Matter & Substance
  November 9, 2021

How to Sell Your Business

Many succession plans ultimately lead to a transaction, usually in the form of selling your business. How this looks can depend on your business structure, entity type and ownership. From preparing through executing the sale, join us as we outline the most important factors for ensuring a smooth transaction.

Preparing for the sale

The first step to selling anything is to determine what it is worth. A business valuation will provide a starting point for price and negotiations and might also help you identify areas that need attention before you begin to market your company.

In addition to a business valuation on the front end, a buyer will often request a due diligence engagement–such as a Quality of Earnings engagement–during negotiations. The goal of these engagements is to verify the assumptions made in sales transaction such as projected revenue, earnings, and working capital are reasonable. Often you will be asked to provide a calculation of your company’s EBITDA (Earnings Before Interest, Income Tax, Depreciation and Amortization) as well as relevant supporting documents.

Do what you can to avoid being caught off guard during these processes. As you know, when you list your house for sale, you notice a lifetime’s worth of little projects to do before it is ready to sell. Similarly, when you prepare to sell your business, there will be some clean-up needed. Give special attention to:

  • Personal expenses: Do the expenses on your company’s books include personal items? Personal items may include non-business-related travel, meals, entertainment, utilities and vehicle expenses. It may also include any benefits granted to the owners or other employees that will not continue on a go-forward basis. These types of expenses should be added back to adjusted EBITDA.
  • Non-recurring items: Do revenue or expenses include business-related non-recurring items? Non-recurring items may include capitalizable costs that were expensed, deal-related transaction costs or non-recurring income such as Paycheck Protection Loan forgiveness. These types of non-recurring items should also be excluded from adjusted EBTIDA.
  • Fixed asset accounts: Has depreciation been properly recorded, or are there any assets you no longer own and should dispose of on the books? Are assets properly classified according to their useful lives?
  • Cash: Are your cash accounts reconciled? Is all interest accounted for? Are there any negative cash balances? And do not forget to follow up with customers on any outstanding invoices.
  • Accounts receivable: Does accounts receivable include legacy balances that are not expected to be collected? If so, old balances should be written off or adequately reserved.
  • Inventory: Do your inventory levels accurately reflect what is available to convert to cash at the time of your valuation? Are all gains and losses recognized in the appropriate reporting year?

If you do not already have them in place, establish accounting policies and procedures which align with your organizational goals and that provide monthly, quarterly and annual financial statements. Start tracking your sales pipeline and develop a financial forecasting model. Organize your historical tax documents and start drafting current year forms. Having easy access to your financial information and taking the time to record adjustments now will provide the most accurate picture of your business, reduce risk and help eliminate any surprises during deal negotiations.

Structuring your sale

During the deal negotiation stage, you will have many decisions to make. Arguably, one of the most impactful will be how to structure the sale.

When you sell a corporation, you can choose to sell the assets or the stock to a buyer. An asset sale may be advantageous to a buyer in a corporation with depreciated assets. When the purchase price in an asset sale is greater than the tax basis of the assets purchased, the buyer gets to “step-up” their basis in the assets. This additional basis is then available for the buyer to depreciate or amortize, reducing future taxable income. For the seller, the additional gain is treated as ordinary income and taxed at a (generally) higher rate than if it had received capital gains treatment, for now. In the instance of a C corporation, there is also potential for an entity level tax on the transaction, meaning it may be subject to double taxation.

A stock sale usually benefits the seller because the gain is taxed at capital gains rates. Stock purchases also allow the buyer to acquire licenses, permits, assignable contracts and other intangibles. There are cases in which the seller can treat a sale as a stock purchase and a buyer can receive asset sale treatment, offering the best of both worlds.

When you sell your interest in a partnership or an LLC taxed as a partnership, however, the tax consequences can vary greatly. Generally, the sale of a partnership interest will represent a capital gain. However, to the extent that the purchase price is attributable to unrealized receivables, inventory items or other “hot assets,” the gain will be taxed as ordinary income.

Why does it matter? For now, at least, the top individual marginal tax bracket is 37%, meaning any ordinary income could be taxed at over 40% after states and localities have their cut. Contrast this with the 20% top capital gains tax bracket, and the difference can really add up.

A little advice goes a long way

While the specifics vary greatly, there is one universal: get help. Bring your network of accountants, financial consultants, bankers, business brokers and lawyers together. Investing in the right advice early on will pay dividends when your transaction is smooth, efficient and profitable.