Business owners decide to sell their businesses for a variety of reasons. Typical reasons to sell may involve a desire to capitalize on their investment and hard work, a desire to retire, or possibly because the business has not been as profitable or enjoyable as the owner had initially desired. No matter the reason for the sale of the business, there are some basic issues to consider in the sale of your business.
Of paramount importance in the sale of your business are the tax implications from the sale. A business owner, in considering any transaction, should first consider the tax implications from the transaction and consult with their tax attorney and accountant before discussing a purchase price with a prospective buyer. In the sale of a business, the tax implications will stem from how the transaction is structured. There are two basic structures for the sale of a business: the straight stock sale (not including mergers or other various tax free reorganizations associated with stock transactions) and the asset sale.
If the business is incorporated, a stock sale is often favored by the seller because with the sale of the stock, all of the assets and liabilities (known and unknown) of the business transfer with the stock and the seller receives capital gain treatment on the sale of the stock at a favored tax rate. In an asset sale, possibly incorporating the assumption of all or some of the business’ liabilities, only the assets specifically referenced are sold and only the specific liabilities assumed are transferred.
The tax implications from the sale of assets and assumption of liabilities will be determined based on the basis of the assets sold and whether there is any depreciation recapture required which would result in some ordinary income recognition, rather than capital gain treatment. This results in a higher tax cost to the seller. Typically a buyer of a business will desire an asset sale because of unknown liability exposure associated with the stock sale and because the new owner will want a basis in the assets tied to the purchase price for their own future depreciation purposes. Being able to depreciate the assets purchased allows a buyer to receive deductions to help compensate for the costs of the acquisition.
As a result of the varied tax considerations to the buyer and the seller with respect to the stock sale or asset sale, this is usually the first negotiated term of the transaction.
The next major consideration in the sale of the business is how the owner is going to get paid. Will the transaction be an all cash transaction or will the seller carry back financing? Obviously, an all cash transaction is preferred because the number one rule is to get paid for your hard work and your asset. Seller carry financing with the sale of a business is a risky proposition because you will be dealing with guarantees and security agreements tied to the assets sold (and possibly other assets of the buyer) to provide a measure of protection that you are going to get paid for what you sold. The major risk in seller carry financing results when the transaction goes bad and the seller has to exercise its remedies under the security agreements to get the assets back. When the assets come back, what condition will they be in? What condition will the business be in? Will anything be salvageable once you get the assets back? A business owner should strongly consider if a bank will not fund the purchase, should you?
Once you have considered the tax implications and how you are going to get paid, the next consideration is the documentation of the transaction. Sometimes one of the parties to the transaction desires a letter of intent to memorialize the basic terms of the transaction and others desire going straight to a purchase agreement. I am not a proponent of the use of letters of intent by sellers because it only adds to the costs of the transaction and even if the letter of intent is stated to be “non-binding”, there can be instances where the letter of intent can rise to the level of a legal binding contract based on the actions of the parties involved. In representing the seller, I am a proponent of going straight to the purchase agreement that I prepare in order to better control the terms for the sale and the overall process for the transaction. Some of the basic terms and the overall process to be considered for the purchase agreement will include the purchase price, deposits (whether refundable or non-refundable), how the purchase price is to be paid, the length of the due diligence review period and whether extensions of this period of time are allowed, representations and warranties to be provided, closing date, extensions of the closing date, and the closing process through escrow which may or may not include Bulk Sale Notices that need to be published.
The sale of a business is a major transaction that must take into consideration the above issues as well as many more issues. This article is not meant to be exhaustive treatise on the sale of a business but provide a seller with some basic thoughts to consider when it comes time to sell their business. An experienced team of attorneys and accountants should be employed by the seller to guide them through the transaction and to properly represent their interests during the transaction and after the transaction.
