Selling a Business Part 5: Deal Structure
12 June 2023: Selling a Business Part 5: Deal Structure
Selling a business requires an understanding of how the deal might be structured – and how the deal is structured has a lot to do with the buyer’s representation.
This is the fifth in our 6-part series on selling a business and this one is about how the transaction might be structured; what a seller or broker should expect and why a buyer would choose a certain approach to buying the business being targeted. If the buyer is represented by a professional business broker or M&A specialist, the deal presented to the seller will be structured with the protection of the buyer foremost in mind.
We’ve discussed deal structure to a greater or lesser extent occasionally over the past several years but understanding how the sale might be structured is one of the key components in preparing the business and the business owner for the sale. It’s an important part of managing our client’s expectations.
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If you’d like to learn more, email me at jo*@Wo*******************.com
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There are, of course almost countless ways to structure a deal but there are two basic types of structures to start with and each offers both pros and cons for both buyer and seller. Knowing why a buyer might choose one or the other will go a long way to reducing the level of seller surprise when an LOI is received.
But first, a little background.
Many small business owners either operate on slim margins or spend the cash flow like drunken sailors. In the former instance, they need to keep the employees paid and the vendors current. In the latter they might like livin’ large and the payments – and insurance! – on that Lambo Huracán must be kept current. As such, the last person, vendor or organization that gets paid is usually the government taxing authorities.
In such instances, the business may have an enormous back-tax liability that, unless the buyer is extraordinarily savvy or represented by a knowledgeable business broker, may not become evident until months or even years after the deal closes and a panic-inducing “Dear Business Owner” letter arrives demanding the immediate payment of tens of thousands of dollars in back taxes, interest and penalties, all of which were incurred prior to the sale of the business – but are now being demanded of the new owner.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
How the buyer chooses to acquire the business – an asset purchase or a stock/equity purchase – will make all the difference for the potential of that “Dear Business Owner” arriving.
Why? Because an asset purchase is when the buyer acquires the assets of a business – and sometimes certain liabilities. An asset purchase give the buyer a choice about which aspects of the business will be bought.
A stock purchase is when the buyer purchases the seller’s ownership in the business entity – if a corporation, the owner’s shares of stock; if a limited liability company (LLC), the owner’s membership interest in such LLC. In a stock purchase, the buyer buys the proverbial whole nine yards. There’s rarely any choosing in a stock purchase.
Asset Purchase
As a rule, potential legal liabilities and tax implications are usually the buyer’s primary concerns in an asset purchase. Aside from the example of the tax liability that I touched on above, there is the potential for additional tax liabilities – based on how the parties allocate the purchase price and a tax professional should be consulted to avoid potential mistakes in this area.
But potential legal liabilities can be just as onerous – and sometimes more so.
For example, in the case of a small manufacturer or distributor of chemicals – or of products that contain chemicals – the potential for lawsuits can be significant. This is particularly true in the United States where suing everybody in sight seems to have replaced baseball as the national pastime.
An asset purchase protects the buyer from most of these types of liabilities if they arise from the business’ practices prior to the transfer.
But an asset purchase also has some disadvantages.
For starters, for the buyer to be able to keep the employees, the seller must fire them and the buyer must then re-hire them. This can be an immense challenge especially if some of the employees have employment contracts with the company.
Another issue is the cost and time required to re-title certain assets.
(The Brokers Roundtable℠, an online community created and hosted by Worldwide Business Brokers, has scheduled a live interview with Jim Wilson, of The Wilson Law Group, for Thursday, 15 June to discuss selling a franchised business. At the conclusion of that discussion there will be a Q&A during which attendees can get their questions answered by a pro. But you’ve got to be a member to attend. You can sign up for The Brokers Roundtable℠ here.)
For example, if the business in question is a long-distance trucking company, it likely owns a fleet of trucks. An asset sale would require the buyer to re-titled each into the name of the buyer’s entity. Yes, this may be little more than a minor hassle but in most areas, this will include not only a re-titling fee but also a sales tax given that the seller is selling the vehicles to the buyer.
And finally, there is the question of contracts. Each existing contract that binds the company will have to be assigned or renegotiated. In some cases – especially if the company has dozens of supply agreements, some with customers, others with vendors – this can be a hassle of the first order.
Some vendors may recognize that they stand in the way of the seller and buyer completing a deal and realize that they all of a sudden have a degree of leverage that would be difficult to imagine under day-to-day circumstances. One or two hold-outs can gum up the works in a heartbeat.
Stock (Equity) Purchase
In a stock purchase, the buyer takes over the business entity lock, stock and barrel. The transaction is simpler and more straightforward but includes all the liabilities, known and unknown.
Rarely will contracts – employment, vendor, customer or any others – need to be dealt with. Unless they include a change-of-control clause, they transfer automatically and seamlessly to the new owner.
Some of the advantages of a stock purchase include no need to value or re-title any assets. That fleet of tractor-trailers stays in the name of the business.
Employees stay employed by the company and no employment contracts are breached or need to be renegotiated.
The same is true for vendor and customer contracts. They, like all other assets and liabilities, simply pass with the business entity to the buyer; UNLESS there is a change-of-control provision in any of them.
As with asset purchases, stock purchases have their own disadvantages.
A big one is that the buyer can’t pick and choose what assets and liabilities to include. They’re ALL included – the good, the bad and the ugly.
For example, if the business is a building supply or auto supply company, there is almost certainly going to be obsolete inventory – stuff that the business has been carrying on its books for the last 10 years – such as a transit level in the age of laser models or a muffler assembly for a ’79 Pinto.
All the payables and past-due receivables are part and parcel of the deal. And if any receivables are 90+ days past due, there might be some serious doubt as to their collect-ability. A good buyer-broker would recommend discounting the value of the receivables, thus lowering the final acquisition price.
Yes, some of these issues might be able to be resolved by creating a side agreement wherein the sellers retain responsibility for certain liabilities. This, however, requires a reasonable seller.
The Bottom Line
The vast majority of deals are asset purchases rather that purchases of the stock of a corporation (or the membership interests of a LLC). The main reason is that knowledgeable buyers generally are not comfortable with the potential of acquiring liabilities that they don’t even know exist.
So, which type of sale is the right one for a particular buyer? The answer to that question requires the input of talent – a tax advisor, a financial planner and an experienced business broker. But the important point here is to recognize that, as professional business brokers, we have to be able to advise our clients, the business owners, on what to expect throughout the selling process. How the deal might be structured is a topic that should be addressed long before the first LOI arrives.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
Searching For…
A U.S.-based private equity fund is looking for opportunities to acquire “small-cap” business anywhere in the U.S.; those with revenue between $5M and $50m and minimum EBITDA of $1M. They are open to opportunities in nearly all industries except restaurants and C-stores.
If any of you know of something that might fit, please let me know.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com