TAXES AND TERMS IN A BUSINESS SALE: DEAL TERMS AND STRUCTURING (Part 2 of 3)

This article is number two in a three-part series that offers a very general overview of how understanding the taxes and terms of a business sale can help a seller discern the true value of an offer and, in a competitive bidding scenario, recognize which offer constitutes the best deal. Bear in mind that the factors that shape the value of a business sale are deal-specific.

KEY QUESTIONS

After the preliminaries are out of the way, your business is on the market, and you are receiving inquiries and letters of intent from potential buyers, major variables that shape the value of your deal will come into play.

• Will the deal be a stock sale or an asset sale?
• Is it a cash deal, or is the buyer asking you to carry a portion of the purchase price?
• Are you free to move on after the deal closes, or does the buyer want you to remain involved for a while?
• Is any part of the sale price contingent on how the company performs under the new ownership?
• How can you reduce your deal-related tax liability?

STOCK SALE VS. ASSET SALE

Business sales generally fall into one of two categories:

• a stock sale, where the buyer purchases the seller’s interest in, and takes possession of, the legal entity, or
• an asset sale, in which the buyer is purchasing specified assets from that entity.

IBG’s John Johson observes that “small deals are most often asset sales, while larger deals more often involve the sale of equity.”

Each type of sale impacts negotiations, terms, price, and tax consequences.

Asset Sale. As a general rule, buyers prefer to purchase assets (not stock) to avoid unanticipated liabilities of the seller’s entity and, more important, to achieve significant tax advantages.

In an asset sale, each individual asset is assigned a value. The process of purchase price allocation, and the ability to start depreciating each asset in the year of the purchase, holds significant future tax value for the buyer.

“We often see buyers paying more in asset deals,” says IBG’s John Johnson, “due to the value of the step-up in basis for depreciation.”

Stock Sale. While buyers like to buy assets, sellers tend to prefer a stock sale. This is especially true in the case of C corporations, which, as we mentioned above, face the problem of double taxation. If a C corp sells its assets, with the seller retaining the stock, the proceeds will be taxed twice: first when the corporation files its tax return(s), and again when the shareholders file theirs.

In contrast, in a stock sale, the proceeds go directly to the shareholders, who report the gain only on their individual tax returns.

The conflicting objectives of buyer and seller make asset allocation an important part of negotiations, with the result that a buyer might give a little on price or terms in order to get a more favorable allocation, while the seller might give on the latter to enhance the former.

ALL CASH VS. SELLER FINANCING

As we mention in a related article, most business sales involve some form of seller financing. The higher the selling price, the greater the likelihood of a seller carryback, with the financed amount paid in installments.

In an installment sale, the buyer takes immediate ownership, but payments are made over multiple years. The good news for the seller: Your tax payments are spread out over the installment period.

Your willingness to offer seller financing can result in a higher price, to (a) reward you for waiting for some of your money and (b) reduce your loss in the event the buyer fails to make all of their payments.

Put another way, in any transaction that’s not all cash, you should discount the expected value of any non-cash consideration.

STAYING ON AFTER THE SALE

The buyer may want you to remain on board for an agreed period, to facilitate the ownership transition, shorten the buyer’s learning curve, and transition key relationships with suppliers and customers.

This arrangement can be beneficial to you, as well:

• Your willingness to stick around can justify a higher selling price.
• While consideration for transitional consulting/employment for a reasonable period post-sale is often baked into the purchase price, longer-term employment can warrant additional compensation.
• You might want to continue your involvement in the business if you are carrying back a portion of the selling price and you want to protect your investment, or if a portion of the selling price is contingent on future profits. (See our discussion of “earnouts,” next.)

CONCLUSION

Deal terms and structure play a pivotal role in the outcome of the deal. It is important for business owners to understand the differences and potential expectations ahead of time. The final part of this series, part three, dives deeper into the post-closing details such as business value and tax considerations.

With a track record of more than 1,100 successful closings, at an 86% closing rate (three times the M&A industry average), IBG Business is well-equipped to help you explore the successful sale of your mid-market business. To start the process of selling your company for top dollar, to the best-fit buyer, contact an IBG Business M&A professional near you.