7 Things to Beware of When Selling Your Business

Category: Mergers & Acquisitions Selling Your Business 

There are a number of scams and rip-offs related to selling a business ranging from identity theft to literally stealing your business. Here’s a list of some common scams and rip-offs to watch out for when you sell your business. The best way to avoid these risks is to engage a professional and licensed Business Broker in Orange County to represent you in the sale of your business and guide you through the process.

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  1. Identity Theft

    A seemingly interested buyer may ask to see your financial statements, tax returns, bank statements, etc before they make an offer. Their story will sound logical, “I need to see the financial details before I can make an offer”, but this is not how a transaction is done if you are working with a professional Business Broker. This level of detail is provided after an offer has been made, accepted and Due Diligence has commenced. Business Brokers prepare an Offering Memorandum (prospectus) that includes a financial summary of the business that does not contain any personal information.

    A professional business broker requires prospective buyers to sign a Confidentiality Agreement and complete a Buyer Profile which includes information on their financial position and other personal details before any information is provided about the business. This protects the confidentiality of the sale as well as eliminating the would-be frauds (they never want to provide any detailed information) and a good broker can spot them.

    If you are selling your business yourself make sure you vet and qualify prospective buyers carefully before giving them any confidential information. When you do provide information make sure you redact private information such as social security numbers, personal information, account numbers, etc. Financial details should not be provided until after a written offer has been accepted and perform due diligence on the sale of your business.

  2. Business Valuation Scams & How to Sell Your Business Seminars

    Over the years there have been several companies with very polished sales pitches offering to sell your business, often at a much higher price than you dreamed was possible. The pitch is very polished and generally goes like this. We have thousands of buyers looking for businesses like yours…and to sell it the first thing we need is a business valuation, some may say a marketing package or prospectus, and the cost for the business valuation is $20,000 to sometimes as high as $50,000. The price varies according to how much they think you can afford.

    The pitchman has a very convincing story and will offer a “discount” if you sign NOW. The promised stream of buyers will never materialize and if you press them they’ll produce a list of “buyers“ that looked at your business. I spoke with one of our clients that spent $20,000 on the valuation and marketing package and after he saw no apparent activity he asked for a list of buyers and actually tried calling them. He did reach a couple and they weren’t real buyers. He pressed the company again and they sent him another list of buyers. Needless to say, he didn’t get his money back and basically threw away $20,000.

    Read more in the blogs below…

    Buyer Beware: Don’t be a Victim of Business Valuation Seminar Fraud

    Buyer Beware: Don’t Be a Victim of Business Valuation Seminar Fraud

    Four Scams that Can Impact Your Small Business

    4 Scams That Can Impact Your Small Business

    (scroll down to last paragraph – Valuation Scams)

  3. Unlicensed-Out of State Advisors

    Business Brokers in California, and many other states, are required to be licensed by the state. In California, Business Brokers are licensed by the California Department of Real Estate which requires each Business Broker office to have a licensed Broker and the agents must also be licensed. Licensed Brokers must follow state regulations, have background checks when they are licensed, and most are members of professional associations such as the IBBA (International Business Broker Association) or CABB (California Association of Business Brokers).
    Unfortunately, licensing is not strictly enforced in many states, including California, and unlicensed “advisors” actively solicit business owners to sell their business. These companies have a good pitch, offering lower commissions with an upfront fee for either a valuation or marketing package. Which is how they make their money, on upfront fees, not on actually selling businesses! The great deal on the lower commission isn’t so great when you end up paying thousands of dollars for a business valuation or marketing package and months later your business hasn’t sold, you’re out that money, and that out-of-state advisor has moved on to the next target.

  4. Quick Stock Sale – a slick trick to literally steal a business

    This one is not as common but potentially the most dangerous. A prospective buyer will approach a seller with an offer for a quick close, perhaps even a full price or very attractive offer and they’re even willing to do a stock sale which will save you a lot in taxes! Sounds great, right?
    The hook is that it is a shrewd scam to get your company for nothing, literally stealing your company! There are a few variations on how it may play out, but all of them result in closing with no actual cash out of pocket from the buyer. Most are a clever shell game where it looks like they are putting money in but actually get it all back and then some. They do this by having a low down payment (maybe no down payment after A/R, assumption of liabilities, and other credits), and after closing leave credit cards, loans, and other liabilities in your name. After closing they max out lines of credit, collect the A/R, don’t pay the bills, and disappear. Sometime later you start getting calls from creditors looking for payment from you – and you thought you sold the company!
    Below are two real-life examples of these scams…
    http://acquisitionadvisors.com/articles-for-sellers/2009/05/beware-of-business-buyer-scams/

  5. Earnouts

    Earnouts are a transaction structure where some of the value of the company is paid overtime as specific financial goals are met. In some transactions earnouts are necessary, but they can lead to problems if they are not structured properly. The risk for the seller is that if the buyer fails to achieve these goals then the seller loses the value tied to that metric. So your purchase price is not guaranteed, if the buyer-business misses those future goals your value goes down, sometimes to zero on the balance due.
    An experienced Business Broker knows when an earnout is necessary and cannot be avoided and equally important knows how to structure it to minimize your risk.

  6. Large Seller Notes = HIGH risk

    If your business qualifies for SBA financing and a buyer is insisting on a larger seller note because they “want to avoid the delays and hassle of working with an SBA lender” beware! SBA financing is prime rate + 2.75% maximum which is presently around 6% over a ten-year term. A typical seller note is between 6% and 8% interest over 5 years. Clearly, SBA financing is the better option for the buyer with much lower debt service. So why would a buyer want a Seller Note with much higher monthly payments? In our experience if a buyer is avoiding SBA financing and insisting on a Seller Note it is typically for one of the following reasons:
    Typical reasons a buyer would want to avoid SBA financing:
    a) They won’t-can’t qualify due to poor credit or insufficient cash down payment.
    b) They don’t want to risk their personal credit and collateral and if they can get you (the seller) to carry the note they have little risk and can walk away if things go badly down the road.
    c) The worst-case scenario is they don’t intend to pay the note and want to get the business with as little cash down as possible and then refuse to pay the note for a reason they cook up later. You can engage an attorney to sue them and try to get paid but it is expensive, takes a long time, and the success rate for collecting is not high.
    Clearly, at Pacific Business Sales, we are not fans of large seller notes, which is why our preferred financing method is SBA financing. SBA lenders often require a 10% Seller Note which means at closing you will receive 90% of the transaction value less closing costs and commission.

  7. Upfront Fees from Brokers or Advisors

    Professional Business Brokers generally do not charge upfront fees. In fact, it is customary for there to be no upfront fees for the sale of small to mid-sized businesses with upfront fees only coming into play on transactions valued at over $10 million. Your Business Broker’s commission is paid from the Seller’s proceeds at the close of escrow. If your business broker is asking for upfront fees of any kind on a transaction valued under $10 million you should shop around, and also check their licensing to see if they are a licensed broker.
    At Pacific Business Sales we do not charge any upfront fees and we offer a comprehensive free Market Value Analysis (that’s right, you don’t need to pay for a “valuation”), and we pride ourselves in Orange County for being chosen as the best business broker to help you sell your business.

How to Get Through Due Diligence on the Sale of Your Business

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

What is due diligence? Why does a buyer need to perform due diligence? What information, records, and/or financial materials will the buyer want to access? How long will due diligence take? As a business owner preparing to sell my business, when should I start preparing for due diligence? Above are common questions sellers ask, never having sold a business before and wondering what the importance of due diligence is, and why they have to provide a buyer with all the detailed and sensitive information buyers and their accountants ask for.

If you are working with a professional Business Broker in Orange County they will guide you through the process and advise you on how to prepare. Your CPA will be a key advisor in Due Diligence and you should involve them early in the process so they are prepared when an offer is made.

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What is due diligence?

Due diligence is the review by the buyer and/or their CPA, after an offer has been accepted, of your business’s financial statements, employee, vendor, customer (names redacted if needed) records, insurance policies, business licenses, and material contracts generally for the last three years.

Why does a buyer need to perform due diligence?

The buyer has based their offer on the information provided and needs to confirm that what was represented to them is true and correct.

Due Diligence is normally a contingency in the Purchase Agreement and If there are any inconsistencies found the buyer can choose to renegotiate or cancel the Purchase Agreement. If you want to learn more about due diligence and be aware of scams when selling your business speak to one of our Business Brokers.

What information, records, and/or financial materials will the buyer want to access?

Below is an example Due Diligence List of information that buyers and/or their CPAs might request. The list can vary according to industry and size. These are common items that will need to be gathered and readily available when an offer is made. For simplicity and convenience, most items can be added to a Dropbox file that your Business Broker sets up to help keep track and facilitate the Due Diligence process.

  1. Bank Statements – Last three years including any year to date bank statements.
  2. Corporate Tax Returns – Last three years. 
  3. P&Ls – Last three years plus Year to Date P&L. 
  4. Balance Sheet – Last year-end balance sheet (included in the offer) plus year to date balance sheet.
  5. A/R aging summary
  6. A/P aging summary 
  7. Add backs – review of Seller benefits and expense add-backs.  Can be accomplished at the Seller’s office in person with the Seller providing the details or through buyer’s view-only access to QuickBooks file or other accounting software.
  8. List of Employees (review of files will have to be onsite due to privacy of employee info).
  9. Review of Contracts (typically onsite since too many to scan and upload).
  10. List of Vendors. 
  11. Equipment list (included in offer). 
  12. Review & Inspect Equipment: Buyer and Seller review the equipment
  13. Customers List with annual sales last 3 years (in some cases customer names may be redacted).
  14. Review of Customer and Vendor Invoices – Review these on-site.
  15. W2s and 1099s for employees. (redact private information) 
  16. Review Seller Disclosure Statement with Seller and Buyer
  17. Business License(s)
  18. Copy of insurance policies, Workman’s comp rates. Note: Buyer will need Loss Runs from Workman’s comp carrier so the buyer can get quotes. 
  19. Office-premise leases.
  20. Corporate Documents: Articles of Incorporation, By-Laws, Minutes, Shareholder Certificates, Stock Ledger (if a stock sale)
    Note: The Buyer’s CPA may wish to request additional information

How long will due diligence take?

The length of time it takes to perform Due Diligence will depend on the size, industry, and complexity of the business operations. Generally, the buyer is given 3 days to prepare a Due Diligence list, the seller has 5 days to gather the materials and the review of the materials typically takes two weeks to complete after receipt of the information. On larger, more complex transactions the review of the material can take up to a month including an attorney’s review on the buyer’s behalf. 

As a seller of my business when should I start preparing for due diligence?

When you list the business you will be asked for some of the information needed for Due Diligence in addition to the amount for Owner’s Add Backs. When starting the listing process it is a good practice to separate your receipts and details for personal and owner’s expenses so they will be readily accessible when an offer is made and accepted.

If you have any questions during the Due Diligence process Pacific Business Sales, as the best business broker to sell will assist you every step of the way and keep you informed to help you navigate due diligence and the entire process for the sale of your business for a smooth and successful outcome. That is why it is important to pick the right Business Broker to sell your business and help you with this process

How to Pick the Right-Best Business Broker to Sell Your Business

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

After making the decision that you are ready to sell and the time is right, the next most important decision is who will represent you in the sale of your business?  Your CPA will be there for financial advice and your attorney for legal advice, but who is going to actually sell the business, structure the deal, handle the negotiations, draft the purchase agreement, guide you through the Due Diligence, SBA or other financing, escrow and closing?  All of this and more is the role of your Business Broker in Orange County.  

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Obviously, your Business Broker is going to play a critical role in the sale of your business.  In fact, your choice of Business Brokers will likely determine whether your business sells or not, how the transaction goes (smoothly or difficult and frustrating), the price you realize, and even your cash at closing (more on this below).  

So how do you choose the right-best business broker, what should you expect from them, and what are the steps in selling your business?  

10 Steps in Choosing the Right-Best Business Broker to Sell Your Business & What to Expect from Your Business Broker

  1. Industry Experience Industry experience pertains not only to experience as a business broker and in business sales transactions but also experience with transactions in your specific industry.  Selling a manufacturing or construction-contractor business is vastly different from selling a small mainstreet business.  At Pacific Business Sales we specialize in manufacturing, construction/contractor businesses, industrial businesses, e-commerce, and healthcare and we do not sell Mainstreet retail, B2C-consumer businesses, or food service businesses. 
    • Manufacturing companies
    • Technology companies
    • Construction-Contractor businesses
    • E-commerce
    • 3PL & Distribution businesses
    • Healthcare
  2. No Up-Front Fees, “Marketing Fees”, “Valuation Fees”, or other advance fees You should not pay any upfront fees on the sale of a small to midsize business.  It is customary for Business Broker commissions to be paid through escrow at closing and up-front fees are rare and generally not required.  Pacific Business Sales does not charge any up-front fees for the sale of your business and we offer a Free Market Value Analysis as part of our services (see below)
  3. Market Value Analysis or Opinion of Value Your Business Broker should provide you with a Market Value Analysis or Opinion of Value before you sign the representation agreement.  At Pacific Business Sales we use Peercomps for our  Market Value Analysis.  Peercomps is a professional business valuation software that includes sold comparable sales data from the SBA transaction database.  Many brokers use standard earnings multiples which are not necessarily appropriate or accurate for your business.  Earnings multiples vary by industry and business size and are NOT a one size fits all figure. 
  4. Tax Strategies Getting the maximum value for your business is great but the thought of giving up nearly half of that to taxes makes every business owner cringe.  There are several tax strategies available that can defer up to 90% of the taxes from the sale of your business and substantially reduce your taxes.  We work closely with a CPA that specializes in tax strategies for the sale of businesses that will meet with you to discuss the best tax strategies for your particular needs and perform due diligence on the sale of your business to provide detailed information and be prepared.
  5. Marketing One of the most common questions business owners have is “how do you find buyers?”.  Most inquiries come from advertising on business for sale websites like BizBuySell.com and BizQuest.com etc.  Business for sale websites have thousands of businesses for sale, but how does your business stand out and get found? At Pacific Business Sales we feature all of our businesses for sale ads placing them at the top of the business for sale websites with expanded headlines/titles.  We also send email blasts to our own buyer list of over 3,000 active buyers and 70 Private Equity Groups plus the BizBuySell buyer email list. 
  6. Offering Memorandum – Company Prospectus The Offering Memorandum (OM), aka Business Profile, is the marketing brochure or prospectus for your company.  It is a confidential document and only sent to prospective buyers after they have signed a Confidentiality Agreement (NDA), completed a Buyer Profile which includes information on their financial position and background, and have been screened.  At Pacific Business Sales our OMs are typically 20 to 30 pages, sometimes more, and very comprehensive.  Our goal is to provide the Buyer with a complete picture of the business so they can determine early on if this business is a fit for them.  We have found this motivates buyers that are well suited and interested in your type of business and of equal importance it filters out buyers that are not a fit. 
  7. Buyer Screening Good marketing will drive lots of inquiries about your business.  That’s the great news, but as a seller, it can become frustrating to meet with a parade of buyers that are not serious about your business, not to mention the time it consumes.  We meet with each buyer to discuss your business and answer the initial questions about the business prior to setting up a meeting with you.  We have found this reduces the number of seller meetings because in our initial meeting some buyers discover the business is not a fit for them after all and sometimes we find that the buyer is not qualified for the business.  Of course, you will still have buyer meetings that do not result in an offer from that buyer, but it does reduce the number of these meetings.
  8. Professional Associations Professional trade associations such as the California Association of Business Brokers and IBBA (International Association of Business Brokers) provide professional training and resources to Business Broker members.  Your Business Business Broker should be a member of the IBBA and local professional associations such as CABB. 
  9. Industry-standard purchase agreements and forms Your Business Broker should use industry-standard forms such as the CABB purchase agreements and disclosures for the sale of businesses or the AIR (Association of Industrial Realtors) purchase agreements and disclosures for the sale of commercial buildings and real estate.  Some Business Brokers use “In-house” forms which may or may not have been written by an attorney and as a client, you have no way of knowing if these forms are adequate or sufficiently cover the legal aspects of your transaction. The problem with in-house purchase agreements often isn’t what’s in them, it’s what’s not in them.
  10. Testimonials and reviews The experience of actual past clients is a great way to see how a Business Broker works with their clients and their results.  At Pacific Business Sales we are very proud of our numerous customer reviews from both buyers and sellers on Google and our website.  

You’ve invested your time and money to build your business, to realize the maximum value for your business you’ll need the best business broker representing you in the sale of your business. You also want to beware of scams and rip-offs when selling your business. We are business brokers in Orange County that you can trust.  

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How to Minimize Taxes & Maximize Net Proceeds Selling Your Manufacturing Business

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

In our Blogs on Developing an Exit Strategy and How to Prepare to Sell Your Business we talked about how to Maximize the Value of Manufacturing Your Business which is obviously a high priority for every business owner.  But what if you could substantially increase the Net Value of your manufacturing business without changing anything in the business at all?  As your Business Broker representing you in the sale of your business our primary goal is to sell your business for the maximum value, and we have found we can often help our clients achieve their financial goals by helping them increase the net value (after taxes) from the sale.   

What do I mean by Net Value?  I’m referring to what you actually realize for the sale of your business after taxes, your net after-tax proceeds.  It’s great to build a business, increasing the value over the years, but frankly, it’s agonizing to think of giving up nearly half of the value you worked so hard to build to state and federal taxes!

It’s true you can reduce the tax bite a bit if the transaction is a stock sale as opposed to an asset sale, but even with a stock sale, with most of the value taxed at the lower capital gains tax rate, the tax bill will be a big one! 

The old adage there are only two sure things in life, death and taxes, doesn’t have to be wholly true.  There are tax strategies used by wealthy investors that can be implemented for small and midsize business owners where you can defer up to 93% of the taxes due at closing and often reduce the overall taxes by as much as 30% or more in some instances.  While these tax strategies have been around since the 1970’s, they are not well known, and often overlooked unless your tax advisor-CPA is very familiar with tax strategies for business sales.  

Example of Business Sale Tax Liabilities with & without implementing a Tax Strategy

As an example, let’s say you sold your manufacturing business for $5 million with no seller note (I’ll discuss this later below). 

Without A Tax Planning Strategy

If you are doing an asset sale, assuming you have very little or no basis in your company since you started it years and years ago, then you are looking at a tax rate of around 39% federal and 11% for the great state of CA. That comes out to a 50% combined tax rate, a potential of $2,500,000 in taxes on a sales price of $5,000,000.  If you have the same basis in a stock sale you are looking at a minimum capital gains rate of 20% ($1,000,000).  In many cases, some of the sale is treated as ordinary income by the IRS, and then that amount goes up even further!

With A Tax Planning Strategy

Installment Sale – With an installment sale, you are basically selling your business to the buyer with a seller note, often a very large seller note.  Meaning you are taking payments over a number of years as the buyer pays for the business.  The great part about an installment sale is the fact that you don’t report the income until it is received.  So, if you have a 5-year installment (aka Seller) note, you only receive 1/5 of the sale each year.  So, you only report 1/5 of income each year. This can be a great way to spread the income over several years, keeping you in a lower tax bracket each year, ultimately saving a lot on taxes.

The drawback to an installment sale is that you do not receive the full proceeds from the sale right away. Therefore, you run the risk of the buyer not being able to make the payments later.

So, in this example, if you were to sell your business as an asset sale with say $2 million dollars down and a $3 million Seller (installment) note, you would pay taxes in the current tax year on the $2 million and pay taxes on the remaining $3 million over the next five years as the income is received (if it is, there is of course risk with a Seller Note). 

So you would reduce taxes a bit on the deferred $3 million of income, but this is not a great solution because your still paying taxes on the $2 million received at closing and the remaining $3 million will be taxed over 5 years which really doesn’t defer much income, not to mention the risk of carrying a Seller Note!

Deferred Sales/ Installment Trust – While this tax strategy has many names, they essentially work similarly and have generally the same benefits.  Ultimately these have many of the benefits of the installment sale and reduce many of the drawbacks (e.g. the risk of carrying a seller note to the buyer).  

In a Deferred Sales/Installment trust, you sell your company to a trust on an installment agreement for 10 years (as an example) and then the trust simultaneously sells the company to the buyer.  At closing, you do not have “constructive receipt” of the funds and therefore your individual tax liability is significantly reduced.  Now the trust is the one who is responsible for the taxes.  

Since the trust just bought the company from you it has a tax basis of 100% of the value, consequently, there is no tax due from the trust.  Now the trust has the full proceeds with no taxes taken out yet, so you eliminated the risk of the buyer not being able to make the payments.  Since you have an installment agreement with the trust you can take money out of the trust at a schedule determined and controlled by you.  

So, you control how often you take money out to keep your tax rate low and deferred for years according to your personal needs.  Meanwhile, the trust is investing your proceeds (pre-tax) so your capital continues to appreciate and grow and is taxed when you take the money out of the trust.  You can almost determine your own tax bracket (not considering your other income streams).

These are only a few of the tax planning strategies available.  There are a lot of moving parts involved with tax strategies that must be handled correctly not only to minimize taxes but also to ensure it is compliant with IRS requirements.  A well-structured Installment sale or Installment trust can be a great strategy for a business owner looking to minimize risk and maximize their net proceeds from the sale of their business.

Business Tax Strategy CPA – Advisor

Pacific Business Sales is not a CPA or financial advisor.  We work closely with a CPA firm experienced in tax strategies and business sale transaction taxes, Morrow & Company.  Darren Morrow of Morrow & Company is the CPA we work with and refer clients to for tax strategy advice and has contributed to this article. 

Darren P. Morrow, CPA

Morrow & Co.

Darren@morrowcpas.com

Office: (714) 385-1212

www.morrowcpas.com

Disclaimer

Tax liabilities are different for every business sale-transaction based on the transaction type (stock vs asset sale), the tax basis for your company, transaction structure, and other factors.  There is no one-size-fits all answer for taxes on the sale of a business.  The examples above are general in nature and will not apply to every or any particular transaction.  You should review your particular prospective tax liabilities for the sale of your business with a tax advisor-CPA familiar with business sale transaction taxes.  Pacific Business Sales and its agents and broker are not tax or financial advisors, the information above is for informational purposes only. 

Should I Pay Upfront Fees to Sell My Business?

Category: Business Valuation Mergers & Acquisitions Selling Your Business 

The short answer is NO!  At Pacific Business Sales we do not charge any upfront fees on transactions less than $25 million in revenue.  We prepare a  comprehensive free Market Value Analysis for each of our prospective clients before we list the business for sale.  We also prepare a comprehensive Confidential Information Memorandum (CIM) for each business we represent. We have spent time developing a marketing and selling process that works in deriving the highest value for your business.  These are the initial steps in selling your business.  

Get Your Free Business Valuation Now

Most Business Brokers do not charge upfront fees to sell small to midsize businesses up to $25 million in revenue, however, some will charge an upfront fee for a business valuation or marketing fee.  When considering the sale of your business and the Business Broker to represent you make sure you ask about upfront fees and if they charge for their Market Value Analysis or any other fees upfront. These upfront fees charged by some Business Brokers are paid by you regardless of whether they sell your business or not and are in addition to their commission.  

On larger transactions for companies with over $25 million annual sales, it is more common for the Broker or M&A firm to charge an upfront fee for a business valuation and preparation of the Offering Memorandum.  

Generally speaking, you should not pay any upfront fees for the sale of your small to midsize business.   Our commission is paid at the close of escrow from the Seller’s proceeds.  

What Fees and Costs are Involved in the Sale of a Business 

  1. Broker Commission at closing 
  2. Escrow fees split with Buyer
  3. Your advisors (CPA and attorney if used)
  4. Pay off business liabilities at closing (as specified in the purchase agreement)
  5. Federal and State taxes (paid on next tax return, review this with your tax advisor or ask to speak with our Tax Strategy CPA)

If you are considering the sale of your business contact us for a free consultation and Market Value Assessment. 

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How to Save 30% in Taxes on the sale of your Contractor-Construction Business

Category: Mergers & Acquisitions Selling Your Business 

Most small-business sales transactions are in the form of an Asset Sale which is great for the Buyer because it limits successor liabilities and offers the maximum depreciation after the sale.  Another reason Asset Sales are the most common transactions is that many Construction Business Brokers are not familiar with or capable of doing Stock Sales.  At Pacific Business Sales we have done many Stock Sales for construction companies and contractors and we explain below why this is important to you as an owner of a construction company.  

The problem with Asset Sales is they aren’t great for the Seller because they result in the maximum tax rate on the sale of the business.  While we work with tax strategy CPAs that have methods to defer and minimize taxes, in an Asset Sale you are starting off at a disadvantage.  

There is good news though for contractors and construction companies because they have a Contractors’ License, the sale of a company with a Contractor’s License, a Stock Sale is the best transaction structure for both Buyer and Seller.  

Get Your Free Business Valuation Now

In the acquisition of a licensed Contractor, the Buyer will have to either already have the required Contractor’s License or the Seller will have to act as the RMO (Responsible Managing Officer) until the Buyer obtains their license or another RMO or RME (Responsible Managing Employee).  This in itself isn’t a major problem, but there is a problem with an Asset Sale.   In an Asset Sale, the Buyer’s new corporation will have to apply for a new Contractor’s License.   This creates several issues, 1) it takes from 6 to 8 weeks to obtain a new Contractor’s License 2) the new corporation will be issued a new (different) Contractor’s License which means all contracts will have to be assigned (transferred) to the new corporation and new Contractor’s License and 3) new insurance and bonding must be applied for.  This obviously creates a messy and complicated transition, not to mention the problems in approaching customers and suppliers to request contract changes. 

In a Stock Sale, the Seller’s corporation remains intact and the Buyer buys the owner’s stock.  The owner (Seller) signs over his shares, the Buyer is issued new shares, the Seller resigns as a Director and the Buyer becomes the new Director,  President,  etc.  While there is an ownership change,  the corporate entity remains the same and the Contractor’s License,  EIN, insurance,  Bonds, etc all remain in place (note there are notifications required to insurance and bonds).  The RMO also remains the same, although there is paperwork required for the new ownership. 

Thus with a Stock Sale, the transition can be seamless and is much more straightforward than with an Asset Sale.  Obviously, this is a very compelling reason for a Buyer to do a Stock Sale when acquiring a contractor or construction company.  

A Stock Sale can save the Seller over 30% in taxes on the sale of their business and our tax CPA partners can defer and minimize the taxes further.  You should consult with your CPA about tax implications on the sale of your business, and if your CPA does not have a tax strategy to defer and minimize your taxes contact us for a referral to our CPA tax experts.  

The Stock Sale has huge benefits for you as a Seller but, it is a much more complex transaction.  At Pacific Business Sales we have done many Stock Sale transactions for construction companies and we have a team of CPAs and attorneys experienced in these transactions.  We also have SBA lenders that will provide SBA financing for construction companies and contractors and are familiar with Stock Sales. 

The bottom line is that a Stock Sale will save you,  the Seller, at least 30% in taxes and make the transition much easier.  But, you will need a Business Broker experienced in both selling construction companies and contractors as well as experienced in Stock Sales.  

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How to Develop an Exit Strategy to Sell Your Business for Maximum Value

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

Every business owner wants to realize the maximum value when they eventually sell their business.  The question is what should you do now to prepare for the sale of your business and maximize business value?  

As Middle Market Business Brokers we have sold hundreds of businesses ranging from manufacturing to technology, construction,  and Healthcare plus other industries.  While these businesses are in diverse industries, the companies that sold for premiums and sold quickly had several things in common.  We have outlined the key elements in developing an Exit Strategy to prepare for the sale of your business and maximize the business value. 

Developing an Exit Strategy for the Sale of Your Business 

Here’s a 7 step outline, with details for each step below, for developing an Exit Strategy to maximize the value of your business.  A good exit strategy will also make your business more marketable and reduce your time on market.  Your Exit Strategy is essentially building your business to sell.

  1. Owner Dependency 
  2. Staff 
  3. Infrastructure 
  4. Customer Concentration 
  5. Financial Statements and Tax Returns 
  6. Tax Strategy to Minimize Taxes on the Business Sale
  7. Financial Performance 

Owner Dependency 

Buyers place a great deal of importance on the ease of stepping in and running the business.   Replacement of the owner is a chief concern in every transaction.  

If you have delegated well and have staff handling much of the day to day operations this makes your business more desirable to buyers.  Conversely, if your business is highly dependent on your expertise and customer relationships and there are no staff members capable of taking on these responsibilities buyers worry about how to replace you and the transition.  If you have delegated much of the day to day operations to staff you have built a business.  If your business is completely dependent on you,  you essentially have a job with helpers.  

Your Exit Strategy should address Owner Dependency to minimize owner dependency as well as plan for the eventual ownership transition. 

Staff

Staff is also important to buyers and a key factor in selling a business.  Buyers like to see staff stability (long tenures), good experience, and in larger companies supervisors, foreman, and leads.  If your company is large enough to have managers this is a big plus with prospective buyers.  

We don’t recommend adding unnecessary staff as part of your Exit Strategy as this would reduce profitably and thereby business value.  Rather, we recommend optimizing the staff you have to build a better business that is less dependent on you, has stability and is transferable.  

For example; if you have experienced and long time employees capable of taking on more responsibility, such as becoming a supervisor, start developing them and give them more responsibility.  

Likewise, focus on staff retention, especially for key employees.  

Infrastructure 

Businesses with excellent systems, procedures, and a well trained staff operate more efficiently and also are more marketable when they are offered for sale.  Buyers see businesses with systems and infrastructure as an easier acquisition and transition as compared to those where everything is in the owner’s head.  This doesn’t mean you need to create reams of documents covering every minute detail of your operations, but the essential procedures and policies should be in place to cover day to day operations.  The goal is to create a business where you are easy to replace and a new owner can step in without relying on you for an extended period of time.  

Customer Concentration 

If your company has a broad customer base that’s great as it minimizes the risk and financial impact of losing any one customer.  

If your company has one or several customers that represent a substantial percentage of your business this increases risk and is a concern for prospective buyers.   We have successfully sold companies with customer concentrations as high as 70% for one customer.  It’s not an easy transaction when a single customer represents a very high percentage of the company’s annual sales and it can make the sale of the business take much longer as well as affecting business value.   

If your company has high customer concentration there are essentially two actions you can take when developing your Exit Strategy. 

  1. Development and implement a plan to diversify your customer base.  This may involve simply developing new customers in your existing area and services or expanding your geographic area and services.  
  2. Securing long term relationships.  In some industries it may not be feasible to simply add more customers due to the company servicing a very narrow niche.  Being a niche player has its pluses and minuses.  On the positive side, niche suppliers often command better margins.  On the negative side these markets are also often narrow and have limited customers which result in high customer concentration.  If you have high customer concentration but have had long term relationships with these customers this can be dealt with in the sale with an experienced Business Broker.  The key is to show the relationship is mature, secure, and most importantly transferable to a new owner. 

Financial Statements 

Your company’s financial statements are absolutely critical in the successful sale of your business.  The tax returns must be current and your P&L should closely match the tax returns (note there are commonly small differences).  

Your company will be valued based on the tax returns and the Discretionary Earnings calculated from there. Discretionary Earnings are the Net Profit from the tax returns plus owner’s salary and all benefits/expenses.  

Below we talk further about financial performance and Discretionary Earnings. Read more about calculating DE here. 

In developing your Exit Strategy make sure you review your P&Ls and tax returns with your CPA and clean them up if necessary.  After an offer is received you will have to prove the company financial performance in Due Diligence and this goes much easier with well organized financial statements. 

Tax Strategy to Minimize Taxes on the Sale of the Business

There will be taxes on the sale of your business.  The question is how much.  There is no simple answer to what your tax liability will be.  It depends on many factors including the type of sale, Stock or Asset Sale, the structure of the sale, the type of entity your company is and your past tax returns (depreciation, etc).  

There are actions you can take to minimize or defer your taxes on the sale of your business.  Tax planning should be a key part of your Exit Strategy and you should meet with an expert.  If your CPA says there’s not much you can do about it and you’ll just have to pay the taxes (yes, some of our sellers were told this) you should seek a CPA that is familiar with this type of tax planning and get some additional advice.  There are several tax strategies available that can substantially reduce and defer your taxes.  These strategies have a wide range in cost, complexity and savings.  A CPA familiar with this type of tax planning can advise you on your options. 

Financial Performance 

Your company bottom line, or in this case Discretionary Earnings, has a direct and proportional relationship to the value of your company.  Broadly speaking, for every dollar added to your net profit, two to three dollars are added to the value of your business.  So if you add say $10,000 to your bottom line or Discretionary Earnings your business value increases between $20,000 and $30,000.   

A common mistake made by business owners is to focus on minimizing their annual tax liability and in doing so they often gut their net profit.  As a result they are also gutting their business value.  This doesn’t just impact the current year, it impacts your business value for as much as 3 years because a business is valued on the tax returns for the past 3 years.  

Before we address how to preserve business value without paying excessive taxes, let’s discuss Discretionary Earnings aka DE.  Businesses are not valued simply on the Net Profit shown on the tax returns because most businesses have a large amount of owner’s salary and benefits included in the expenses.  Discretionary Earnings is used to value small and midsized businesses instead of Net Profit or EBITDA.  DE is the total economic benefit the owner derives from the business.  It is calculated by taking the tax return net profit and adding the owner’s salary plus all benefits and expenses run through the business.  

As you can see, you can minimize the Net Profit and preserve the DE by tracking owner benefits and expenses on your tax returns.  It is best to have owner benefits and expenses well identified in separate expense categories so they can be easily verified during Due Diligence and underwriting if SBA financing will be used.  

Another,  often overlooked, way to minimize taxes without reducing Discretionary Earnings and thereby business value is starting a retirement plan.  The owner’s retirement contribution is added back as an owner’s benefit.  Many business owners think the cost of a retirement plan such as a 401K or Defined Benefits Program is prohibitive because they would have to include employees in the plan.  We have sold several businesses that had retirement plans. The owners were able to contribute substantial amounts into the plan and the costs of providing the plan to the employees was reasonable.  Offering a retirement plan is also great for employee retention and recruitment.

Revenue and profit growth is obviously a key financial metric.  Businesses showing steady growth often sell at a premium and businesses with declining revenue and profits are difficult to sell, often being discounted.  Driving revenue and earnings growth should be a focal point of your Exit Strategy.  It should be noted that businesses with steady or flat revenue and earnings are also very marketable.  For buyers, the key here is minimizing risk and financial stability delivers this. 

ADDITIONAL INFORMATION ON SELLING A BUSINESS

Small Business Survival through COVID-19

Category: Mergers & Acquisitions Selling Your Business 
Bill Grunau

COVID-19 has shut down businesses across the US and worldwide.  In most US states non-essential businesses have been ordered or requested to close, employees have been told to work from home, and the general population has been told to stay home as much as possible.  These are times no one has faced before and business owners are facing challenges no one could have anticipated or planned for. As a business owner you must plan carefully, think strategically, and above all else take action to ensure the survival of your business.  Many people depend on you and your company; your employees, customers, and community all depend on small business owners like you.  

Companies Providing Essential Services 

Some companies are fortunate to provide essential services such as defense/military equipment and manufacturing, healthcare, essential construction services, financial services, etc.  While the nature of their business requires these companies to stay open, which ensures their financial survival, they are facing unique challenges during this time that must be dealt with. 

  1. Health and Safety of your Staff:
    The health and safety of your staff should be of paramount concern.  Since they are needed to work during this crisis it is critical to educate them in good health practices in the workplace and at home to minimize the risk of them becoming ill and potentially infecting others.  If they suspect they are sick they should stay home and see a doctor if necessary. Ensure that your staff are taking this seriously.
  2. Maintaining a Safe Workplace: 
    1. Implement Work from Home where possible
    2. Provide hand sanitizers and hand washing soap/sinks 
    3. Maintain Social Distancing at the workplace 
    4. Encourage the staff to wipe down workstations and clean the facility
  3. Keep Customers Informed:
    Stay in touch with your customers and let them know your company is operating.  Let your customers know what steps you have taken to maintain a safe workplace and a healthy staff. Keep them informed of schedule or delivery changes. 
  4. Maintain Your Supply Chain:
    Contact your suppliers to confirm they are open and your scheduled deliveries are on schedule.  Consider looking into backup suppliers in case your supply chain is interrupted.
  5. Manage Cash Flow and Expenses:
    Although you are fortunate enough to still be operating this is a turbulent time with business conditions changing constantly and quickly.  Preserve your cash in case customers start paying more slowly and to cover unexpected expenses or interruptions in your cash flow. Likewise, now is a time to watch expenses carefully in order to maintain both cash and profitability.  If cash becomes tight you can work with your vendors, creditors, bank and landlord.  
  6. Preserve and Expand Lines of Credit:
    Your credit lines may be needed if cash gets tight. You can explore the possibility of getting higher limits on your credit lines and credit cards in case you need them later.

Companies facing temporary shut down

Many companies such as restaurants, hospitality, retail, and consumer service businesses will have no choice but to shut down during this crisis.  The duration of these shutdowns is unknown and as a business owner you have no way of knowing what the economy will look like when your business emerges and reopens.  Below are some steps to take to ensure your survival and plan for your re-emergence.  

  1. SBA Disaster Loan:
    The SBA has a special disaster loan program for COVID-19 affected businesses.  You can apply online but be aware the website is running slow from the flood of applications.  There is an 800 number for help, but it is flooded as well and wait times are very long. The process requires a lot of paperwork (listed below), but you can complete it on your own with some patience.  NOTE: you can save your work on the application if you don’t have everything you need at the time and come back to complete it later.

    SBA COVID-19 Disaster Loan – Economic Injury Disaster Loans  link: disasterloan.sba.gov/ela

    • Loans up to $2 million
    • Loans are for substantial economic injury where the business is unable to meet its obligations
    • Required Documentation
      • Disaster Loan Application – 3 pages completed online
      • IRS 4506T transcript authorization (you can fill this out online and submit it)
      • Company/Corporate Tax Returns (you can upload or email separately) 
      • SBA form 413 Personal Financial Statement (you can complete online) 
      • If 2019 taxes have not been filed, 2019 Year End P&L is sufficient
      • Year to Date P&L and Balance Sheet 
      • SBA form 1368 monthly sales (you can complete online and email separately)  
      • NOTE – if you have problems uploading your documents you can email to disasterloans@sba.gov or fax to the SBA at 202-275-5852
  2. City & State Small Business Relief Programs:
    Several cities and states have launched small business emergency loans ranging from microloans in the $5,000 range to loans up to $200,000.  You can do a Google Search for your city and state and also see the list below from Forbes.

    List of Small Business Relief Program, Forbes
    https://www.forbes.com/sites/advisor/2020/03/20/list-of-coronavirus-covid-19-small-business-relief-programs/#df4830e89dd0

    List of Banks Offering Relief to Customers Affected by COVID-19, Forbes
    https://www.forbes.com/sites/advisor/2020/03/12/list-of-banks-offering-relief-to-customers-affected-by-coronavirus/#765f8cc53ee3
     
  3. Manage Lines of Credit:
    If you have lines of credit you are likely going to have to tap into them.  View these as your safety net and do your best to minimize the use of these, you will likely need these credit lines when it’s time to reopen.  

  4. Control Expenses & Cash:
    Even though you are shut down there are still expenses rolling in.  Work with your vendors, landlord, creditors and bank to minimize your payments until you reopen.  
  5. Insurance:
    Check your insurance policies to see if you have business interruption insurance.  If so you may be covered for some of your lost revenue.
  6. Helping Your Staff:
    If your business is shut down you likely have had to lay off your staff.  Every business owner dreads laying off their staff. If you are in a financial position to help them in any way or offer them some form of work during the shutdown that’s great, if not, you can help them with unemployment insurance through the state.  Make sure you keep them informed about the status of the company and when you may be able to reopen.
  7. Keep Customers Informed:
    Make sure you keep your customers informed along the way through email, social media, and your website.  They will be essential to your re-emergence from this.
  8. Planning & Re-Emerging:
    Start planning now for reopening and rebuilding now.  COVID-19 will pass and while this is a very difficult time, your business can survive and re-emerge.  Planning for reopening now will make the process go smoother and faster, plus it will be a productive distraction while you are shut down.  

Does a Bear Market Affect Business Values and Sales?

Category: Buying a Business Mergers & Acquisitions Selling Your Business 

A Bear Stock Market causes (or is the result of) the values of publicly traded companies to plummet; but does a Bear Market affect the values of small to midsize (SMBs) privately held businesses?  One may think that in a Bear Market the values of SMBs would be pulled down with those on Wall Street, but this is not necessarily the case. 2018 is a good example of how Wall Street can be on a wild ride while SMB values hold steady, revenues and profits remained solid, and sales of privately held businesses are at record levels.  In fact while the Dow and S&P 500 was down overall in 2018 and nearly lost 20% of the value during December, 2018 was actually a very good year for small and midsize businesses.

A Bear Market can be created on Wall Street by economic forecasts, increasing interest rates, slowing earnings growth, world events, and government economic policies. Small business values are driven by earnings, more specifically the Discretionary Earnings or EBITDA of the business.  That’s it, earnings drive value for SMBs. Because the stocks of publicly traded companies are liquid and easily bought and sold, they are susceptible to speculation and when the economic winds shift, they become volatile. Privately held SMBs are not subject to speculation and are held for long term investment by the owners, thus their values are not driven by speculation.  They do not experience meteoric growth in a Bull Market, nor do they plummet in a Bear Market. In fact, the only time the value of a privately held business is of any real concern is when the owners are contemplating selling the business.

What Does Affect the Value of a Small-Midsize Business?

Earnings are the primary determinant and driver of small business value and the earnings of a business can be affected by internal and external forces.  Internal forces (things within the control of the management) such as management, product life cycles (obsolescence), quality, and pricing can cause the revenue and/or earnings of a business to decline.  External forces (things outside the control of management) such as the economy, competition, and commodity/materials prices, to name a few, can also cause the revenue and earnings of a business to decline.

Thus, if the economy is weak or other external forces affect the sales and earnings of a business the value of that business will be directly affected.  In this sense small business values can follow Wall Street values if the economic factors also affect directly the business and its earnings. While external forces cause the stock market to swing wildly and seemingly instantaneously, changes in the values of privately held businesses are only detectable when an owner is preparing to sell the business or perhaps obtain new bank financing.

Growth in revenue and earnings also affect the value of a business.  Businesses that are growing steadily or rapidly generally get a premium, and businesses with declining sales and earnings are discounted.  The industry type (e.g. distribution, e-commerce, healthcare, manufacturing, construction, B2B or B2C services, retail, etc.) drives the earnings multiple for that business, however, the multiple is a constant and does not generally vary much although it can be discounted due to factors such as lower earnings within each industry, dependence on owner for day-to-day operations (little to no employees) and/or poor books and records.  

How is the Value of a Small Business (SMB) Calculated?

When a small business owner is considering the sale of their business and wants to establish the market value, the first step would be to contact a professional business broker and ask for a Market Value Analysis.  At Pacific Business Sales we offer a free Market Value Analysis for our prospective clients and also offer formal third-party valuations for a fee for clients in need of a full appraisal.

To establish the value of a business, the first step of course is to obtain copies of the last three years tax returns, year to date Profit and Loss Statement and balance sheet.  The next step is to recast the financial statements to calculate the Discretionary Earnings, or DE, of the business. Simply put, DE is the total economic benefit or total income the owner realizes from the business.  Recasting the financial statements involves reviewing the expenses shown on the tax returns and P&Ls and adding back owner’s benefits and non-essential expenses that are discretionary to the owner. The tricky or complicated part of recasting financial statements is that only expenses shown on the tax returns can be added back and any owner’s expense must tie to an expense line item on the tax returns.

When the recasting is complete the business broker or valuation analyst will use a valuation program to calculate the market value of the business based on comparable sales (comps) data and often a valuation method such as the income approach.  At Pacific Business Sales we use the Peercomps valuation program and comps database along with other comps databases to calculate the market value of our client’s business.

Knowing the Market Value of your business is a critical first step in preparing to sell your business.  If you would like to meet with us to discuss the prospective sale of your business and the Market Value of your business please use the button below to contact us.

 

How to Minimize Taxes on the Sale of Your Business

Category: Mergers & Acquisitions Selling Your Business 

As business brokers the first question on every prospective seller’s mind is “how much is my business worth”, immediately following that, the second question is “how can I minimize the taxes on the proceeds?” We are not CPAs, tax or financial advisors, but over the years we have developed relationships with some of the best CPAs and financial advisors in the business and along the way we have found what we consider to be the best tax strategy to minimize taxes on the sale of your business. That tax strategy is the Deferred Sales TrustTM.  

First, let’s look at what happens if you do nothing and just sell your business. Depending on the structure of the sale of your business your taxes capital gains tax could be as low as 15% to 20% if the business is sold as a Stock Sale and if the business is sold as an Asset Sale a portion of the proceeds could be taxed as ordinary income (ouch!). Exactly how your proceeds will be taxed unfortunately is not a simple question and you will have to review this with your CPA or tax advisor to determine exactly what your taxes would be. Regardless, when you sell your business, you will be paying significant taxes unless you take action in advance and implement a tax strategy.

Now let’s look at what you can do to minimize the tax liability when you sell your business. Before we dig into what works, a  word of caution, there are a number of “tax strategies” that have been created and the IRS has recently ruled that several are not legal or valid. For the sellers that used these now overruled strategies they are facing the full taxes on the sale of the business plus penalties and it is now too late to implement another tax structure. So it is critical that if you chose to use a tax strategy you review with your CPA or tax advisor. There are two tax strategies to minimize taxes on the sale of a business that have survived IRS scrutiny over the years, one is the Charitable Remainder Trust (aka CRT) and the other is the Deferred Sales TrustTM (DST). Our experience with the CRT is that it is complicated as well as expensive to implement and maintain. The DST on the other hand is more straightforward and much less expense to implement and maintain while offering the same tax savings. Here’s how the DST works.

The DST defers the proceeds of the sale of your business by putting the cash into a trust. Thus you do not pay taxes on the full amount of the sale and only pay taxes as the proceeds are taken out of the trust. You can choose how much you take out of the trust each year and the term of the trust to fit your needs. The structure of this is much like a Seller Note or Installment Sale where with the DST the seller transfers the assets of the business to the Trust before the close of escrow and the Trust issues a Note to the Seller for the purchase price of the business. The Buyer then purchases the business from the Trust and the cash is sent to the Trust (no taxable event has occurred for the Seller). The Seller has complete control of the funds in the Trust and can direct the financial advisor to structure the investments as they wish. The Seller can also determine how much cash is taken out of the Trust, the timeline for these payments and can change the payment schedule if they wish. Taxes are paid as the funds are taken out of the Trust.

The diagram below illustrates how the DST works.  

Deferred Sales Trust - DST flow chart - Orange County Business Broker

We mentioned above that several tax strategies have recently been overruled by the IRS. The DST has been in use for nearly 20 years and in 2009 the IRS issued a Private Letter Ruling on the DST which validates this tax strategy.

For more information on the DST you can use our DST calculator to estimate tax savings on your own and request a complimentary analysis and consultation with the tax advisor advisor we work with, Darren Morrow at Morrow & Company CPAs. 

For a complimentary initial tax strategy consultation please contact Darren Morrow at Morrow and Company below or contact us. 

Contact Us - Free Consultation

Morrow & Company, CPA & Advisors 

Darren Morrow, CPA

Website https://www.morrowcpas.com/

email darren@morrowcpas.com

Office 714-385-1212

Disclaimer

Pacific Business Sales, it’s Broker and Agents are not financial advisors and are not providing financial or tax advice in this informational blog. Before implementing any tax strategy or tax planning you should obtain the advice of your CPA or tax advisor.