Business intermediaries are not typically licensed to provide tax guidance on transactions involving the sale of a business, however, it remains important that he or she possess a working knowledge of all of the intricacies that surround a business sale. Included amongst the most critical elements of the sale of a business is the impact of federal taxes upon a transaction.

Since most business sales in which professional business intermediaries have been engaged are those of non-public entities and, as such most likely take the form of an asset sale (as opposed to a stock sale), it is this type of sale upon which we will focus. The IRS has established guidelines for the allocation of purchase price for asset based transactions under Section 1060 of the Internal Revenue Code.

Allocating the purchase price to the entity’s assets in a business sale/acquisition is both science and art. The science aspects dictate that the rules established by the Internal Revenue Service be followed, along with documenting the underlying assumptions that are used. Art comes into play in the actual identification of the intangible assets and allocating value to these intangible assets.

It is important that the seller and buyer seek direction from their tax advisors when purchase price allocation is being negotiated. Failure to do so can have a significant affect upon the economics of a sale/acquisition. The allocation of purchase price is often overlooked while price, terms and other conditions of the sale are being negotiated. It is not uncommon, in fact, for the buyer and seller to have agreed upon these terms before discussing the purchase price allocation and its corresponding tax effects. Therefore, itshould be evident that the purchase price allocation, and the potential cash implications following close of the transaction, can assume such a critical role that the inability to mutually agree upon the allocation can cause a deal to fall apart. The intermediary, knowing that the seller seeks to maximize the after tax proceeds from the sale and the buyer desires to maximize the after tax cash flow of future operations, should be prepared to bring the parties together at the appropriate time to incorporate the discussion of purchase price allocation during the discussions and negotiations of other terms.

Once the parties have agreed upon the purchase price allocation and the transaction closes then IRS Form 8594 must be filed by each of the parties. The allocation of purchase price reported on IRS Form 8594 is binding unless the IRS determines it is not appropriate.

The sale includes all the assets of the business not specifically excluded and may include equipment, inventory, work in progress, trade fixtures, leasehold improvements, contractual rights, business records, licenses, franchises, customer lists, goodwill, covenant not to compete, trade secrets, trade names, telephone numbers and supplies. Other intangibles and intellectual property could include patents, trademarks, secret formulas, etc.

The allocation discussed above is based on what is referred to as the “Residual Method” and, pursuant to IRS guidelines, must be determined in the sequence outlined below:

• Step One: Value all identifiable assets
• Step Two: Determine total amount to be allocated (certain non-specific transaction costs such as employment/non-compete agreements must be considered)
• Step Three: Assign to respective classes of assets in the following order:

o Class I – Cash
o Class II – Marketable Securities
o Class III – Accounts Receivable
o Class IV – Inventory
o Class V – Assets Not Otherwise Classified
o Class VI – Section 197 Intangibles (i.e., specifically identifiable intangible assets other than Goodwill)
o Class VII – Goodwill

The total value allocated to the assets must equal the purchase/sales price. Some tax implications of the purchase price allocation are shown below.

Amount allocated to Tangible Personal Property (e.g., buildings, leasehold improvements, trade fixtures, furniture, and equipment):

• Seller: If held more than one year, gains in excess of depreciation are long-term capital gains; otherwise ordinary income
• Buyer: Depreciates new basis per IRS schedules

Amount allocated to Covenant Not to Compete/Customer List and similar Intangibles:

• Seller: Ordinary income
• Buyer: Amortize over 15 years

Amount allocated to Training/Consulting:

• Seller: Ordinary income
• Buyer: Expense as incurred

Amount allocated to Goodwill:

• Seller: If held for more than one year, long-term capital gain
• Buyer: Amortize over 15 years

Amount allocated to Land:

• Seller: If held more than one year, long-term capital gain; otherwise ordinary income
• Buyer: No immediate tax impact

Amount allocated to Inventory:

• Seller: Ordinary income, to the extent over basis
• Buyer: Treated as cost of goods sold upon sale of inventory

In summary, Huntington Business Group, Inc. highly recommends that the seller and buyer address the allocation of purchase price in connection with negotiations of the other terms of the transaction. Licensed and/or accredited brokers, CPA’s and attorneys should be consulted.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group is the leading business brokerage firm in North Texas and the Dallas/Fort Worth Metroplex. Our firm is comprised of professional business intermediaries that specialize in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

You’ve decided to buy a business but how do you know that the business you’ve chosen is the right one for you? Here are 7 questions every buyer should ask when they’re looking to buy a business.

1. Are The Numbers Provable?

One of the more frequent comments we get from buyers is that there are too many businesses where the seller cannot prove the numbers. So the strategy here is simple – if the seller cannot prove it, buyers will not pay for it, so only represent what can be documented. Additionally, if the seller has unreported income, do not expect to get paid for it. The benefit has already been realized.

The ability to provide buyers with detailed documentation to validate the financials is vital to a successful transaction. If the books and records are in disarray the seller should take time to organize them before taking the business to market.

2. Can It Be Financed?

Cash sales are rare. Serious buyers, however, do understand they have to put down a substantial down payment, but buyers want to utilize some financial leverage. There are three primary options for financing:

• Traditional lenders
• SBA loan program
• Seller financing

Traditional lenders rarely provide funds for acquisitions unless the loans are fully collateralized.

SBA type programs are growing in popularity. VR Huntington Business Group has established relationships with several SBA lenders and will pre-qualify the Seller’s business to determine the amount a qualified buyer may borrow. This greatly enhances the marketability of a business.

Seller financing is quite common and is addressed extensively amongst the various articles that have been posted on this site. Please read these articles as they offer valuable insight to this ever more popular means of securing financing.

3. What Does The Future Hold?


A business will almost always be sold that is valued upon past financial results, but the decision to buy will be based upon the future potential of the business. While some buyers consider growth to be their main criteria, at the very least the majority of buyers want to know that history will repeat itself. In other words, is the business sustainable and are there any issues that could impact it negatively after they buy. A realistic picture to the buyer should be presented, but at the same time the seller will want to present the business in a compelling fashion that demonstrates that all the parts are in place for them to takeover and continue to be successful.

4. Will Employees Remain?


This is especially important in businesses that may have some key employees. The buyer will more than likely want to meet them prior to closing. The seller should consider structuring the milestones of the deal to allow for the meeting.

5. If The Business Relies on Location Will the Lease Be Assigned?


Landlords can sometimes derail the sale. Consider meeting with the landlord to determine what issues will have to be addressed. A SBA loan will require that the business have a home for the term of the loan. Therefore, renewal options should be in place. To ensure that this doesn’t kill the sale, buyers should find out if their business broker is licensed to handle real estate transaction. For example, VR Huntington Business Group requires all staff members to have a real estate license to handle just such issues. In addition, we also have a Real Estate broker on staff to assist with the complexities of leases and landlords. If the seller owns the real estate and wishes to include it in the sale of the business then we will likewise guide you through this process.

6. Are there Any Hidden Problems?


The best strategy is to be upfront with prospects about any potential issues so that they can be dealt with early in order to maintain credibility and trust. When the seller wants to sell and the buyer wants to buy and the parties trust each other, it is almost impossible to prevent a successful transaction.

7. Is The Business Right For Me?


Ultimately, this is the question that is the make or break question. The buyer must make this decision, but the seller and his advisors should be of some assistance. VR Huntington will soon be releasing a proprietary program designed to answer this question. This program is in the beta stage now, but is called “Business Match Indicator”. The Business Match Indicator helps the buyer and seller to better understand the ideal profile and skill set of the perfect buyer for the business. This process helps the business intermediary conduct the pre-qualification screening of prospective purchasers.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

Everyday, I’m asked this question by business owners who are looking to sell their business. It’s good question. Why do you need to hire a business broker? The answer is simple - expertise.

As a business owner, you understand that you need to hire experts to handle certain aspects of your business to protect your investment and its continued success. That’s why you don’t think twice about hiring a CPA or an attorney. The principal is the same when hiring a business broker.

Typically, business owners hire a broker because:

• You have spent a great deal of time and energy building your business
• Your business may be your largest financial asset
• You are uncertain how to protect your confidentiality
• You have no real idea of what the business is worth
• You don’t know how to find and qualify buyers
• You may not have negotiating skills
• You don’t want to take your eyes off the business while it’s being sold
• You may not even be certain of what the first steps are to sell your business

Just like hiring a CPA or an attorney, you need to do your homework when hiring a business broker. A good broker is a skilled professional who will manage the sales process for you and handle all of the complications so you can continue to grow your business!

A member of the VR network which has been providing sell-side services since 1979, VR Huntington Business Group in Dallas has been recognized on numerous occasions as a leading firm amongst all professional intermediaries and business brokers in North Texas.

What you should know before hiring a Business Broker

Prior to engaging a broker let us first begin with the skills and qualifications that your broker should possess and how to determine if you are selecting the right broker to represent you.

Seller Due Diligence: A prospective buyer will undertake due diligence - so should you. Review the broker’s experience, credentials and references. Visit their office to be certain they are not operating from their home. Check the BBB. Have they handled sales of your type of business before? How long have they been serving your market?

Check IBBA: The International Business Brokers Association® (IBBA) is a non-profit trade association of business brokers that provides a professional certification process after a rigid education program is completed. Are the leading members of your brokers’ firm certified?

Use a Specialist: A business broker who spends all their time selling businesses, as opposed to real estate agents for example or part-time business brokers, will add more value to your sales transaction.

Confidentiality: Selling one’s business is a highly confidential matter. Your business broker should ensure all measures are in place to protect your company. Any knowledge by your suppliers, employees, or customers that you are selling can have adverse repercussions.

Marketing Plan: Selling your business is all about strategic marketing. Properly positioning the sale of your company to attract as many buyers as possible is the objective. A skilled broker will have a detailed marketing plan with advertising strategies designed to attract a wide range of prospective buyers.

No Upfront Fee: A business broker’s fee ranges from 10 to 15% commission of the sale price of your company. Avoid any broker asking you for an upfront fee.

What a Good Business Broker Will do for You

Qualified brokers will meet the standards outlined above and will, in addition, be able to provide the following to ensure that your objectives are fully satisfied:

Value your business using several different methods and give you an idea of the price your business is likely to sell for. good broker will adjust your financial statements and recalculate the cash flow since it could be higher than what was disclosed to the IRS

Add a layer of confidentiality to the transaction thereby protecting the value of your business and helping you get the best possible sale price for your business.

Reach more buyers through channels that you may not be able to access directly on your own.

Negotiate with buyers and their advisors to get you the best price and sale terms for business.

Educate you about the sales process - Many sellers are not aware of what they have to disclose in documents such as the Non-Disclosure Agreement or Purchase Agreement

Manage the due diligence process. Selling a business can be a long and tedious process. A good business broker will help you by answering many of the typical questions that buyers have allowing you to focus on the daily operation of your business.

Complete the deal. An experienced business broker can work with you to structure the financing of the sale and help close the deal.

Remember - A good broker will allow you to get you a lot more money at the best terms (even after you have deducted their fees).

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

While there are a few good and strategic reasons for the owners of a C Corporation (“C Corp”) to maintain C Corp status (e.g., plans to take the company public, preserving health care deductions, etc.) the owners MUST prepare in advance and develop an Exit Strategy in order to avoid the shock that typically comes when they receive the tax bill following the sale of their company.

We at VR Huntington Business Group often find that business owners have very little knowledge of the tax consequences that are triggered when they sell their business. These consequences are most especially severe for the owners of C Corporations.

C Corporations pay taxes on the income earned and, if the earnings and cash levels warrant, they then distribute the after-tax earnings in the form of dividends to the shareholders who will in turn pay taxes on those dividends. This is known as “double-taxation” and is the subject of much frustration for many C Corporation owners.

When a C Corp is sold it will generally take the form of an asset sale as opposed to a stock sale, which means the buyer will purchase the assets of the corporation and the proceeds will go to the corporation. The corporation will then pay taxes on any profits from the sale. What remains is then distributed to the owners who will in turn be taxed a second time - the “double-taxation” I mentioned earlier. Tax rates vary according to earnings and capital gains rates but, of critical importance, if the C Corp owners are not careful they will pay double taxes on the sale of the company.

If owners of a C Corp are considering the sale of their company in the next few years, they should meet with professional advisors to begin developing an Exit Strategy. The owners’ CPA and a professional business intermediary should be contacted to start developing an exit strategy well in advance of the sale. For example, it may be desirable to make an S Corp election and take advantage of favorable tax strategies now available under the American Recovery and Reinvestment Act of 2009.

We, VR Huntington Business Group, have on numerous occasions advised our clients to consult with their CPA regarding how they can minimize their tax burden by classifying the sale as one that predominately includes personal goodwill. This structure may be applicable and can substantially reduce the taxes on the sale of a C Corp. In other cases the owners’ CPA or other advisors may be able to develop alternative tax strategies to substantially reduce the tax liability. There are, as noted above, advantages to C Corporations but when selling a C Corp the owners must plan carefully and well in advance.

In summary, VR has often been contacted by owners of C Corporations that it most cases should have considered converting to an S Corp many years earlier. These owners are now presented with significant hurdles that advance planning could have avoided. We find that many middle-market business owners, unfortunately, do not understand the effects that a C Corp status has, not only on the eventual price the owner will receive for the business and the taxes to be paid on the sale, but also on the challenges that a C Corp status presents in marketing the business.

Focus should be on advance planning – VR Huntington Business Group offers consultative services to ensure against the pitfalls that many C Corp business owners should avoid before selling their business.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

Understanding how much money the business owner is truly making is one of the most difficult, if not THE most difficult aspects of buying a business. If the 5.6 million-word tax code doesn’t make it difficult enough, business owners and their accountants sometimes only add to the confusion with their “creative” bookkeeping techniques.

You’ve probably heard a dozen terms that describe the profits of a business – Cash Flow, True Owner Net, Seller’s Discretionary Earnings (SDE), Seller’s Discretionary Cash Flow, Owner Benefit, EBITDA – these terms all pretty much answer the same question … How much money does the owner really make?

What you have to understand and accept first, before even looking at a financial statement or report, is that the objective of a business owner is to make as much money and pay as little tax as possible, and that “good” accountants and CPAs find ways to help business owners accomplish this goal. This can make your attempt to determine true cash flow a little more difficult but always keep one thing in mind – business owners have to prove what they claim.

Recasting

The first step we take in determining a business’ cash flow is to recast the financials. Recasting financials is a fancy term that simply means we “correct” them or adjust them to provide a more accurate picture of what the business is truly producing in regards to profit. When we recast financials, we are looking for expenses to “add back” into the net profit of the business – we call these items add-backs or fringe benefits.

Personal Expense

As a rule-of-thumb, anything that is a personal expense is an add-back. This commonly includes items such as family cell phone plans, family health insurance coverage, personal vehicles and meals. Keep in mind that some of these items could be a combination of both personal and business expenses, so we must be careful only to add back the portion of the expense that is truly for personal use.

Discretionary Spending

In addition to personal expenses, we also have discretionary spending to account for. These expenses can include charitable donations, excessive legal fees or season tickets to a local sporting venue. What we are looking for here are specific items, although they are often legitimate business expenses, that are not mandatory to operate the business – hence, discretionary, meaning a new owner can choose not to spend this money and the business will not suffer.

Non-Recurring Expense

Another major add-back can be the one-time, non-recurring or extraordinary expense. Maybe a business owner paid cash for a new piece of equipment or maybe there was a major repair that had to be done to the building after a storm. These are examples of legitimate business expenses that were unique and only appear once in several years of financial records. We add those items back in because they skew the “normal” cash flow picture of the business.

Owner’s Salary

Don’t forget about the owner’s salary, or any payouts to partners or other family members that are shown as expenses. We add these items back too. They are the easiest expenses to add back because the owner could very easily choose not to pay himself a salary and those dollars would simply fall to the bottom line profit of the business.

EBITDA

Finally, a note on EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization. This simply refers to a business’ profit before any interest, certain types of taxes, depreciation and amortization are deducted as expenses. Any CPA will tell you that EBITDA is universally accepted. Although EBITDA becomes less and less relevant as businesses become smaller in size, those items are still added back in our recast.

So once we have examined the financial statements and determined what personal expenses, discretionary spending, non-recurring charges, owner’s salary and EBITDA items should be added back, we have completed the recasting of the financials. Now we have a very clear understanding of what the business’ true cash flow is. Think of it as a pot of money at the end of the recasting rainbow – then it’s up to you as the new owner of the business to determine how you want to run your books, and allocate those funds accordingly to empty your pot as you see fit.

Jeremy Furtick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

VR Huntington Business Group is active in the middle-market sector and defines this sector as being one comprised of companies with revenues between $10 million and $200 million.

There are many complexities surrounding an M&A transaction, but arguably the key component is the valuation. Attention should be directed to the value drivers of a company with a specific focus upon those drivers that can enhance value for the client company owners. While many professional intermediaries lack the consultative expertise to advance its clients interests, VR Huntington Business Group recognizes the benefit its clients derive from a broad offering of services. Our ability to identify value drivers and to effectively advise our clients will vastly expand the likelihood of a successful transaction.

We believe the following nine value drivers will enhance a valuation and strengthen a client’s company position while being marketed:

#1: The Customer Base

The customer base of the company being acquired is a primary focal point. What percentage of sales is generated by repeat customers? How many new customers have been acquired annually over the past few years? Is the customer base stable? Is there a concentration of customers and how will economic fluctuations and impact the customer base?

#2: Recurring Revenue

Recurring revenue from the customer base provides confidence to a buyer that the revenue streams can be sustained. What percentage of sales is recurring? Will the combination of revenues from the acquiring company and the acquired company create an opportunity for a higher recurring revenue percentage of the total when the deal is completed?

#3: Product Integration

A major reason for making an acquisition is to acquire a new and complementary product line so that the acquiring company can leverage its current distribution system and, therefore, increase revenues and gross margins.

#4: Gross Margin

This is often the most important line item on the P&L. A detailed analysis must be completed to determine whether an acquiring company can improve gross margins.

#5: Intellectual Property

Intellectual property includes trademarks, patents and copyrights, but it also can refer to a process such as a unique method to generate sales leads and close sales. Proprietary processes should be closely examined – these processes can add considerable value.

#6: Human Capital and Management Depth

Post-sale integration failures of the past are largely the result of management departing after the deal is closed. When valuing a company that is for sale a close look at the human capital of the organization is a necessity. Also, does the management team have substantial knowledge and can they add value to the new management team?

#7: General and Administrative Leverage

Almost as important as gross margin is the general and administrative leverage when combining the acquiring company and the company to be acquired. Careful planning is necessary in this area prior to the LOI stage since synergies carry value.

#8: Sales and Marketing Effectiveness

Another important element of a successful transaction is to determine whether the company has developed an effective sales and marketing model. How long has the model been in place and what are the historical results of the model? Is the model scalable through the forecasted period?

#9: Barriers to Competitive Entry/Competitive Differentiation

Barriers to competition are becoming more difficult to identify, as many companies are reluctant to file for patents even if a technology or process is evaluated to be “protectable.” Buyers seek effective barriers to competition when evaluating a potential acquisition through competitive differentiation.

Conclusion

In today’s tough M&A environment, the professional intermediary must analyze the numbers and make solid recommendations based on that analysis. It also is more important than ever to concentrate on these value drivers when advising middle-market clients on maximizing value during the transaction process.

Mike Derrick is a Senior Business Intermediary with VR Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.

When you stop and consider all of the different factors that lead to the success of selling a business, no one single aspect is more important than the price. You have probably heard the old saying “you make your money in real estate when you buy.” Well, a similar statement can be made about successfully selling your business …

“The success of selling your business is determined when you price it.”

I believe there are three ways to price a business – unfortunately two of them are disastrous for the seller. Price the business too high, and buyers will steer away from the listing. Price the business too low, and you don’t get the full value you deserve. But if a value for your company can be generated using proven methods and applicable research, then the ultimate of goal of pricing the business fairly and correctly can be achieved.

So how do you generate this value? If I was guessing, I would say that you have probably heard of ways to value your business – from a CPA, another business owner or from a book or website. Although some of these “tips” may be relevant, a true professional opinion of value is the only way to give yourself the piece of mind that your business has been valued correctly.

The Huntington Professional Business Valuation is a tool that combines the most relevant valuation models used today, along with industry research and business analysis, to produce a fair market value for your company. We don’t just consider one valuation technique – we utilize several ways of looking at your business and evaluate which carry the most weight.

This valuation is an invaluable tool for all parties involved in a transaction – we are able to determine the marketability of your business, you are able to determine if this is the right time to sell based on understanding how your business is priced, and buyers enjoy the confidence of knowing the price they are considering has a substantial amount of research and analysis backing it up.

Don’t leave such an important aspect of selling your business to chance. When it comes to establishing your asking price, make sure you have the analysis and methodology behind the value to support it. In the end, this type of diligent attention paid to your valuation will pay off in a faster, smoother and less-frustrating transaction.

Jeremy Furtick is a Senior Business Intermediary with Huntington Business Group Inc. a VR Business Sales firm in Dallas (www.vrbigd.com).

VR Huntington Business Group, located in the heart of the DFW Metroplex, serves the entire Dallas-Fort Worth Metro area as well as North Texas. The company specializes in Business Brokerage, Mergers & Acquisitions, Business Valuation and Consulting services focusing on small businesses and mid-market companies.