company transactions are priced according to RMR.  Some have an EBITDA component but that is rare.  When we are allocating for tax purposes our only goal is to fairly segregate the assets by tax treatment to the Buyer and Seller.
          The RMR is an IRC Section 197 asset (agreements with customers for services to be provided in the future).  Typically there are some hard assets (vehicles, fixed assets, inventory; sometimes receivables) and restrictive covenants, that are taxed to the Seller as non-capital items and may provide a shorter depreciable life to the Buyer.  If they are specified in the agreement (Non-compete covenants have value, but non-solicits are generally simply affirmations of implied restrictions anyway so that doesn’t have value), then we allocate the price to them if it is reasonable.  i.e. if a truck’s value is based upon the NADA price then we allocate purchase price to it and reduce the value allocated to the accounts.  This is because there is typically ordinary gain or loss on the net book value of the truck.  Once we have allocated to the hard assets we allocate the balance to the accounts.  The only time you would encounter goodwill is when the multiple paid is inflated (50x or more) or there is an EBITDA component so that the price is far in excess of the account value.
          It really doesn’t matter to the seller as both IRC 197 assets and goodwill are capital gain items, nor does it matter to the buyer as they both have a 15 year depreciable life.  The difference is that if the return is audited I can support a price of 44x or less as a pure account transaction and break out some to hard assets.  If any is allocated to goodwill then I have to explain why the accounts are on the books, especially if the APA sets the price based upon RMR x a multiple.
Mitch Reitman
Reitman Consulting Group, Inc 
MReitman@Reitman.US 
817-698-9999 
http://WWW.Reitman.US
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Ken Kirschenbaum,Esq
Kirschenbaum & Kirschenbaum PC
Attorneys at Law
200 Garden City Plaza
Garden City, NY 11530
516 747 6700 x 301
ken@kirschenbaumesq.com
www.KirschenbaumEsq.com