You're Buying a Business for $2 Million—But What Exactly Are You Buying?

Imagine someone offers you the opportunity of a lifetime: a business generating $3 million in annual revenue for a $2 million purchase price. The seller tells you, “The business makes $600,000 a year.” You are already thinking about financing and closing. But before you sign anything, your CPA asks one simple question: “What exactly does ‘makes $600,000’ mean?”

Imagine this.

A business owner is ready to retire.

He owns a successful company.

Annual revenue: $3,000,000.

He tells you:

“The business makes about $600,000 a year.”

Asking price: $2,000,000.

You immediately calculate: $2 million purchase price. $600,000 annual earnings.

You think:

“I'll make my money back in a little over three years.”

Sounds incredible.

You meet with the bank.

Start discussing financing.

Maybe even sign a letter of intent.

Then your CPA asks:

“Can I see the financial statements and tax returns?”

The seller sends them.

And suddenly:

The $600,000 isn't so obvious.

What Does “The Business Makes $600,000” Actually Mean?

This is the first question.

Does $600,000 mean:

Revenue?

Gross profit?

Net income?

EBITDA?

Adjusted EBITDA?

Seller's discretionary earnings?

Cash flow?

Owner compensation?

Money transferred to the owner's personal account?

Those are completely different numbers.

If you're about to spend $2 million, you need to know exactly what number is being represented.

Revenue Is Definitely Not Profit

Imagine someone says:

“This is a $5 million company.”

What does that mean?

Usually they mean revenue.

But a company generating $5 million of revenue could make $1 million, $500,000, $100,000, or lose money.

Revenue tells you the size of the activity.

It does not tell you what the owner keeps.

Start With the Tax Returns

When evaluating a business acquisition, I generally want to see multiple years of business tax returns, financial statements, and supporting accounting records.

Why multiple years?

Because one year can be unusual.

Maybe 2025 was incredible.

2024 was average.

2023 was terrible.

You need to understand the trend.

Imagine the Seller Shows You Only 2025

2025 profit: $700,000.

Great.

Then you request 2024: $350,000. 2023: $250,000.

Now ask:

What happened in 2025?

New customer?

One-time contract?

Price increase?

Temporary expense reduction?

Sale of equipment?

Unusual accounting?

The business may genuinely have improved.

But you need to understand why.

Tax Returns and Financial Statements Should Tell a Similar Story

Imagine the seller's internal P&L says:

Profit: $800,000.

The tax return shows: $300,000.

That's a $500,000 difference.

Maybe there is a legitimate reconciliation.

Depreciation.

Tax adjustments.

Different accounting treatment.

Other items.

But you need to understand it.

Do not accept:

“The accountant does something different for taxes.”

Ask for the reconciliation.

“The Tax Return Is Low Because We Write Everything Off”

You may hear:

“Don't worry about the tax return. We show low profit because we write everything off.”

Okay.

Then show me:

What was written off?

If the seller claims $400,000 of personal expenses ran through the company, we should be able to identify them.

Vehicle?

Travel?

Family payroll?

Personal insurance?

Other expenses?

Do not add expenses back merely because the seller says:

“That won't apply to you.”

Verify them.

What Is an Add-Back?

Imagine the business reports $300,000 of net income.

The seller says:

“Add back my $200,000 salary.”

“Add back $50,000 of personal vehicle expenses.”

“Add back $30,000 of travel.”

“Add back $20,000 of one-time legal fees.”

Now the broker presents $600,000 of adjusted earnings.

Some adjustments may be reasonable.

Some may not.

The question is:

Will that expense truly disappear after you buy the business?

The Seller's Salary Is Not Automatically a Full Add-Back

Imagine the seller pays himself $250,000.

The broker adds back all $250,000.

Now adjusted earnings increase dramatically.

But who is going to perform the seller's job after closing?

You?

If yes:

What is your time worth?

Or do you need to hire a CEO, general manager, salesperson, or operations manager?

If replacing the seller costs $180,000, then treating the entire $250,000 as extra profit may overstate the economics.

Imagine Buying Yourself a Job

You purchase the business for $2 million.

The seller tells you it produces $500,000 annually.

After closing, you discover that to maintain that income you personally need to work 70 hours per week.

Now ask:

How much of the $500,000 is return on your investment?

And how much is compensation for your labor?

Those are different things.

Understand Why the Seller Is Selling

Retirement?

Health?

Family?

Moving?

Partner dispute?

New opportunity?

Business decline?

Loss of customer?

Upcoming competition?

You should understand the story.

The seller's reason does not automatically make the deal good or bad.

But it can tell you where to investigate.

Customer Concentration Can Change Everything

Imagine the company generates $3 million annually.

One customer generates $1.5 million.

That's 50% of revenue.

The business may look extremely profitable.

But what happens if that customer leaves after the ownership change?

Your $2 million investment could look very different.

Ask for Revenue by Customer

During due diligence, you should understand how concentrated revenue is, who the largest customers are, how long they have been customers, whether contracts exist, whether contracts can transfer, and whether relationships are tied personally to the seller.

Recurring revenue is valuable.

But only if it actually continues.

Imagine the Seller Is the Business

The company has $3 million of revenue.

But every major customer calls the owner personally.

The owner does sales, pricing, relationships, negotiations, and problem solving.

Then the owner sells you the company and leaves.

What exactly did you buy?

Customer relationships may not automatically transfer just because the legal entity changed hands.

Employee Dependence Matters Too

Imagine one employee runs everything: operations, customers, vendors, and scheduling.

The seller tells you:

“Don't worry. Maria knows the whole business.”

Great.

Does Maria know the business is being sold?

Will she stay?

What is she paid?

Is she underpaid?

Will she demand a raise after closing?

A key employee can be almost as important as a key customer.

Payroll Needs to Be Reviewed

Ask for payroll reports.

Understand employees, wages, bonuses, benefits, payroll taxes, owner compensation, family members, independent contractors, overtime, and turnover.

A business may look profitable because employees are underpaid, working excessive overtime, or certain family members are working without market compensation.

Your post-acquisition payroll may be higher.

Independent Contractors Can Create Exposure

Imagine the company has 30 workers classified as independent contractors.

After closing, you discover some should potentially have been treated as employees.

Now there may be payroll-tax exposure, employment-law issues, benefits issues, and other liabilities.

Worker classification should be part of due diligence when material.

Look at Gross Margin

Imagine revenue is stable at $3 million.

But gross margin has fallen: 2023 — 40%. 2024 — 35%. 2025 — 29%.

That tells you something.

Maybe materials increased, labor increased, pricing weakened, competition increased, or customer mix changed.

Revenue may look stable while the economics deteriorate.

Look Beyond Net Income

Net income is important.

But also examine gross profit, gross-margin percentage, payroll, rent, marketing, insurance, repairs, professional fees, interest, management compensation, and other major expenses.

The goal is to understand:

How the business actually makes money.

Cash Flow Matters Too

Imagine the P&L shows $600,000 of profit.

But customers take 90 days to pay.

The business requires $700,000 of working capital just to operate.

After buying the company, you may need more cash than simply the purchase price.

The Purchase Price Is Not Your Total Investment

Business price: $2 million.

You think:

“I need $2 million.”

Maybe not.

You may also need down payment, closing costs, legal fees, CPA fees, loan fees, working capital, inventory, payroll, insurance deposits, equipment repairs, technology upgrades, and post-closing improvements.

Suddenly your $2 million acquisition requires $2.5 million or more of total capital.

Working Capital Can Make or Break the Deal

Imagine you close Friday.

Monday morning:

Payroll: $100,000.

Vendors: $150,000.

Rent: $25,000.

Insurance: $20,000.

Customers won't pay for 45 days.

Where does the money come from?

You need to understand the company's normal working-capital requirements before closing.

Accounts Receivable May or May Not Be Included

Imagine the company has $800,000 of accounts receivable.

Are you buying it?

Is the seller keeping it?

What portion is collectible?

How old is it?

Who gets collections received after closing?

The purchase agreement should clearly address this.

Not All Receivables Are Worth Face Value

Accounts receivable: $800,000.

Sounds like $800,000 of value.

Now age it.

Current: $300,000.

31–60: $200,000.

61–90: $100,000.

Over 90: $200,000.

Will you really collect all $800,000?

Maybe.

Maybe not.

Inventory Can Be Overstated Too

Seller says inventory is $500,000.

But what is actually there?

Current inventory?

Obsolete?

Damaged?

Expired?

Slow moving?

Missing?

Inventory should be physically verified when material.

The accounting number alone may not be enough.

Imagine Paying $500,000 for Inventory Worth $300,000

The seller's books show $500,000.

After closing, you discover $200,000 is obsolete.

You just paid for assets that may never produce value.

Inventory quality matters.

Equipment Values Need Review

The balance sheet shows equipment of $1 million.

Does that mean the equipment is worth $1 million?

Not necessarily.

Book value, tax basis, fair-market value, replacement cost, and loan balance are different numbers.

Inspect major equipment.

Understand age, condition, maintenance, expected replacement, and liens.

The Equipment May Need $500,000 of Replacement Soon

Imagine you buy a company with trucks, machinery, and production equipment.

The seller says:

“Everything is included.”

Great.

Then six months later, three trucks need replacing, a major machine fails, and technology is obsolete.

The purchase price may have looked attractive because the seller deferred capital expenditures.

Debt Needs to Be Understood

Does the company have bank loans, equipment debt, lines of credit, credit cards, shareholder loans, vendor balances, tax debt, leases, or related-party debt?

Are you assuming any of it?

Is it being paid off at closing?

Debt can materially change what you are actually buying.

Search for Liens

Depending on the transaction and legal due diligence, your attorney may investigate UCC filings, tax liens, judgments, and other encumbrances.

You do not want to pay for assets and later discover someone else has a claim on them.

Taxes Need Due Diligence Too

Imagine you buy the company.

Six months later:

IRS notice.

State sales-tax notice.

Payroll-tax assessment.

Prior-year income-tax issue.

Now everyone asks:

“Whose problem is this?”

The answer can depend heavily on transaction structure, purchase agreement, type of tax, applicable law, and other facts.

Tax due diligence matters.

Sales Tax Exposure Can Be Significant

Imagine the company has $5 million of annual taxable sales but has been handling sales tax incorrectly for four years.

Potential exposure can become enormous.

Before buying a business with sales-tax obligations, understand where it operates, what it sells, where customers are located, what registrations exist, whether returns were filed, and whether tax was collected.

Payroll Tax Exposure Can Be Worse

Payroll taxes deserve special attention.

Review Forms 941, Form 940, W-2/W-3, state unemployment, payroll deposits, notices, and reconciliations.

If a company has been falling behind on payroll taxes, you want to know before closing.

What About Income-Tax Returns?

Review several years when appropriate.

Ask:

Were returns filed?

Were they timely?

Any amended returns?

Any audits?

Any notices?

Any net operating losses?

Any unusual positions?

Any international reporting?

Tax returns can reveal issues that the sales presentation does not.

International Ownership Can Add Another Layer

Imagine the company has foreign owners, foreign subsidiaries, foreign bank accounts, cross-border related-party transactions, Forms 5471, 5472, 8865, FBAR, or other international reporting.

Missing international forms can carry substantial penalties.

If the business has international activity, your due diligence should include it.

Now We Get to the Biggest Question: Asset Purchase or Equity Purchase?

Imagine the seller says:

“You're buying my company for $2 million.”

That can potentially mean very different things.

Are you buying the company's assets?

Or the ownership interests in the existing entity?

This distinction can have major tax and legal consequences.

Imagine an Asset Purchase

In a simplified asset purchase, the buyer may acquire selected business assets.

Potentially equipment, inventory, customer relationships, trade name, goodwill, contracts, and other assets.

The buyer may sometimes be able to choose which liabilities are assumed, subject to applicable law and the transaction documents.

Tax basis in acquired assets may generally be determined through the purchase-price allocation under applicable rules.

That can create future depreciation or amortization deductions depending on the asset.

Imagine an Equity Purchase

Instead of buying assets, you purchase the corporation's stock or the owner's equity interest.

Now the existing entity continues owning its assets and liabilities.

You stepped into ownership of the existing company.

That can mean you are also stepping into its history, contracts, tax positions, employees, liabilities, and potential unknown problems.

This is why legal and tax due diligence become extremely important.

Buyers and Sellers May Want Different Things

A buyer may prefer an asset purchase.

The seller may prefer a stock sale.

Why?

Tax consequences can differ.

Liability consequences can differ.

Contract transfer issues can differ.

Depreciation opportunities can differ.

The negotiation should consider after-tax economics for both sides.

Purchase Price Allocation Matters

Imagine the asset purchase price is $2 million.

How much is allocated to cash, accounts receivable, inventory, equipment, furniture, vehicles, customer relationships, noncompete agreement, goodwill, and other intangibles?

That allocation can affect seller tax consequences, buyer depreciation, buyer amortization, and future gain or loss.

This should not be an afterthought prepared months after closing.

Buyer and Seller Reporting Should Be Consistent

Certain business asset acquisitions can require Form 8594, Asset Acquisition Statement Under Section 1060.

Buyer and seller generally report the agreed allocation.

Imagine the seller wants $1.5 million to goodwill while the buyer wants $1 million to equipment.

Those preferences can create very different tax outcomes.

Negotiate allocation as part of the transaction.

Goodwill Is Not Just “Whatever Is Left”

Goodwill can represent value associated with reputation, customer relationships, going-concern value, brand, and other intangible business value.

But purchase-price allocation should be supportable.

Do not simply manipulate categories to create whichever tax result one side wants.

The Buyer's Tax Deductions Matter

Imagine two deals both cost $2 million.

Deal A gives the buyer substantial depreciable or amortizable tax basis.

Deal B provides much less near-term tax deduction.

Same purchase price.

Different after-tax economics.

This is why your CPA should review the structure before you sign the final purchase agreement.

Seller Tax Consequences Matter to the Negotiation

Imagine the seller says:

“I need $2 million.”

Maybe what the seller really means is:

“I need a certain amount after taxes.”

If one transaction structure creates significantly more tax for the seller, the seller may demand a higher price.

Now tax structure affects negotiation.

Don't Negotiate Only the Purchase Price

Imagine Offer A is $2 million and Offer B is $1.9 million.

You assume Offer B is obviously better for the buyer.

But what if working capital differs, inventory differs, debt differs, tax basis differs, seller financing differs, payment timing differs, or representations and warranties differ?

The purchase price is only one term.

Seller Financing Can Change the Deal

Imagine the seller finances $500,000 of the purchase price.

That can reduce the buyer's immediate cash requirement.

But ask:

Interest rate?

Term?

Security?

Subordination?

Balloon payment?

Default provisions?

Tax consequences?

Seller financing can be useful.

But it is still debt.

An Installment Sale Can Affect the Seller's Taxes

Depending on the transaction and applicable rules, seller financing may create installment-sale treatment for certain gain.

But not every type of gain necessarily receives identical installment treatment.

The seller needs tax advice too.

The buyer's CPA should focus on the buyer.

The seller should have their own advisor.

Don't Use the Seller's CPA as Your Due-Diligence CPA

The seller's CPA may be excellent.

But the seller's CPA represents the seller.

You need someone looking at the transaction from your side.

This is a multimillion-dollar purchase.

Independent advice matters.

Your Attorney and CPA Need to Work Together

The attorney focuses on the purchase agreement, representations, warranties, indemnification, legal liabilities, contracts, entity documents, and closing.

Your CPA focuses on financial statements, tax returns, earnings, cash flow, working capital, tax structure, purchase-price allocation, tax consequences, financing implications, and post-closing accounting.

Both sides need to coordinate before the deal becomes final.

The Letter of Intent Can Already Matter

Imagine you tell yourself:

“It's only an LOI. We'll worry about taxes later.”

But the letter of intent may already establish important economic expectations.

Asset purchase?

Equity purchase?

Purchase price?

Working capital?

Seller financing?

Expected closing date?

Before agreeing to major deal terms, it can be valuable to have your CPA and attorney involved.

The earlier advisors see the transaction, the more opportunity there may be to structure it properly.

Don't Wait Until the Purchase Agreement Is Finished

This happens more often than it should.

A client sends me a 70-page purchase agreement and says:

“We're closing Friday. Can you tell me if the tax structure looks okay?”

At that point, changing the deal can become much harder.

I would much rather receive the proposed deal, financial statements, tax returns, and letter of intent before everything is finalized.

What About Buying the Real Estate Too?

Imagine the seller owns the operating business and the building.

Business purchase: $2 million.

Real estate: $3 million.

Total transaction: $5 million.

Now you are really analyzing two investments.

Does the operating business generate enough cash to support the acquisition?

What rent should the business pay?

How will the real estate be owned?

How is the purchase financed?

Should the real estate and operating business be held in the same entity?

What are the depreciation consequences?

This needs additional planning.

The Business Can Be Great and the Real Estate Can Be Overpriced

Imagine the business is worth $2 million.

The seller says:

“I'll only sell if you also buy the building for $4 million.”

Maybe the building is worth $4 million.

Maybe it isn't.

Do not overpay for one asset simply because you want another.

Business valuation and real-estate valuation are different exercises.

What About the Lease?

Maybe you buy only the operating business and lease the property from the seller.

Now review rent, term, renewal options, rent increases, CAM, property taxes, insurance, maintenance, assignment, and personal guarantees.

Imagine the business looks profitable because historical rent was $10,000 per month.

After closing, the seller charges you $25,000 per month.

That's $180,000 of additional annual expense.

Your acquisition economics just changed.

Normalize the Rent

If the seller owns both the business and building, historical rent may not reflect market economics.

Maybe the business paid almost nothing.

Maybe it paid too much.

If you will operate under a new lease, model the business using the rent you will actually pay after closing.

Insurance May Change After the Acquisition

The seller has operated for 30 years.

Insurance cost: $100,000 annually.

You obtain your quote: $180,000.

That's $80,000 less annual profit.

Do not assume every historical expense will remain identical after ownership changes.

Your Financing Changes the Cash Flow Too

The seller owns the business debt-free.

You borrow $1.5 million to purchase it.

The seller's historical financial statements have very little interest expense.

Your business will have loan payments, interest, debt covenants, and maybe a balloon payment.

The company may be profitable before acquisition debt but much tighter after debt service.

Imagine Buying a $600,000-Profit Business and Keeping Only $150,000

Seller says:

“The business makes $600,000.”

After closing:

Replacement management: $150,000.

Higher insurance: $50,000.

Additional rent: $75,000.

Acquisition interest: $100,000.

Necessary technology: $50,000.

Suddenly, your economic benefit looks very different.

This is why we need pro forma financial statements.

Build a Post-Acquisition P&L Before You Buy

Do not look only at what the seller earned.

Build a financial model showing what you expect to earn.

Use your financing, payroll, rent, insurance, management, expected revenue, expected margins, capital expenditures, and debt service.

Then ask:

“Does this business still make sense under my ownership?”

That is the number that matters.

Run a Downside Scenario

Imagine the base case says revenue is $3 million and profit is $600,000.

Now model:

Revenue falls 10%.

Largest customer leaves.

Payroll rises 10%.

Insurance rises.

Interest remains high.

What happens?

Can you still make loan payments, pay employees, pay taxes, and pay yourself?

A deal that works only when everything goes perfectly is a risky deal.

Ask What Happens If Revenue Drops 20%

Maybe the company survives comfortably.

Great.

Maybe it immediately violates loan covenants and runs out of cash.

You want to know that before you buy it.

The Bank Approving the Loan Does Not Mean the Deal Is Good

The bank's job is to decide whether it is willing to lend under its underwriting standards.

That does not automatically mean you should buy the business.

You are the one investing money, time, personal guarantees, and risk.

The bank's approval is one piece of the transaction.

Not the investment decision.

Understand Personal Guarantees

Imagine the acquisition loan is $1.5 million.

You personally guarantee it.

The business fails.

The legal and financial consequences can extend beyond:

“The company didn't work out.”

Understand what you are signing.

Your attorney and lender should explain the legal obligations.

Your CPA can help you understand the financial exposure.

Don't Forget Taxes After Closing

You buy the business.

Congratulations.

Now you have payroll, sales tax, income tax, estimated taxes, property tax, information returns, and potential franchise or state filings.

Tax compliance starts immediately.

Do not wait until the first tax return is due to establish accounting, payroll, tax calendars, and internal controls.

Day One Accounting Matters

The acquisition closes June 1.

Your accounting should clearly distinguish seller activity, buyer activity, opening balances, acquired assets, assumed liabilities, purchase-price allocation, new debt, owner contributions, and working capital from day one.

Trying to reconstruct the acquisition 18 months later makes everything harder.

The Opening Balance Sheet Is Important

After buying the business, the accounting system needs a proper starting point.

What did you acquire?

Cash?

Receivables?

Inventory?

Equipment?

Goodwill?

Other intangibles?

What liabilities did you assume?

What debt did you incur?

What equity did you contribute?

The opening balance sheet should reflect the transaction.

Your Depreciation Schedule Starts With the Deal

If the acquisition includes equipment, vehicles, furniture, buildings, or certain intangible assets, the purchase-price allocation can affect depreciation, amortization, and future gain or loss.

This information should flow into your tax records from the beginning.

What Should You Ask Before Buying a Business?

Before signing the final agreement, you should be able to answer questions such as:

What is the company's real normalized earnings?

How were those earnings verified?

Why is the seller leaving?

How concentrated are customers?

Which employees are critical?

What working capital is required?

What assets are included?

What liabilities are assumed?

What capital expenditures are coming?

Are taxes current?

Are payroll taxes current?

Is sales tax current?

Are there pending IRS or state notices?

What does the A/R aging look like?

What does inventory actually consist of?

What debt exists?

Are assets subject to liens?

Is this an asset purchase or equity purchase?

How is the purchase price allocated?

How will the acquisition be financed?

What will the business look like after acquisition debt?

What happens if revenue falls?

And:

How much cash do I need after closing to keep the business alive?

The Best Deal Isn't Always the Cheapest Deal

Imagine Business A costs $1.5 million and Business B costs $2 million.

Business A looks cheaper.

But it has declining revenue, old equipment, customer concentration, weak employees, tax problems, and working-capital issues.

Business B has recurring customers, strong management, clean books, modern equipment, good margins, and strong cash flow.

The cheaper company may actually be the more expensive mistake.

Sometimes the Best Advice Is “Don't Buy It”

Imagine you have already spent months negotiating, legal fees, travel, and loan applications.

You're emotionally committed.

Then due diligence shows the earnings are overstated, customer concentration is dangerous, equipment needs replacement, tax exposure exists, and the business does not support the debt.

Walking away may feel like losing.

But losing $25,000 of due-diligence cost can be much better than losing $2 million after closing.

How LUNA CPA Helps With Business Acquisitions

At LUNA CPA, we want to help clients understand what they are buying before the transaction becomes permanent.

A business acquisition should not be evaluated only from the asking price, the seller's presentation, or how much revenue the company generates.

Depending on the transaction and scope of our engagement, we can assist with reviewing historical financial statements, business tax returns, revenue and profitability trends, gross margins, owner compensation, potential add-backs, payroll, accounts receivable, A/R aging, inventory accounting, fixed assets, debt, working-capital requirements, cash-flow trends, tax compliance information, potential tax exposures identified through available records, asset-purchase versus equity-purchase tax considerations, purchase-price allocation, depreciation and amortization considerations, acquisition financing, post-acquisition projections, tax implications of the proposed structure, opening-balance-sheet accounting, and the buyer's post-closing accounting and tax setup.

We can also work alongside the buyer's attorney, lender, business broker, valuation professional, insurance professional, and other advisors.

Our goal is not to decide whether you personally love the business.

Our job is to help you understand:

What do the numbers actually say?

What are you really buying?

How much cash will you need?

What tax consequences come with the structure?

What will the business look like after the seller leaves?

And:

Does the expected cash flow support the price and debt you are taking on?

The best time to discover a problem is before closing.