Transitions 2020: Structuring the Deal

The way you put together a business sale can determine the quality of the time you spend after the deal is done. Taking action now can keep more of your options open later.

By Dennis Boone

Retirement may beckon, or you may simply be looking for a second act in a business. Whatever your motivation, you’ve made the call: It’s time to prepare your business for a sale.

“I think we’re going to see a lot more seller financing/earn-out situations in the coming months. A lot of times, those are gap-fillers on price—they bridge the gap between what a buyer is willing to pay and a seller is willing to sell for.” — Kirstin Salzman, Husch Blackwell

If your primary consideration going into that process is on the final number, though, you may be making a very costly mistake.

“With the exception of serial entrepreneurs, most business owners probably only sell a company once or twice in their careers,” says Patrick Respeliers, a partner at Stinson LLP.  “As a result, they do not always understand all the intricacies of a sale transaction and often focus only on the purchase price number without considering the many other deal terms that have a real effect on the after-tax cash that the ultimately realize from the transaction.”

The potential pitfalls, he and others in the legal and brokerage spheres say, are many and varied. Tax implications, legal issues and post-sale time commitments are just a few of the elements that will shape the structure of the deal, and potentially alter the price you’ve had in your head as walk-away money.

This year-long series has focused on many of the issues that must take place months, even years in advance of that transaction if you’re to maximize and monetize the true value of your life’s labors. But when it comes to the actual structuring of a deal, it’s important to keep in mind that seating around the negotiating table won’t be limited to you, your buyer and your trusted advisers.

“The three parties impacted with the purchase price allocation are the buyer, the seller and the IRS,” says Mike O’Malley, of the business brokerage firm O’Keeffe & O’Malley. “Of course, the goal is to minimize the IRS tax impact in the transaction, but most often the impact goes in the opposite direction for the seller when trying to benefit the buyer, and vice versa.”

It is to the seller’s advantage, say legal experts and brokerage executives, to get capital-gain tax treatment on most items—it is, after all, a tax rate considerably lower than the high individual rates you’ll likely be pressed into with proceeds from a sale.

“And it’s to the buyer’s advantage to expense or write off as much as possible each year,” O’Malley notes. “In the asset-purchase agreement, the buyer and seller must agree on the allocation of the purchase price, and it must be reported accordingly on IRS Form 8594. A stock sale will normally favor the seller greatly and disallow most write-offs for the buyer, with the exception for some allocation to personal goodwill and the owner’s non-compete.”

It’s important, as well, to understand the way economic conditions impact the terms a buyer might bring to the table. Those conditions will vary depending on the business sector involved, the size and financial health of your company, and the factors that motivate private equity and acquisition-minded executives to get into the market.

For the near term, says business-law pro Kirstin Salzman of Husch Blackwell, “I think we’re going to see a lot more seller financing/earn-out situations in the coming months. A lot of times, those are gap-fillers on price—they bridge the gap between what a buyer is willing to pay and a seller is willing to sell for.”

The wild gyrations amid a pandemic are redefining the calculus on sales, she said. “Maybe some businesses have skyrocketed up or down, but the buyer is not necessarily going to pay for the skyrocket up, since it may not be sustainable.”

Another consideration in structuring any deal, professionals say, is understanding that while you may want to cut the cord and head to a beach, the chances are you’re going to be asked to stay on in a transitional role, perhaps for a year, two, or even more.

That’s why you need to understand your options in terms of structuring a deal. It may come as an asset sale, where a buyer is acquiring the physical assets, IP and data that are the lifeblood of your operation. It may come as a stock sale, where the business continues in its existing form, and only the ownership players have changed. Or it may come in the form of a merger, with implications for the timing of your exit.

“We’ve been keeping statistics for our office over the years and I think ours are pretty typical,” says Doug Hubler of Apex Business Advisors. “The vast majority (90 percent) of our transactions are asset sales. For the most part, stock sales have been used in situations when buyers believed that was necessary to maintain seller contracts or licenses.”

With transactions financed through banks using SBA guarantees, he said, the structure of the deal is important because there are limits to what the SBA will allow.

“All cash is the easiest and quickest way to complete a transaction and we have several of those each year,” Hubler said. “Cash deals may involve earn-outs more often, or a large piece of seller financing. Earn-outs are not very common when financing the transaction, due to SBA limitations. However, we find earn-outs are necessary when it comes to selling professional services, such as accounting practices.”

Often, asset sales will be used, especially in lower and mid-market deals, where a buyer is taking the same approach as a prospective homeowner: putting 20 percent down and financing the balance. “In about 40 percent of the cases, the seller may finance part of the deal,” Hubler said. Sellers may be required to finance a piece to meet lender requirements or just to satisfy the buyer’s offer.

As for stock sales, Hubler said, buyers generally “aren’t interested in buying stock due to the risk of taking on unknown seller liabilities.”

Still, Respeliers says, “an all-cash, stock deal is probably the easiest and quickest deal to document and close. When you start bringing in earn-outs, sell financing or equity roll-overs, there are a lot of additional terms that need to be negotiated between the buyer and seller (and potentially other third parties) that can slow down the process and drive up the costs.”