Selling a Business: Structuring the Transaction
08 May 2023: Selling a Business: Structuring the Transaction
If you’re selling a business, do you know that there are three general ways to structure the transaction?
Few owners of small, Main Street businesses – and a surprisingly small number of owners of lower Middle Market businesses – are aware of this. As such, it’s incumbent upon professional business brokers to explain how each method of structuring the transaction could impact their clients. It’s important that our clients – generally the sellers – understand the differences and, in conjunction with their accountant or financial advisor, which method is preferable for their specific situation.
But it’s also important that we explain to our client that, even though X method might be most ideal for them, that may not be the case for the buyer. We need to make sure our client is cognizant of the fact that a qualified buyer might present an offer structured differently.
The three general ways of structuring a transaction are as an asset sale, stock sale and merger. The vast majority of small and lower Middle Market business sales are usually structured as asset sales.
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Stock sales and asset sales impact the parties’ tax liabilities differently – an issue to be addressed with their respective financial advisors and tax consultants.
Stock sales are not used very oftem for reasons we’ll discuss in a moment.
Mergers – quite uncommon in the market segments we work in – are when two companies become one. Because they are so rare, they are beyond the scope of this discussion.
Asset sales, though in practice usually involve the purchase of all the company’s assets, in theory allow the buyer to choose which assets to buy. They also allow the seller to omit certain assets from the sale.
An asset sale would almost always include the business’ proprietary processes, trademarks, service marks and trade names, any specialized software and other IT-related assets along with some or all furniture, fixtures and equipment (FF&E).
But the seller may want to hold on to that souped up pickup or some other asset that the company owns. And from the buyer’s standpoint, he or she might not want the three delivery trucks sitting on blocks out behind the warehouse – ever though those trucks are being carried as assets on the balance sheet.
The same would be true of the $120,000 in outdated inventory that’s been sitting in the back of the warehouse since Bill Clinton was frolicking in the West Wing. Astute buyers will analyze the balance sheet for assets that hold little or no value to them and will want to strike such assets from the deal.
But business transfers also involve liabilities and this is another area of concern for a buyer and our clients need to realize up front that the buyer may not want to assume all of them.
For example, payables and receivables can present unpleasant liabilities and collection problems. A receivable that is 90 days past its due date has little value for the buyer. Even though it’s usually shown as an asset at face value on the balance sheet, the astute buyer will realize – or at least suspect – that collecting it will be, at best, a costly challenge; and may result in receiving far less than face value. The disposition of payables and receivables is generally negotiated between the parties during due diligence.
But other liabilities are also to be considered.
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
From notes payable, unpaid taxes, environmental concerns, etc., asset sales provide the best protection for the buyer against any number of unforeseen – indeed, unforeseeable – problems that might pop up years down the road after a stock sale.
We’ve experienced all of these problems with client businesses at one time or another. Undisclosed underground fuel tanks and unpaid payroll taxes are two of the most popular ones. We started asking about this at the time we start the valuation process. In an effort to keep our butts out of as many court houses as possible, we’ve actually begun submitting to prospective clients a disclosure questionnaire that we have the seller sign attesting to the seller’s knowledge of certain possible issues.
Unlike an asset sale, a stock sale is the acquisition of the business entity.
Assets do not get transferred per say when selling a business using a stock sale structure. The entity that owns the assets – the business, be it a corporation or limited liability company (LLC) is what is transferred. This is an important distinction in that the buyer, when using a stock sale method, does not get to pick and choose what they buy.
(The Brokers Roundtable℠, an online community created and hosted by Worldwide Business Brokers, has a live interview with Jim Wilson, principal of Wilson Law Group, scheduled for Thursday, 11 May. At the conclusion of that discussion there will be a Q&A during which attendees can get their transaction questions answered by a pro. But you’ve got to be a member to attend. You can sign up for The Brokers Roundtable℠ here.)
Yes, when acquiring the entity, the buyer “buys” the assets – as well as the liabilities; the good, the bad and the ugly. The fact that the “bad and the ugly” are included generally means even greater scrutiny is paid by the buyer during the due diligence process.
But why, one might ask, would a buyer prefer a stock sale to an asset sale when the potential for hidden problems exits? There are several reasons.
- The buyer is buying less than 100% of the company. (See this post on Buying Part of a Business.)
- The buyer requires the seller to roll over part of their equity into the acquiring entity.
- The target company holds expensive or hard to get licenses. A stock sale would include those licenses whereas an asset sale might require re-licensing.
- The target company is asset-rich and re-titling those assets (a trucking or delivery company, for instance) would entail significant expense.
These reasons are all legitimate concerns of a buyer but a stock sale will subject the buyer to greater liability exposure, both known and unknown, a condition that underscores the likelihood of a deeply invasive due diligence and the buyer requiring lengthy and wide-ranging representations and warranties from the seller.
The Bottom Line
It should be clear why the vast majority of transactions are conducted as asset sales. If there are problematic liabilities – i.e., unpaid taxes (especially employee withholding taxes) and potential or existing lawsuits, as example – our sellers have to be aware that even when selling a business those liabilities will remain with them in any asset sale – and that trying to offload them to an unsuspecting buyer in a stock sale will probably limit the buying pool significantly.
And, as we advise the new brokers in our network – and revisit regularly in our FAWUs – dishonest and unethical sellers are out there. When we discover a material issue that should have been disclosed to us early on, we retain the right to walk. We don’t need our reputation to be muddied by a seller who is less than honorable.
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.
This week we were contacted by a U.S.-based private equity from looking for opportunities in B2B services, particularly facility services. They want minimum EBITDA of $4 million and the company can be location anywhere in the United States.
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 500 in the world. He can be reached at jo*@Wo*******************.com