Once the decision has been made to sell or acquire a business, the next steps are, by their very nature, very complicated. Downstream consequences from both tax and liability perspectives drive the deal terms that both the buyer and the seller will ultimately agree to. The nuances of such a sale could fill an entire textbook, but below are three upfront considerations you’ll want to talk through with both a lawyer and a CPA as you start to plan the sale or acquisition of a business.
(1) Find the Hidden Landmines that Can Blow Up the Deal
Before investing resources and energy into preparing financials and drafting a non-disclosure agreement and letter of intent, think through what types of issues have the possibility of blowing up the deal – other parties who may block the sale or big-picture deal breakers. Such issues include: (i) working with a landlord to structure a new lease or lease assignment (and the landlord’s willingness to do so), (ii) pending (or actual) liabilities, such as a lawsuit that has been threatened, (iii) the unwillingness for human talent to remain engaged with the new buyer, and (iv) the need to pay off the seller’s outstanding debt simultaneously when the deal closes. If landmines like this can’t be resolved, then there may be little point moving forward with discussions and negotiations.
(2) Will the Sale be Structured as an Asset Sale or Stock Sale
A business can be sold in one of two ways: the sale of the entire corporate entity (stock sale) or the sale of the company’s assets (equipment, intellectual property, cash). For small business owners operating as a sole proprietorship or single member LLC treated as a disregarded entity this will not be an issue, as there isn’t an entity to purchase, so the deal will organically be structured as an asset sale. For corporations or multi-member LLCs, however, the structure of the sale is important.
If the business is a corporation, in general the buyer would like the deal to be structured as an asset sale, and the seller would like it to be a stock sale. A buyer is interested in a step-up in tax basis of depreciable and amortized assets, and also not purchasing the seller’s liabilities (debts, lawsuits, etc.). Alternatively, the seller would like to sell the stock (and the liabilities, if any) and pay a single tax at the capital gains rate. However, in some cases open contracts of a business or a team of employees can only be taken over by the buyer through the purchase of the corporate entity, so the buyer may find benefits to a stock sale.
The moral of the story is that the tax consequences to both the buyer and the seller can vary dramatically between an asset and a stock sale, and for the buyer there may be benefits to buying the liabilities of the company so that the full value of the company is obtained. These complex considerations emphasize the importance of not only working with a CPA and a lawyer during the sale, but also finding a price that allows the seller to feel good about the return and the buyer comfortable with the after-tax purchase price.
(3) How Will the Payment Price be Structured
As the saying goes, a dollar today is worth more than a dollar tomorrow, and the timing for when the entire purchase price will be paid is a big negotiation topic. A seller in need of cash now may be willing to take a lower price upfront, as opposed to an installment sale over time. Alternatively, generally a buyer would like to think of the business as paying for itself, and so an installment sale has a lot of appeal as it takes less present day capital to complete the deal.
Additionally, it is common to incorporate an “earn out” as part of the sale, which are payments to the seller based on the future performance of the business after the sale takes place. The rationale behind an earn out is that in many sales the seller will stick around to help facilitate a smooth transition, and so it keeps the seller invested in ensuring that the sale and future of the business is successful, as well as the buyer essentially saying “prove your business is really worth this selling price.”
The topics above are only a few of myriad considerations that must be made when a business is sold or purchased. We strongly recommend you take the time to speak to an experienced lawyer and CPA who can help you navigate what next steps look like for your unique situation.
Disclaimer: This post discusses general legal issues and developments, is intended to serve as informational only, and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Archetype Legal PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.
