See this article as it originally appeared in the Westfair Business Journal covering Westchester and Fairfield Counties.
You’ve founded a business and watched it thrive. What’s next? You might not be ready to move on just yet, but maybe you can see that moment on the horizon, potentially even this year.
As a company founder, what can you do right now to make sure your exit from the company — when the time is right — goes smoothly and you retain the wealth you’ve built?
Make sure the business’s financials and tax positions are already in order. Before you even contemplate going to market, get your financials and tax positions in order. You never know when you might be approached by a potential buyer. You don’t want to be scrambling to get everything in line and derail an opportunity. Look for any potential financial issues and tax exposures before that happens.
When you present your business’s financial picture to a buyer, you should have a good understanding of which line items the buyer is likely to carve out when they’re valuing the business. For example, buyers may carve out one-time or non-recurring revenues (i.e. PPP loan proceeds), conversely, they may allow a portion of the owner’s salary (if excessive) to be added back, because that won’t be an ongoing cost for them (i.e. they can hire a replacement at a lower cost – this is a positive addback for the seller and can make the deal more attractive).
On the other hand, if the buyer feels the owner wasn’t taking enough salary for the services or efforts provided, they may need to increase that number if they’re planning on hiring a qualified replacement.
Make sure you’re up to date on all your non-income tax filings. If you’re providing services in another state but haven’t been paying sales tax, that’s something a buyer might carve out of the purchase price.
Also, take a look at how you’re categorizing any personal expenses that run through the business. This is something you should be carefully tracking anyway for accounting and tax purposes, but it’s especially important before a sale.
Being prepared means you can go to market quickly, striking while the iron is hot, especially if your industry is on an upswing.
Prepare for different potential deal structures. The kind of deal on the table has serious tax implications, so it’s especially important to look at how the deal is structured. Is it an asset or a stock deal? In a stock deal, the buyer buys an ownership share in the existing company, which remains intact.
An asset deal means the buyer remains separate from the company but purchases specific assets or items from the company. There are pros and cons to each, and different tax implications.
If you’re an S-corp, a buyer may want to do an asset acquisition, which can cost the seller more at tax time. In some deals, the buyer wants the owner to stay involved after the transaction. Sellers prefer cash up front, but the current market means more of the compensation for the purchase of your company might be paid out over a longer term, rather than immediately.
The structure of the deal has specific tax implications for both buyer and seller. In an asset sale, the seller may be looking at depreciation recapture which is taxed at a higher rate. The buyer receives tax benefits from an asset sale, including a step up in depreciable basis and no responsibility for the seller’s income tax liability, so buyers may be less rigorous about due diligence under those circumstances.
Sellers can try to push for better terms. For example, if the buyer wants an asset deal but the seller wants a stock deal, can you meet in the middle with the purchase price to compensate for the difference in the tax cost? Running these scenarios ahead of buyer interest can help founders enter acquisition conversations with the specific structure they want in mind.
Rein in spending and extend your runway. Businesses faced a number of challenges in 2023. Labor markets are an issue, there’s lingering concern about recession, and inflation is having a real impact.
In this environment in which capital is more expensive and harder to come by, maintaining a leaner balance sheet and doing more with less will be appealing to potential future buyers. If you are raising money, raise a little extra so you have a cushion and can avoid borrowing.
If you can, raise prices to keep up with inflation and maintain margin levels. Automate as much as possible to create efficiencies in how your business is run. Since we don’t know when the economy will get hot again, maintaining a longer runway removes pressure to rush into a sale or take on investment with unfavorable terms.
Deals still happen. As the saying goes, “Strong businesses are bought, not sold.” Companies with sustainable, continuous revenue, fewer supply-chain issues, good management and good infrastructure will always stand out to buyers.
The current environment presents more challenges than we’ve seen in a while, but M&A rolls along. This could still be the year to sell your business — if you’re ready.