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Article Author:

What’s Actually Included in the Offer Price for Your Business? Part 1 of 2

Stella Y. Su, MBA, CPA, ABV
Senior Manager, Corporate Finance Consulting
ssu@BlackmanKallick.com, 312-980-2912

If a potential buyer approached you today with an offer to buy your company, what steps would you take to evaluate that offer? In this issue and the next, we’ll take a look at some things you should know about the components of a company’s selling price.

All offers are not created equal

Let’s assume your BK advisor recently performed a business valuation and advised you that the fair market value of your company is between $24 million and $28 million. A few weeks later, you receive an offer to buy your business for $30 million.

You might ask yourself, “Why do I need help in selling? Why don’t I just take the offer?” But before you start drafting the sales contract, it’s important to understand exactly what is included in the offer price. Without a careful evaluation of the offer’s components, you could end up receiving as little as $20 million of the initial $30 million offer.

No two offers are alike; the table below illustrates the components of the $30 million offer in this example.

What is included in the purchase price?

• Cash. The $30 million offer may be contingent on your paying off all debt on your company’s books. And if you have a lot of cash in the bank, the buyer could say he wants all assets on the balance sheet. The cash paid to the seller at closing includes amounts the buyer has financed through senior debt, mezzanine financing and equity investment.
• Deferred compensation. Part of the sales agreement may include the buyer offering to pay deferred compensation—for example, $1 million a year for the next three years, as opposed to your receiving $3 million at closing.
• Seller note. As the seller, you may take back a note—for example, $5 million—from the buyer. The value of this note depends on its terms as well as the buyer’s ability to repay the note. Bear in mind that a seller’s note is subordinate to bank loans and is subject to loan covenants. The buyer also may try to repay the note early at a discount, thus giving you a lower price than you anticipated.
• Earn-out. Some sales contracts include an earn-out portion tied to the company’s future performance. There are several key points to consider when evaluating an earn-out.
  • What is the time period? Many earn-out agreements are payable the first and second year after closing.
  • What is the guideline or threshold? Is performance being compared to last year’s sales, for instance, or to gross profit or next year’s projected sales?
  • How long after the end of each period will the earn-out be determined? Be sure to determine an appropriate evaluation period; as the seller, you will want to get your earn-out as soon as possible. Also, bear in mind that after the company is sold, you will no longer have control of the business, so the value of the earn-out depends on how well the buyer is running the company.
• Debt—who is responsible? If the purchase agreement is based on your paying 100% of your company’s outstanding debt, this could have a significant effect on the net amount you receive from the sale.

See what's in the $30 million offer

Which works to your advantage: an asset sale or a stock sale?

Many closely held businesses are C corporations (C corps), which are subject to taxation at both the corporate level and at the shareholder level. By contrast, S corporations (S corps) are “flow-through” entities for tax purposes. S corps are not taxed at the corporate level; the corporation’s earnings are taxed directly to the shareholders.

This distinction becomes very important when it comes time to sell your company. (See “C corp or S corp? The difference could cost millions when selling your business”.)

If your company is a C corp, it may be best to negotiate a stock sale. An asset purchase, on the other hand, is usually more advantageous to the buyer because he can get a step-up in the tax basis of the assets, which will reduce the buyer’s future taxes. Another reason buyers prefer an asset sale is that the buyer assumes only the liabilities he specifically agrees to assume in the sales agreement.

What is included in the sale?

Another critical question is, what is the buyer actually buying? Small businesses often co-mingle assets; be sure to separate your personal property from your business assets and keep proper titles. What does the buyer value? Your employees? Technology? Customer list? Brand name? Distribution channel? In some cases, a buyer may want only certain units of your business.

Evaluate the financial variables

The sale of a company can be structured in a variety of ways. Here are some factors to consider in selling your business:

• Working capital (current assets minus current liabilities). When purchasers are buying an ongoing operation, they want to make sure they’re buying assets, including a certain level of working capital in the company to help the business going forward. The buyer wants to make sure that before the sale, the seller won’t sell off all its assets or fail to pay its liabilities. The seasonality of the business should be considered in determining an appropriate level of working capital for the sale of your company. Here are two components of working capital to consider:
  • Receivables vs. cash in a cash-free deal. If cash is not part of the working capital in the contract, how you manage your receivables and payables will affect your level of working capital.
  • Inventory. Sometimes buyers and sellers get into disagreements over inventory levels. Smaller companies often don’t have their books audited to physically confirm their inventory. If you are preparing to sell your company, be sure to get your financial records in order and deal with any obsolete, off-book or excess inventory. A physical inventory will need to be conducted before the closing. Being well-prepared will help minimize any surprises during the sales process.
• Capital expenditures. Be careful about spending on physical assets during the sales negotiations. If you are buying equipment or spending considerable amounts on technology, for example, and the buyer does not think it is necessary, you may not get the return you expected on your capital investment.

Agree on accounting principles and procedures for the sale

Your written sales agreement should spell out every aspect of the sale to avoid future disagreements with the buyer. Be as specific as possible; try not to leave anything open to interpretation. Even if you use a phrase such as “according to GAAP” (generally accepted accounting principles), there is still room for disagreement. Some buyers may use a difference of interpretation as a means to try to lower the selling price. By spelling out every agreement component, you can help avoid unpleasant surprises.

For more information on selling your business, contact Stella Su at 312-980-2912.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.