TAXES AND TERMS IN A BUSINESS SALE: PRE-SALE (Part 1 of 3)

A wise business seller understands that price is just one of multiple factors that determine, after the dust has settled, the actual value of their deal.

In most business sales, it’s natural for the seller to focus on the price as the defining measure of their company’s market value and their satisfaction with the sale.

However, obsession with the selling price can obscure other important considerations – the terms and structure of the deal, the resulting tax liability, and the net cash received.

“Terms are as important as price,” says Jim Afinowich, managing partner in IBG Business’s Arizona office. “It’s not how much you sell the business for; it’s how much you end up with after tax. And there can be a tremendous difference in tax consequences and how you structure the sale.”

A major role of an M&A advisor is to help the seller keep their eye on that bigger picture, adds IBG managing partner John Johnson (Oklahoma).

“We are always alert to the tax aspects and, during the sale and negotiating process, will work to negotiate a structure that favors the seller. Deal structure can help whittle down the actual taxes through buyer-seller negotiations and cooperation.”

This article is one of three in a 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.

As you read on, bear in mind that the factors that shape the value of a business sale are deal-specific. Because of the nearly infinite number of variables – the seller and their issues; the buyer and their issues; the company and its issues; and the type, timing, and terms of the transaction – our objective is to help you anticipate, from 30,000 feet, some of the factors that can shape a deal’s ultimate value.

PRE-SALE MANEUVERS

At least three tax-related issues should be addressed and resolved before your business is presented to potential buyers.

Estate Taxes. You should ask your estate planning attorney to analyze how selling your business might affect your estate tax liability. This is especially important if your business’s current market value (we can help you with a reliable projection) is considerably higher than it was when you last updated your estate plan.

This is a timely concern. If Congress does not act before the end of 2025, the estate tax exemption will drop from the current $13.6 million per person to just $6.2 million (i.e., $5 million adjusted for inflation since 2017). As a consequence, your seemingly modest estate, which up to this point has not warranted estate tax planning, could become subject to taxation after your death, due to a combination of a lower estate tax exemption and an unexpectedly high selling price for your business.

Gray Dollars. One of our key functions in preparing your business to go on the market is to recast its financial statements to show its true earnings and book value, in a way that buyers except.

In recasting your financials, we will cleanse them of what Jim Afinowich calls “gray dollars”: personal expenses, or expenses of a dubious business nature (think “condo in Vail”), that you have been running through the company.

“In years past, those gray dollars served a useful purpose by reducing your taxable income,” Jim noted in a recent podcast. “But now you’re in sell mode, and it’s time to pay the piper. If your business is likely to sell for a multiple of four times earnings, each of those gray dollars is going to cost you four dollars in selling price.”

That’s why recasting your financials is so important, and it needs to be completed before the first potential buyer looks at your company.

Double Taxation. If your business is a C corporation, check with your tax professional about the pros and cons of – and your C corp’s eligibility for – electing to be taxed as an S corporation.

An S corp election might allow you to avoid double taxation on the proceeds of an asset sale. However, this strategy requires long-range planning, as gains recognized within five years after the election may be subject to built-in gains (BIG) taxes that would defeat your purpose.

CONCLUSION

Keeping these pre-sale considerations at top of mind during the early stages is important to how the deal will ultimately shake out. Stay tuned for the rest of the series which covers other key areas to look out for in your future deals, including deal terms and structuring, and post-closing.

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.