How the Deal Structure Can Impact the Sale
After all the painstaking time and effort it takes to build a business, it probably wouldn’t dawn on a business owner that selling a business could be as challenging as it is. The good news is there are primarily two ways to structure a sale – an asset sale or a stock sale. However, determining which one would be most beneficial requires a thorough evaluation of several factors. In addition, because buyer and sellers are impacted differently by tax implications, they tend to favor different structures. That can make it more difficult to structure a deal in which both parties walk away with everything they want. In considering the sale of your business, it would be important to understand how the two sale structures work and why a buyer or seller would prefer one over the other.
It Starts with Knowing How Much Your Business is Worth
Before moving too far along in determining how to structure a sale, it’s a good idea to know how much your business is worth. Ultimately, the sale price of any business is determined by the market and what a buyer is willing to pay for it; but, it would be important to put some numbers to it have a better idea of what they will be looking at. The most common way to measure your business’ potential value in a sale is by calculating its normalized earnings. The first step in this calculation is determining EBITDA, which is its earnings before interest, taxes, depreciation and amortization. Essentially, EBITDA is a measure of a business’s future earning capacity.
EBITDA is not a thorough measure of your business’s value, but it is widely accepted as a starting point for buyers and sellers to evaluate profitability and future returns. The more astute buyers look beyond EBITDA to focus on free cash flow and other factors. As a seller, you may want to make adjustments to your EBITDA value – such as adding tangible or intangible assets to the equation or by depreciating certain assets – to create a stronger representation of your business. At that point valuing your business based on EBITDA becomes more of an art than a science. Just know that your buyers will want to make their own adjustments.
Although any number of factors – the type of industry, the size of your market and its rate of growth, the uniqueness of your product or service, barriers to entry, gross margins, etc – can impact the value of your business, the average benchmark valuation for most small- to mid-sized businesses is 4-6X EBITDA.
Asset Sale vs. Stock Sale
Generally, buyers favor asset sales because they are able to depreciate the assets at a stepped-up basis. This gives them a stream of deductions they can use to offset revenues over time. They can also decide to exclude certain assets and purchase only what they need. In many assets sales, the buyer may buy equipment or technology and leave the business in the seller’s name. In an asset sale, the seller can also purchase assets without assuming the business’s liabilities. In those cases, the seller may be left with cash and/or accounts receivables over remaining liabilities. The benefit to the seller is the buyer may value the business or the individual assets more with an asset sale. However, the seller winds up paying ordinary tax rates on “hot assets”, such as accounts receivable and inventory; however, the seller does receive capital gain tax rates on the sale of fixed assets.
Generally, a stock sale is less complex than an asset sale because it is done in single, straightforward transaction. The buyer simply acquires all of the entire legal entity, including the assets, liabilities, and rights of the business.
A stock sale can be beneficial for a buyer who wants to continue the operation of the business without disruption. However, the contingent liability issue tends to push more buyers towards an asset sale. A stock sale tends to favor sellers more than buyers. For one, the seller realizes a more favorable capital gains tax in a stock sale. They may have to accept a lower price for the business, but they typically pay significantly less in taxes.
Plan Well Ahead Don’t Try to Go it Alone
As you can see, the structure of a business sale can impact the buyer and the seller in different ways. However, there are many other factors that can also influence the decision as to which structure is ultimately chosen. If you are contemplating the sale of your business, it would be important to consult with your advisors early in the process to carefully consider the implications and understand the issues before making any decisions.