Selling your small business may not have been your focus in 2020 and may not be your focus in 2021. With an economy in flux and public health at the forefront of every decision, you may be simply focused on keeping your businesses — and yourself — healthy.
But if there are two things that 2020 has taught us, it is that even the most certain things can change quickly, and planning ahead comes with huge advantages. As a small business, you never know when you will pick up the phone and take a call from an investor or private equity firm with a buyout offer, or when the door will open and the next generation will be ready to take the reins.
No one knows when it will happen, but those who are prepared will be able to take the most advantage. A basic knowledge of sales transactions is one of the best moves a business owner can make so that when the call comes, they know where to turn and what to look for.
Four-Part Webinar Series: Buying, Selling or Not So Sure? Transaction Service Basics for Business Owners
MMA is partnering with the closely held business experts at Claying & McKervey to offer a four-part series that will speak to manufacturing business owners who may be considering a transaction or those already in the process. Hear from leaders of the firm’s Manufacturing & Distribution, Transaction Services, and Private Client Services teams. See Events to learn more and to register.
Here are four things to consider when preparing for a deal.
Ownership of the business is not the only thing that changes hands when buying or selling—the entire company changes hands. To ensure a smooth handoff, buyers and sellers need to understand the full range of contracts and considerations that need to be transferred, including:
- Employee/non-employee contracts
- Vendor/customer contracts
- Approved vendor agreements
- Purchase orders
- Lease agreements
- Bank debt or other loan agreements
- Related party agreements or lack thereof
Within each of these contracts are countless provisions that impact the business, including change of control, approval rights, termination penalties, and acceleration clauses. Without a full understanding of the implications of each, sellers and future owners could be taken by surprise.
The same needs to be considered for employees and human resources in order to have a full picture of the business. Does the business have employee and non-employee contracts, and, if so, what are the terms? Have all parties signed non-compete agreements or would you like them to? How do 401(k) plans function and what is the contribution? What strategies does the business use to keep key managers in place?
It is hard to overstate the advantages that come with knowing the answers.
2. Tax Free Reorganization
Limiting tax liabilities on transactions should be a key focus area. Although maneuvering through the tax code is complex, tax free reorganization prior to the deal may offer buyers and sellers the opportunity to make post-closing operations easier for escrow, holdbacks and earn-outs, especially when there are many sellers. It is important for buyers and sellers to consider vendors, charitable giving options, estate planning, and whether a foreign buyer is involved.
If you are looking to acquire another company, buyers often establish a new parent company and keep the operating company intact. Alternatively, if you are looking to sell, pushing assets into a disregarded LLC will allow only desired business assets to be sold, therefore keeping continuity but avoiding other complications.
3. Quality of Earnings
Having a full financial picture of a company is also critical for buyers and sellers—an income statement is often not adequate. We usually advise our clients to assemble or ask for a quality of earnings report as it offers a full picture of net revenue, credit or debit sources, and whether or not they are reoccurring.
A quality of earnings report also gives insight into the company’s accounting mechanisms, errors (one-time or ongoing), and the existence of related party transactions.
4. The Impact of COVID-19
In the wake of the pandemic, the fundamentals of buying and selling have not changed very much. Technology has allowed us to continue working seamlessly with our clients and their partners.
We do urge clients to remain wary of an economy that is uncertain. In many cases valuations are down from their 2019 levels. As sales continue to close, valuations in many industries may continue to reflect this uncertainty.
With that in mind, it has never been more important for buyers and sellers to be meticulous about understanding the financial picture for their business before, during, and after COVID-19. Some companies may come out of the pandemic unscathed, but the only way to know for sure is to have a complete understanding of financial and internal considerations.
Clayton & McKervey, P.C. is an MMA Premium Associate Member and has been an MMA member company since February 2018. Visit online: www.claytonmckervey.com.
About the Authors
As a Clayton & McKervey shareholder, Tim Hilligoss manages a portfolio of closely held businesses. He consults business owners on transactions and helps them tackle the top financial, tax and operational issues impacting their bottom line. Tim can be reached at 248-208-8860.