Selling Your Business: Things to Keep in Mind
Throughout the year, we meet with a number of clients wanting to “cash in” and sell their business. Among the most important considerations to selling a business is determining the structure itself and then doing the cash flow analysis of the transactions. Frankly, most owners who are selling their business are interested in only one thing: How much cash will I have when all has been said and done?
There may be more important questions, though: How do you want to structure the sale? What is the difference between the options?
Sale of Assets
When the seller structures an asset sale, they are selling the assets of the company. These assets include hard assets (i.e., fixed assets) and intangible assets (i.e., trade secrets, customer lists, trade name, etc.) The seller retains ownership of the entity. If the seller has debt owed to outside creditors, this must be factored into the cash flow analysis as these debts will either be assumed by the buyer (a non-cash increase to the selling price) or paid off by the seller from the sales proceeds (use of cash). Assuming there are no more assets or liabilities in the entity, the entity is just a shell. The seller can continue to own this entity shell or dissolve it under the state laws that govern its formation. The timing of the dissolution should not be taken lightly. If the dissolution results in a capital loss to the seller, the seller may opt to dissolve the entity in the year of the sale so as to offset any gain from the sales transaction. Otherwise, the loss is realized in the future with no ability to carry it back. As a practical matter, sales of privately held entities normally are structured as an asset sale since buyers are leery of any unknown liabilities that may come along with sale of an ownership interest.
Sale of an Ownership Interest
Sellers can choose to sell the ownership interest (corporate stock or partnership interest). Though all the assets and liabilities are being transferred over to the buyer, the buyer is really purchasing the ownership interest in the entity that has within it the assets and liabilities. Prior to the consummation of the deal, the buyer may select what assets and liabilities they want to be retained, which could ultimately have a bearing on the seller’s cash flow from the transaction. Though sale of an ownership interest is less common in the privately held entity arena, it can still happen. Important considerations such as contractual commitments may not be transferable and necessitate a sale of the interest. State taxes must also be considered. The sale of an interest, in many cases, is considered to be a sale of an intangible. Depending on state laws, the gain on that sale may be sourced to the owner’s resident state and not the state that the business is located in. This could mean the difference between paying upwards of a 10% state tax rate to paying no state taxes.
- Letter of intent: This is normally a summary of the transaction prior the sales contract being drawn up. This should be written in lay terms so that all parties (owners, advisors and professionals) understand exactly what the transaction consists of.
- Qualified Advisors: Retain and consult with experienced transaction advisors (attorney and accountant) before you enter into any negotiations for the sale of your business.
- Cash Flow Analysis: This can’t be stressed enough. The owner’s expectations need to reconcile with the ultimate amount of cash (or other assets) they will end up with.
- Due Diligence by the Buyer: This is often an under-appreciated and overlooked element of the sales transaction. It’s almost like having a baby: Until you have one, you really don’t have a clue as to the cost, time and stress it entails.
- Earn-outs: These are payment terms to the seller normally based on future performance of the company. Sometimes they are unavoidable parts of a deal, but you should always assume that the performance measures might not be met and payments may never be made.
- State Issues
- Dissolution: As stated above, if an entity is being closed, a formal dissolution notice should be filed with the state of formation. In some instances, it’s easy; in others, not so easy.
- Withdrawal: To the extent an entity is formally registered in a state to do business and that business is closing, a formal withdrawal notice should be filed with that state. Again, in some cases this is easy; in others, not so much.
- State Filing Obligations: Prior to getting into the thick of the sales process, a call to the state’s Bulk Sale Unit can help quell a lot of grief later. Inevitably, there is always an unfiled state form (payroll, litter, SUI, etc.) from 5 years ago that needs to be filed that, if not taken care of, could slow down the sales process.
- Withholding Tax: If any tax is expect to be owed to the state as a result of the sale, many states will want to make sure they get paid before closing, so it is always a good idea to check in with state on this during the early stages. The taxes paid will then be used as a credit on the owner’s state return.
- Building Operational Infrastructure: It is always a good practice for a business to look for opportunities to create solid operational infrastructure whether it be on the factory floor or in the marketing group or accounting department. But this is most true in setting up a business for sale. Most buyers are not looking for an opportunity to baby sit your company. They want to get a good sense that there are steady hands, other than the seller, in place to run the business.