Sell your Business : Deal Structure
If you sell your business, I personally believe that the deal structure is a challenging but exciting part of the process . Since almost every aspect of the transaction is negotiated and since many deals face challenges, this phase of the sale can be very time consuming, not only for a business broker but also for the seller and the buyer.
Before you sell your business and before I get into the various elements of deal structures I want to discuss the various team members that play a role. Whether you are buying or selling, regardless of the size of the deal it is important to seek the appropriate advice when necessary.
Attorney: Your legal counsel's duty, in the context of a business transaction, is to protect you from future litigation, verify that the transaction is structured lawfully and to draft and / or review the contract(s) that you will execute. This is an area where it is important to select an attorney that specializes in business transactions. One note, an attorney does not care if you sell your business - he or she may actually be losing a client.
CPA / Tax advisor: Your CPA's duty is to minimize your tax exposure. Make sure to ask your CPA if he or she has had experience with business transactions.
Business valuation consultant: Some sellers seek an appraiser to arrive at a selling price. Valuations are sometimes needed to sell your business.
For more information about business valuations click here.
Your California Business Broker: The broker's duty is to sell your business and facilitate the entire transaction. My experience is that it is the business broker who drives the deal forward. Some industry estimates state that it takes about eighty hours of work to get the deal from offer to closed. Note that this is after the marketing and screening of buyers and it is not uncommon for deals to fall apart and to have to do it again.
On California Business Broker .com I have devoted and entire group of web pages to the different aspects of structuring a deal. Just like the different types of businesses out there, the variables and possibilities are endless. With this being said, here are the general areas of concern for both buyers and sellers:
SELLER FINANCING: Will the owner carry a note? All sellers desire to sell and walk away with all cash. Yet all cash deals are exceptionally rare. Virtually every transaction involves financing of some sort. It makes more financial sense for a buyer to leverage their money than to buy a business all cash. To sell your business, seller financing may bee needed.
Click here for a detailed description regarding leveraging and business sales.
There are several instances where a seller may be required to carry a note.
1. A lender will not finance the deal
2. Buyer does not qualify for financing
3. Business risky, not profitable, no revenue, declining, speculative
4. Sale price over 2 Million SBA cap
5. Buyer needs seller to finance some of the down or bridge the gap.
When a seller carries a note they take on some risk. There is a correlation between the amount of risk that a seller will tolerate and the total compensation that an owner will receive for his or her business.
Less risk , IE all cash the lower the sales price. More risk, seller financing, earn out, etc., generally the greater the total compensation.
There is a good deal of additional information about seller's risk here. Including, security for the note, representations and how to mitigate the risk.
Seller financing is a popular tool to employ when selling. It shows that the owner has confidence in the business and in some cases it is the only way to make the deal happen.
Coincidentally, sellers do not have to be stuck with the note forever. There are institutions that buy notes. If a owner want to cash out it is possible to liquidate the note. There are some caveats:
1. The note must be seasoned - It can't be sold right away.
2. It is sold at a discount.
3. Usually it must not be subordinate to other loans.
4 Note buyers usually are very concerned with how the note is secured.
FINANCING STRUCTURE AND TERMS: If the seller is going to carry a note then the interest rate, term and repayment terms need to be agreed upon. Buyers are interested in recouping their investment and with cash flow. A seller, also, does not want the buyer to be very cash strapped. Sellers, typically want to see a note in the range of 5 -15 years at a reasonable interest rate. Installment payments (monthly or quarterly) can be tax favorable to the seller. Regular installment payments are generally preferred by sellers and are deemed less risky. With regular payments, if a buyer defaults on payment a seller can take action right away versus waiting for a large balloon payment to com due. It is advisable for a business transaction attorney to draft the terms of the note.
TAX CONSEQUENCES: The sale of a business has significant tax consequences for the seller. Conversely buyers also have tax implications to be aware of. There is more information on the page that deals with asset and stock sales. (Below)
For sellers there are two big factors: regular income versus capital gains income and when the income is earned. Differing the income to a later date can be beneficial a seller. If a business is organized as a C corp the tax consequences of a asset sale can be huge. The advise of a CPA is highly recommended.
Regarding taxes: Sellers are concerned with the affect taxes have on their total compensation. Buyers are concerned with cash flow, amortization and depreciation. Buyers are also responsible for California sales tax on furniture, fixtures and equipment.
TYPE OF SALE: One of the most common questions the business broker's are asked have to do with asset and stock sales. There are benefits and negatives for both the buyer and seller.
I have devoted a seperate page to asset and stock sales.
POST SALE OWNER INVOLVEMENT & ADDITIONAL FORMS OF COMPENSATION:
Earn out: Earn outs are quite popular.
I have devoted a seperate page to the topic of earn outs.
Non compete: Buyer do not want a seller to open up shop down the street from them six months after you sell your business. Enter the non compete clause or covenant to not compete. For small businesses (main street) a three year thirty mile non compete is adequate. For larger deals or for a niche businesses the length of time is longer, usually 5 - 7 years, and California courts have upheld non-competes that encompass the entire United States. Some non-competes can be very detailed and the advice of business attorney is recommended.
Employment Contract: It may seem strange to sell your business and then keep working there but it is actually very common. This is a form of seller compensation that also pays the seller over time and has tax advantages for both the buyer and seller. Buyer has a payroll write off and the seller is taxed at regular income instead of capital gains. The employment contract is separate from the sales contract.
Consulting Contract: If the business requires the seller to remain involved to aid in the transition, a popular option is the consulting contract. This, too has tax advantages for both the buyer and seller and should be a separate agreement. It is best to have the required duties and time requirements clarified before the contract is executed.
Often times, with both employment and consulting agreements, it is rare for the seller to remain for the entire period.
Financing, down payment, earn outs, consulting contracts, options, and seller financing; How all of these pieces of the puzzle fit together comprise deal structure. Deal structure can significantly impact the total compensation a seller receives and can make or break the deal for the buyer.
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