PREPARING FOR THE SALE OF YOUR BUSINESSBy Angela Sadang | Mark R. Cuccia
January 27, 2017 | Download PDF
So, you founded your business and, over the years, built it into the profitable — and flourishing — operation it is today. Or maybe you inherited the business, maybe even bought out an existing enterprise. But, whatever your path to success, you’ve no doubt worked long and hard to get to where you are.
But now it’s time to move on, and you want to sell your business. Questions abound: where do I start, exactly? What do I do first? Who should I talk to?
If the whole process seems daunting, it doesn’t have to be. Just keep in mind that when it comes to valuing your business — any business, in fact — there are a variety of valid, equally acceptable, ways of arriving at the answer. The truth is that the entire valuation process is more art than science.
First things first
Your first step should be to contact a professional business appraiser who is qualified to perform business appraisals and has both the training, and the experience and has the credentials such as the ASA, CVA or CBV. They employ a variety of approaches when quantifying the value of your business, but in any event having an appraisal prepared by an established, qualified specialist will lend credibility to your go-to-market price.
How do appraisers actually gauge the value of your business?
There are a number of ways in which the worth of your company can be assessed. However, for our purposes the main issues you should take into account when determining the value of your business include:
- An upward growth history and a potential for future growth.
- A robust balance sheet that establishes a positive cash flow, acceptable margins and manageable debt levels.
- Competitive business advantages, plus an established and expandable client base.
- The overall competence of your workforce, especially the expertise and experience of your management team.
- The value of any proprietary systems, applications, intellectual property;plus ownership of any significant intangible assets.
- If it applies, the condition of your company’s equipment and property.
Getting you books organized and ready for examination by the potential buyer
We cannot overemphasize the importance of keeping accurate and comprehensive business records ― and making sure that they are well-organized and accessible. It can make the difference between a successful sale — or no sale at all.
For example, we were recently approached by a client who wanted to sell his company. Unfortunately, he had failed to keep his books and records up to date or accurate. As a result a number of previous deals had fallen through, simply because of his forgetfulness. However, we were able to help with the ‘clean-up’ process and, as a result, the owner was able to successfully sell his company — for $32M. After taxes and other closing costs, he walked away with approximately $20M.
While it is by no means exhaustive, here is a list of the records you should have on hand — and in good order:
- Accounting and bookkeeping documents
- Bank and corporate records
- Contracts and all correspondence
- Intellectual property and employee records
- Marketing and advertising documents
- Permits and licenses
- Stock and tax records
Pulling together schedules or needed analysis
At this point your CPAs (or their accounting firm staff) will have moved on to what is perhaps the one of the most important stages in the valuation process: the assembly of those files and accounts that show exactly how your company has recently performed.
The first step is to calculate the TTM, or Trailing Twelve Months, which is an objective appraisal of your company's overall financial health. Usually based on your firm’s financial reports — be they quarterly, annual, or interim — the TTM determines exactly what income your company generated for the twelve-month period immediately preceding the assessment.
In addition to disclosing your company’s monthly P&L schedule, the TTM will disclose such data as overall revenue/earnings, or EBITDA, that is, a company’s Earnings Before Interest, Taxes, Depreciation and Amortization.
However, in order to provide complete transparency in this pre-sale process, your CPA will also require a complete listing of non-recurring or personal expenses, as well as your (and if applicable, your spouse’s) compensation.
The best tax structure for the deal — and the questions to ask
Now we come to what, for you is a crucial step in the sales process: structuring the deal so that it yields the best possible tax outcome. This is yet another reason to have the expertise of an experienced CPA at your disposal; many otherwise good deals have been undermined at this stage.
At this point there are a number of questions you should ask yourself, and, with the assistance of your CPA, answer, among them:
How do you define your business?
The first thing you and your accountant need to determine is how you actually do business.
Do you run your business as a sole proprietorship, a partnership, a limited liability company (“LLC”) or an S corporation? Whichever one it is, these are all defined as “pass-through” entities and actually give you a great deal of flexibility when you are negotiating the sale.
However, if your business is a C corporation your flexibility is limited in a sales transaction, since a C corporation doesn’t enjoy the “pass-through” taxation rates that other entities do. That, in turn, raises the real possibility that you will be faced with double taxes when you sell your assets and share the proceeds with your co-owners.
Can you construct a tax-free deal?
A sale like the one you have in mind is, more likely than not, a taxable transaction. However, you might be able to affect the sale tax free, or more accurately, as a tax deferred transaction. Provided you meet all the IRS requirements — which, by the way, are extremely complex ― then you could theoretically exchange your S corporation or C corporation stock for the corporate stock held by your buyer.
What are you selling ― stocks or assets?
Since it’s unlikely that you’ll undertake a tax-free transaction, it’s important that you understand the implications structuring your sale as an asset or stock deal before you agree on the provisions of the contract. However, most buyers prefer assets rather than shares because there is virtually no possibility of their being burdened by any liabilities that the seller failed to disclose. Careful due diligence should prevent that anyway, but a savvy buyer will still opt for assets since they can secure more advantageous tax deductions later on.
What are earnout payments?
If you and your buyer are unable to agree on a purchase price, you can agree to the buyer making an ‘up-front’ payment, which then requires additional ‘earnout’ or contingent payments — provided the buyer can attain agreed-upon financial objectives within a predefined time period. One caveat here: even if the initial contract was eligible for long-term capital gain treatment, some of the contingent payments will be regarded as imputed interest, which the IRS treats as ordinary income for you, and which is therefore taxable as ordinary income.
Are installment sales possible?
You are actually allowed to receive payment from your buyer over an extended period of time, provided that all parties are in agreement. The downside is that you don’t receive the full amount immediately. The upside is that you can postpone the overall gain on the transaction until the buyer delivers on their financial commitment. However, any part of the transaction having to do with depreciation recapture or gain on ordinary income type items — such as accounts receivable or inventory — does not qualify for deferral.
Why is the allocation of the purchase price so important?
The reason is fairly straightforward: when a business is sold the federal taxes imposed can vary widely: from as much as 39.6% — which reflects ordinary income rates — down to 20%, the rate at which long-term capital gains is taxed (if you’re in the highest tax bracket). Plus, these rates also don’t contemplate the net investment income tax of 3.8%.
This means that you and your buyer need to agree on the distribution of the total purchase price to the assets acquired. As your CPA will undoubtedly tell you, you and your buyer are required to file an IRS Form 8594 to formally acknowledge the agreed-upon allocation.
Plus, your CPA will undoubtedly tell you that if the purchase price allocation is being discussed, you will need to decide if you run your company on a cash or accrual basis. The distinction is important, because depending on the answer you give, you will have to separate your company’s assets into their constituent parts, which might include accounts receivable, equipment, inventory, real property, cash, intellectual property and other intangibles.
What about state and local taxes?
Last, but certainly by no means least, is the subject of state and local taxes — and it may well be more important that you think.
Depending on where your business is located — or, in some case, registered — the way a state regards a particular deal depends on whether it is structured as an asset or a stock transaction. Moreover, if an asset sale, or a deemed asset sale, is part of the deal, then you may owe taxes in the state in which your company has assets, sales or payroll obligations. Plus, a lot of states don’t offer long-term capital gain tax rate benefits, which means that even if an asset sale gain qualifies for long-term capital gain taxation under federal rules, it may nevertheless still be subject to state taxes.
Finally, keep in mind that stock sales are usually subject to tax in the state in which you reside — even if your company conducts its business in another state.
Some closing observations
It’s worth pointing out that there is often a very large divide between what you think your business is worth and the price a potential buyer is willing to consider. This is actually very common, especially since owners like you have an emotional investment in your businesses.
Like countless others, you probably factor in more than financial data when you try to decide what your business is worth. However, the truth is that your emotional attachment to your business cannot be part of the valuation equation.
Angela Sadang, MBA, CFA, ASA, is a Director in the Financial Advisory Services Group at Marks Paneth LLP. She specializes in business valuation and has more than 15 years of experience providing corporate financial consulting services. Angela serves both publicly traded and closely held companies in a wide range of industries that also involves various asset classes.
Before joining the consulting industry, Angela worked in the financial services industry at JP Morgan Securities and Schroders PLC, focusing on institutional equity research covering the Asian equity markets.
Angela is a Chartered Financial Analyst (CFA) as designated by the CFA Institute. She is also an Accredited Senior Appraiser (ASA) with specialty in business valuation as designated by the American Society of Appraisers. Angela holds a Master’s Degree in Business Administration with a concentration in Finance from The Wharton School of the University of Pennsylvania. She is based in Marks Paneth's midtown Manhattan headquarters.
Mark R. Cuccia, CPA, is a Director at Marks Paneth LLP. He has 15 years of experience serving clients across a wide range of industries including manufacturing, importing, wholesale and distribution, retail, restaurants and professional services industries. Mark is currently responsible for overseeing all aspects of audit, review and compilation engagements, as well as assisting clients with forecast and projection modeling. In addition, he advises clients on all facets of accounting and tax issues. He has conducted numerous in-house accounting and auditing seminars.
Mark is a member of the American Institute of Certified Public Accountants (AICPA) and the New York Society of CPAs (NYSSCPA). He is currently co-chair of the NYSSCPA, Nassau Chapter of its Accounting and Auditing Committee. He is also a member of the Hauppauge Industrial Association.
About Angela Sadang
Angela Sadang, MBA, CFA, ASA, is a Director in the Financial Advisory Services group at Marks Paneth LLP. Ms. Sadang specializes in business valuations and the valuation of intangible assets and has nearly 20 years' experience providing corporate financial consulting services and performing valuations. She serves both publicly traded and closely held companies in a wide range of industries that also involves various asset classes. Her valuation experience includes business enterprise and intangible asset valuation for financial... READ MORE +
About Mark R. Cuccia
Mark R. Cuccia, CPA, is a Director at Marks Paneth LLP. He has 15 years of experience serving clients across a wide range of industries including manufacturing, importing, wholesale and distribution, retail, restaurants and professional services industries. He is currently responsible for overseeing all aspects of audit, review and compilation engagements, as well as assisting clients with forecast and projection modeling. In addition, he advises clients on all facets of accounting and tax issues. He... READ MORE +