In order to navigate the sale minefield and to come up with a fair negotiated deal, you will require a team that includes a strong lawyer(s), accountant and maybe even a mergers and acquisitions consultant.
With all that to look forward to, I figured I would provide some of the meat and potato issues you will also have to solve and negotiate.
Assets vs. Shares
In general, the sale of shares will yield a better return for the seller than the sale of assets, especially if the vendor(s) have their $750,000 Qualifying Small Business Corporation (“QSBC”) capital gains exemptions available. However, the purchaser in most cases will prefer to purchase the assets and goodwill of a business for the following two reasons: (1) The purchaser can depreciate assets and amortize goodwill for income tax purposes, whereas the cost of a share purchase is allocated to the cost base of the shares (2) the purchaser does not assume any legal liability of the vendor when they purchase assets and goodwill; whereas under a share purchase agreement, the purchaser becomes liable for any past sins of the acquired corporation (of course, the purchaser’s lawyer will covenant away most of these issues as best they can).
Consequently, the purchaser typically wishes to buy assets whereas the seller wishes to sell shares and thus, the first negotiation point. Whichever way it goes, the buyer knows why you want to sell shares and will typically discount the offer when buying shares instead of assets.
Working Capital (“WC”)
WC is the difference between current assets and current liabilities and measures the liquidity of a company. In simple terms, working capital is cash plus accounts receivable and inventory less accounts payable. WC can be a huge bone of contention in any sale, but especially in an asset sale. The purchaser in most cases blissfully assumes they will keep all the WC and also get a multiple of the corporation's earnings as the sale price. The purchaser typically wants enough WC left in the business such that they will not need to finance the business once they have made the initial purchase and contributed whatever cash or line of credit they feel is required upon the initial purchase.
The WC is a very esoteric concept at best and very hard for most sellers to grasp. Thus, it is vital to deal with this issue upfront and not leave it to the end where it can derail a deal, something I have experienced first-hand.
For many acquisitions, especially by public and larger corporations, the multiple is based on Earnings before Interest, Taxes and Amortization (“EBITA”). However, in addition to EBITA, there will be adjustments to the upside for management salaries in excess of the salary that would be required to replace the current owner (typically you are adding back bonuses paid to the seller in excess of their monthly wages and any other family wages). Occasionally the adjustment could be to the downside, but that is typically only in situations where the business is a technology company or similar that is just starting to make money or finalize a desired product, and the owners wages have not yet caught up to market value. Finally, there will be other additions to EBITA for things like car expenses, advertising and promotion, etc. that a new owner would not necessarily need to incur upon the sale.
Where a purchase is made by a private company, instead of EBITA, the price may be based on a capitalization of normalized after-tax earnings or discretionary cash flows.
In most cases, the purchaser will require the seller to stay on for a year or two to ensure a smooth transition. The owner will thus be entitled to a salary for that period in addition to the sales proceeds. The retention period can go several ways, some blow up quickly, some end after the year or two, but often the former owner stays on as the business is now growing due to additional funds or more sophisticated management and they enjoy remaining with their baby without the stress of ownership.
It is not uncommon for a purchaser to require that the seller maintain some ownership in their company so that they still have some “skin” in the game, especially when they will be staying on with the business. This is also the case where the purchaser is consolidating several similar businesses with the intent of going public. In these cases, we counsel our clients to assume the worst (i.e. that the new owner will make a mess of the business) and to ensure they receive proceeds equal to or only slightly less than they initially desired. We have seen several disasters in consolidation purchases where the seller ends up with minimal proceeds after keeping significant share positions with the lure of the consolidated entity going public and the consolidated company just does not have the expected synergies.
I have only touched on a few of the multitude of issues you encounter upon the sale of your business. As noted initially, it is vital to understand the process and how stressful it may be from the start, and to assemble the proper team to help you navigate through the sale process.
The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.
I am the sole shareholder in my corporation and the only asset left in my corporation is a rental property. I would like to close my corporation(not possible to sell and not eligible for $750k capital gain exemption). Can I just transfer the rental property to myself personally and then close the corp.? what are the tax implications? Many Thanks
No. You would trigger a deemed sale in the corp and personal tax issues. You are probably stuck with the property in your corp until u sell it, but your accountant should be able to provide the options, which may be very limitedDelete
I am 50% owner in a family incorporated company. I wish to sell my shares to my business partner due to health reasons. I have not brought it to his attention yet but he has recently employed his son in the business and now I feel it is time I brought up the topic. Can you possibly give me some guidance in what to do?
This is a very complex and delicate situation. You need to have a consultation with your accountant or an advisor to review your tax and business issues before you approach your partner. There are far too many variables for me to even start answering this question.
Regarding QSBC shares, they must be common shares right? If so, I see
that each common share can be voting/non-voting and also participating/
nonparticipating.. Would any common share be eligible for QSBC shares?
Thanks in advance!
I am considering selling my business. To keep things confidential I will only say that I own a company that uses 3D computer technology in the construction industry and that a lot of fabricators will outsource work to us but if the opportunity should arise that they can own the service we provide then some fabricators would be interested. We currently have 3 employees including myself.
On an average year we earn somewhere between 250K to 300K per year. Last year we make of net profit of 65K. All our assets are quite new (computers, software, etc) and would not need to be updated for 3 to 4 years except for annual software subscriptions.
I am trying to determine an very approx. valuation to start the process. I am the sole owner/shareholder of my corporation. We have no debt or liabilities. Just a little guidance and realistic concept of value would be appreciated. Total asset value is approx. $60K-$70K
I would like to help, but (a) I am missing so many facts and (b) I am not a valuator. Also in your industry valuators look at your annual subscriptions as well as EBITA etc. Sorry, but you need to get your accountant involved or hire a valuator who knows your industry.
I will be inheriting a house that is owned by small corporation (it's the only asset of this corp, with a rental unit and owner's unit). Is it better for me to get the (100%) shares of this corporation or just the house title alone?ReplyDelete
This is way too complicated a question for a blog. There are shareholder benefit issues already regarding a personal use unit in a corp, never mind the transfer of that unit. Speak to the corporations accountant or engage an accountant.
Great Blog. My family trust owns 50 percent of the shares in an opco. I am selling them to the other 50 percent shareholder, which is a trust. What is the most tax advantageous way for the purchaser to buy my shares? Should they have a holco and amalgamate with opco so the shares can be purchased with after corporate tax dollars? JodyReplyDelete
Sorry, I dont provide personal tax planning advice on this blog. You should speak to your accountant or the person who advised you on setting up the trusts, they know all the facts of your situation.