When retirement is contingent on selling a business, extra attention is needed
By Beau Ruff for TCAJOB
At some point, the lucky entrepreneur is able to realize the fruits of her success and ride off into the sunset after the momentous occasion of having sold her business. But, the path to the sale is a complicated one. Preparation is essential. Too often, the seller pencils out a deal to sell her business with a prospective purchaser without ever getting her metaphorical house in order. Then, when the seller goes to the lawyer to draft the deal (and wants to close next Friday) the deal is not anywhere close to where it needs to be to move to drafting. The key is to visit your attorney early to prepare for the sale before entering into sale discussions. Here are some of the important considerations:
Get your company organizational books (the legal side) in order. Most companies will be entities (corporation or limited liability company). You should have on hand all of the organizational documents. For a corporation, this includes the Articles of Incorporation, the Bylaws, the Organizational minutes and the annual minutes.
For an LLC, this includes the Certificate of Formation, the Operating Agreement, and any annual minutes. Check the documents to make sure all the information is correct. The information listed, such as officers, directors or managers should match the information on the Secretary of State’s web site.
Clarify ownership. For many small businesses, the stock seems irrelevant. For an outside party, it is crucial to understanding the players in the business. Locate your stock or unit certificates. Check the stock transfer ledger. If either the stock certificates can’t be found or the transfer ledger is not up to date, the company should fix the record, issuing the correct stock and updating the transfer ledger.
For most small companies, I think it is best to keep all the stock certificates in one place with all the other original organizational documents of the company.
Get your accounting books in order. You should have at least the last three years of financial statements readily available. And, you should maintain balance sheets for the same period. In addition to the past three years, you should also expect to provide updated quarterly reports concerning the same information. The buyer will also likely want to see the past three years of tax returns.
Become familiar with your sale options. At the outset, you should learn the different options for how your business could be sold.
The top three sale options follow: First, it could be structured as a stock purchase agreement where the buyer purchases 100 percent of the stock of the company. This is usually preferable by the seller as it can simplify the transaction. On the buyer’s side, the buyer is taking on all the assets but also the liability associated with the business.
The second way is through an asset sale. In an asset sale, the buyer does not buy the stock, but rather purchases the assets of the business. This allows the buyer to pick and choose the assets he or she purchases and to leave everything else, which could include some liability, with the company. To the public, the distinction is not evident, as the buyer also usually buys the business name and all associated intellectual property and intangible assets. The buyer usually prefers the asset sale, since he can pick the assets he wants and use the sale price as his tax basis for depreciating the assets.
A third, more advanced technique, is a sale through the exchange of stock. This is more often used when a large or publically-traded company acquires a smaller one and is more appropriately termed a tax-free reorganization. It looks like a stock sale, but the purchase price is paid with the buyer’s stock. On the upside, this transaction can qualify as a tax-free transaction, with no tax due upon sale from the seller and the buyer need front no cash — just stock. On the downside, the seller will be a stockholder in the buyer’s business and subject to the potential price fluctuations in that stock, although some of the price fluctuations can be mitigated with a put-and-call combination, sometimes called a “collar.”
Be prepared to disclose (and warrant) an exhaustive list of information concerning your business. The buyer will not only want to thoroughly examine your business and your books, but will also want the seller to make certain representations or promises about the business. Any misrepresentations could result in seller liability, and, if the seller misrepresents anything, it could be grounds for liability.
Some of the typical representations might include the following: the seller owns all the shares of stock of the company; the seller warrants the financial statements and balance sheets; there are no liabilities of the company except as disclosed in the sale documents; the company has all necessary licenses, permits, and governmental authorizations to conduct the business; the seller knows of no claim or lawsuit pending or threatened against the company; the seller has paid all of its taxes; the seller has no employment claims; the seller owns all the tangible and intangible assets, etc. There are potentially many, many more.
Know and document your business relationships. Know all your customers and vendors and keep lists of them both and of any contracts you have in place and whether they are personally guaranteed — by the owner or the company — or not.
In any deal other than a cash transaction, the seller will provide some degree of financing. And, it is typical that the seller receives some kind of security or collateral to secure the payments. The assets of the business can be used to secure the payment, but so can other assets of the buyer.
It is important to have a working understanding of the collateral options you have to secure your payments.
While potentially time consuming, challenging and expensive, careful planning with a qualified expert can ensure that your ride into the sunset is indeed a momentous and carefree occasion where you are able to enjoy the fruits of your labor.
[panel title=”About Beau Ruff:” style=”info”]
Attorney Beau Ruff grew up working for his father at Ruff’s Giant Burgers. He graduated from Kamiakin High School and obtained his Bachelor’s degree and law degree from Gonzaga University. He also has Master of Laws degree in Taxation. After law school, Ruff entered the U.S. Army as an attorney in the Judge Advocate General’s Corps. He served for four years, including a year-long tour to Iraq for which he was awarded the Bronze Star. Ruff later practiced as an attorney with the law firm of Leavy, Schultz & Davis, P.S., where he focused on business planning, estate planning, and taxation. Ruff works for Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick, where he focuses on assisting clients with comprehensive planning.