By: Jason Pourakis, Christopher Lieto and Paru Shah, Mazars USA LLP
There comes a time in every company’s lifecycle where the decision has to be made whether or not to sell the business. This turning point can be due to several factors – lack of proper management team to continue the business, lack of a younger familial generation to take over, or simply “it is time” due to outside competitive or financial pressures. The best practices below outline important practical considerations to address when going through this process.
Preparing to Sell Your Business
Selling a business is like selling a house – you must prepare it for the market. It is a process, not an event. This requires time, teamwork, research, planning and commitment. At the beginning of the process, you should:
- Document the final decision to close your business with a written agreement.
- Assemble a team of professional advisors such as accountants, lawyers, a business broker and bankers.
- Get professional help to evaluate and price your business. An independent valuation is generally one of the most reliable methods of establishing a market value. Another option is to seek out your industry trade association for industry specific valuation services.
- Physically prepare the site such as repairs and deferred maintenance.
- Ensure that financial and corporate records are up to date. Address any issues existing in internal systems for accounting, performance reporting and internal controls
- Make sure that all tax returns (income, payroll, sales and use) are filed to date and all taxes are paid.
- Be informed on filing of proper dissolution documents, cancelling registrations, permits, licenses, business names.
- Make a plan on when to notify your creditors, employees and customers.
- Identify potential buyers and plan a marketing strategy.
Preparing for Buyer Due Diligence
The below information should be kept ready and available to assist the buyer in completing their due diligence process as quickly and easily as possible.
- Proper non-disclosure agreements to be signed by potential buyers.
- The company’s Articles of Incorporation, Good Standing Certificate, Bylaws, list of shareholders and minute book.
- Copies of the past three years’ income tax returns. Copies of sales tax returns and employment tax filings for the past three years.
- Detailed financial statements. As with tax returns, most buyers will want to see three years of statements.
- Monthly management reports and P&L information for purposes of net working capital calculations and quality of earnings calculations.
- Copies of real estate leases, deeds and mortgages.
- List of physical assets and approximate values, equipment leases.
- Valuation of inventory.
- Copies of any licenses, permits or franchise agreements, if applicable.
- List of any intellectual property like patents, trademarks, or copyrights
- Any contracts with suppliers, customers.
- Any environmental issues.
Tax Structure of the Sale
Business owners should meet with legal and tax professionals before a sale to discuss tax strategies for making the company attractive to buyers, while minimizing their own tax liabilities. One of the major considerations in structuring a sale is the tax consequence. Taxes on the transaction will depend on two factors:
- How your business is set up legally: The form of the seller’s organization, for example C Corp, S Corp, or LLC, is important to consider. In a C Corp sale, as opposed to an S Corp or LLC, the gains are subject to double taxation. First the gain from the sale of assets is taxed at the corporate income tax rate, then the remaining proceeds are distributed to the shareholders and the difference between the liquidation proceeds and the stockholder stock basis are taxed at the individual’s long-term capital gains rate. This reduces the individual’s after-tax proceeds. An S Corp or LLC sale results in gains being taxed only once as the income or losses of these entities flows through to the shareholders, who report those numbers on their personal income tax returns and pay taxes on that income.
- Whether you are selling assets or company stock. Buyers generally prefer asset sales and sellers generally prefer stock sales because the entire gain is taxed at the more favorable long-term capital gains rate. For an asset sale, a portion of the gains will be taxed at the less favorable income tax rate. Note that treating a sale of a business as a stock sale is made through several different types of tax elections with a range of additional requirements. Your tax professional will be able to advise the best structure.
Post-Sale Tax Considerations
It is important to clearly define in the purchase agreement the responsibilities of the buyer and the seller, specifically who is responsible for preparing and paying for the tax returns pre and post-sale.
The individual seller should also consider the following items as the sale moves toward its conclusion:
- The gain on the sale may be considered ordinary income (subject to the highest tax bracket, 37%) or capital gain (20%) or a combination of both rates. If there is depreciation from fixed assets, then there will be a depreciation recapture tax of 25%.
- Any passive losses or At-Risk losses from this business that have accumulated will be released in the year of sale. These losses can help to offset the overall gains and other taxpayer income.
- If the gain is deemed to be capital, it may make sense for the individual to review their personal portfolio. They can sell securities that are in a loss position and offset these losses against the gains from the sale of the business.
- An easy way to reduce the overall tax liability in the year of sale is to consider additional charitable contributions. The contributions can be made any time before the end of the calendar year for the year in which the sale takes place.
- While not an income tax savings measure, the seller may contemplate making gifts. Currently, donors can gift up to $15,000 tax free.
- There are also many different trust instruments that can be employed to shift the wealth to a different family member or another generation. In some instances, the trusts can be tailored to meet the needs of the seller.
The sale of a business can seem like a daunting task, but with the proper planning, adherence to best practices, and guidance from business professionals it can be a smooth process.
Jason Pourakis: Partner in New Jersey can be reached at 732.475.2159 / Jason.Pourakis@MazarsUSA.com.
Christopher Lieto: Partner in New Jersey can be reached at 732.475.2121 / Christopher.Lieto@MazarsUSA.com.
Paru Shah: Manager in New Jersey can be reached at 732.475.2199 / Paru.Shah@MazarsUSA.com.