One of the more common engagements for our firm is to assist with business sales and acquisitions. This article is part of a series of articles which will walk through and discuss the steps typically associated with the sale of a business. This series of articles will discuss the process and means of selling a business from both sides of the table from the beginning to the end.
This article will begin a multi-part series of articles about the sale of a business. In these articles, we intend to walk the reader through the basic considerations and steps taken in selling (or buying) a business.
Overview of the Process
A typical transaction will generally entail the following steps:
- Initial Negotiations;
- Letter of Intent/Term Sheet;
- Due Diligence;
- Definitive Agreements;
- Transitional and Post-Closing Matters; and
- Tax Reporting.
Breakdown of the Business
When considering how to price a business for purchase or sale, a multitude of factors are considered. A manufacturing business differs tremendously from a professional practice. Both a professional practice and a manufacturing business are an extreme contrast from a retail business. So, how does one consider value? What are the crown jewels from which the business derives it true value?
When analyzing and preparing to buy or sell a business, one must look beyond just the financials. Are there material contracts, key employees, valuable licenses which could be transferred? This initial analysis is crucial when making decisions with respect to the purchase or sale of a business. Not every valuable asset is a line item on a balance sheet. Typically, when reviewing a business, the following items are of key importance:
Physical Asset Values
Physical assets bring value to the business because these assets are generally the working assets of the business. Such assets may consist of equipment, computers, software, or even furniture used in the business. Further, these assets are generally able to be converted to cash in relatively short order if needed, albeit not always for full value.
Earnings Before Interest, Taxes, Depreciation, and Amortization (“EBITDA”)
EBITDA is a useful, though not dispositive, metric for measuring the profitability of a business. After factoring out capital costs, taxes, and depreciation and amortization, one can view what the business is really doing from a profitability standpoint. Though this number may not be a perfect metric because while capital expenditures may be high and recurring, the assumption is generally that those are infrequent expenses.
Key employees are crucial for the continuity of a business in many cases. A buyer will likely want to keep those employees that are material to the business because without such employees, the business may not be nearly as successful. It is not uncommon for these employees to be under contract and such contracts to be the subject of negotiation and subsequent transfer.
Intellectual property can be comprised of a multitude of different intangible assets from trademarks, copyrights, and patents to specialized processes andknow-how, customer lists, and the company networks. Today, many companies are bought and sold just to acquire intellectual property.
In tandem with intellectual property, there can be goodwill, another intangible asset. Goodwill can be considered a bit of a catchall, but really goodwill is more or less the excess value of a business beyond that of its balance sheet assets. The value of goodwill may be attributable to a number of non-balance sheet items such, as reputation, a company’s brand name, a solid customer base, good customer relations, good employee relations, or any patents or proprietary technology (although the latter two may also be part of intellectual property). Further, goodwill can be personal and an asset of the owner and rather than the business itself.
In many industries, a barrier to entry to start a new business is registration and licensure with certain business regulatory agencies, or better yet, state and/or federal regulatory agencies. At times, it may be easier to acquire an existing business rather than start a new business due to the sometimes onerous registration and licensure processes.
Identification of Relevant Parties to the Transaction
The Direct Parties
The Seller (the business owner)
The seller is the one selling the business, the party subject to potential significant taxes upon the sale, and who may be a key employee going forward with respect to the business. As a key matter, the seller is the one that knows the business, likely better than anyone else. In the event of a sale of the assets, the business will technically be the seller. However, for the purposes of this article, we will refer to the business owner as the seller.
The buyer is the party bringing in the money. As such, the buyer is generally sensitive to verification of the due diligence items. Therefore, the buyer’s advisory team will usually be highly scrutinizing of the due diligence items.
The business itself will usually be the subject of some pre-sale clean up and data gathering. It is not uncommon that the seller will require that the transaction itself remain confidential until a certain event to prevent any disruption in the business or issues with the business employees.
The Indirect Parties
Part of the reason for such extensive and at times onerous due diligence on the part of the buyer is due to the requirements of the buyer’s bank. Purchases are generally debt financed and the bank will want to ensure viability of the business, clear title of the assets to be acquired, and the ability to place valid liens on the acquired business assets.
The Key Employees
Key employees can be a major bargaining point as an asset of the business. Some employees may have certain executive compensation rights in the event of a transfer. This can impact a number of factors in the transaction. A review of the contracts relating to key employees is a critical aspect of the transaction. In the end, the buyer will want to effectively transition key employees to its control after the acquisition to ensure continuity of the business purchased.
A common factor to many deals, but one easily ignored, is the role of the regulators. From a restaurant, scrap facility, waste management business, surgery center, or hospital, licenses are critical. At times, some licenses may be able to be transferred as part of the business. Other times, new licenses may need to be acquired. Usually, the licenses are the key to being able to legally continue the business and are what allow the business to be a business instead of a pile of assets and employees. Licenses must be transitioned or reissued as part of a business transition.
The Advisory Team
The CPA is a common primary participant in business sales. It is usually the role of the CPA to prepare and deliver the financial statements as part of the due diligence (from the seller’s perspective), review and advise regarding due diligence items, and to assist in assessing effects of negotiated items (particularly, purchase price adjustments, tax allocations, and tax effects).
The Financial Advisor/Investment Banker
Working in tandem with the CPAs, the financial advisors and investment bankers can assist with helping the seller identify likely buyers, prepare the business for eventual sale, and assist the seller with identifying and realizing the true value of the business. With the assistance of an advisor, a seller may be able to achieve a higher price and have an easier means of managing the sale process.
While the job of the attorneys may overlap with the CPA and financial advisors, the attorneys are the parties that handle a large part of the negotiation, document preparation, and generally assist in working with any governmental agencies. It is also not uncommon that the attorneys assist with the analysis of the tax effects of the transaction and assist the buyer or seller with follow-through items with respect to the tax reporting and planning surrounding the transaction at hand.
Types of Transactions, Generally
In an equity purchase, the entity/business itself is purchased. This may be the purchase of all corporate stock or of all the limited liability company interests. A key factor in this type of purchase is that with an equity purchase, liabilities come with the transaction and there is a potential to avoid certain higher tax rates in some types of transactions. Generally, sellers prefer equity sales.
In an asset sale, the assets of the business are sold and transferred. These transactions can generate transfer taxes, sales taxes, and increased income taxes in certain cases. While increasing transaction costs and complexity, these transactions allow the buyers to land in a better tax position and avoid many liabilities of the predecessor business entity. Generally, buyers prefer asset sales.
In the next part of this series, the beginning of the transaction will be discussed in more detail. This will include preparing the business for sale, the preliminary negotiations, initial tax considerations, and arriving at the letter of intent.
Our firm is regularly engaged to handle many types of business transactions from simple equity sales to complex asset sales involving publicly traded corporations. With significant analytical, business, and tax expertise, our firm is well equipped and ready to assist our clients with their business transactions.