Selling a Business: Two New Considerations
As if there wasn’t already enough agita-inducing complexity in the process of selling a business, two new issues have been added to the mix. One, hopefully, will be banished in a few months. The other may not be.
The first, of course, in the Covid virus.
It has made buying or selling a business a bit more challenging from the standpoint that many meetings are now held virtually and not everyone – particularly older business owners – has gotten comfortable with that. But that’s really a minor issue and doesn’t add a great deal of complexity.
But the real issue with Covid and it’s impact on selling a business is the volume of government assistance that has been made available to businesses, the number of business owner that have availed themselves of this assistance and the as yet uncertain rules for paying back that assistance.
In the United States, the most widely used assistance program for businesses has been the Payroll Protection Program (PPP) in which businesses could apply for ostensibly forgivable loans. These funds were intended to help the recipient businesses avoid laying off employees.
The current problem is that final rules for forgiveness have not yet been completely formulated. Some businesses may enjoy complete forgiveness of any PPP loan they received. Others may benefit from partial forgiveness. Still others may be obligated to repay the entire amount.
Until final rules are laid out in detail, the liability of any business that received PPP funding will be unknown. And “unknowns” in our business are not at all helpful in getting deals done.
Right now, PPP loans are the most significant pandemic-related issues impacting all parties when selling a business. Their uncertain status will very likely have an impact on the purchase price, and sellers should expect a buyer’s due diligence to include a thorough review of their PPP application and certifications.
“PPP loans are, in and of themselves, not overly complex, but the rules governing their forgiveness are still being developed,” said Howard Krieger, managing director in CBIZ Valuation Group in New York. “Buyers have to do more due diligence around the loan application and … use of loan.”
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Are There Any Work-Arounds?
For business owners that want to sell more quickly, we’ve seen a couple of proposals from lawyers suggesting that a certain portion of the sales proceeds be escrowed to protect the buyer from any PPP liability.
If you’re a business broker working with a company that has received any PPP or other stimulus funds – or the owner of such a company and you’re thinking of selling – this is an important issue to discuss with a knowledgeable transaction attorney.
If you’re a buyer, the issue is arguably even more important. Hopefully, you’re working with a professional business broker that is aware of the potential pitfalls these programs present to any M&A transaction.
Most prognosticators that I’ve read believe that this issue will fade by mid-2021 as the rules are finalized and determinations are made on who qualifies for loan forgiveness and who doesn’t.
But Julia Carlson, CEO and founder of Oregon-based Financial Freedom Wealth Management Group, recommends that business owners, “go through the loan forgiveness process before you sell your business. You’ll need to provide proof the that funds were used for qualified expenses.”
For business brokers and business sellers, the next six to eight months requires a lot of attention to this issue. If the business you’re representing has been a recipient of any of this government stimulus money, the potential for buyers to ask for concessions to offset any perceived liability is high.
- George Harrison
The other significant issue facing business owners considering selling is one with the potential to be far more broad, more far-reaching and much more disruptive – though only for U.S.-based business owners.
In case you haven’t heard, there’s a fairly significant American election coming up. Indeed, as I write this, the event is only four weeks away. This particular election features two diametrically opposed visions for the United States in almost all respects. But no matter where you stand on any particular issue, one thing business owners – and the business brokers that advise them – must know. The outcome of this election will have a significant impact on how much money a seller will walk away from the closing table with.
The Democrat candidate, Joseph Biden, is promising to raise the capital gains tax substantially. Should he win and is successful in getting that legislation passed, this will reduce the seller’s net proceeds. Depending on the size of the business, the reduction could be significant.
But no matter how large or small the business is, if the seller’s post-closing plans were to be funded by the sales proceeds of the business, either those plans will have to change or the sale will have to be postponed while the owner continues to build the business so that whatever sales proceeds the government doesn’t take will be sufficient to fund those plans.
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When Buyers Become Sellers
If the capital gains tax is increased as proposed by the Biden campaign, it’s an issue that impacts buyers, as well.
Buyers of businesses know that they will eventually sell the business they buy and, assuming they are looking for and calculating a minimum rate of return, they will need to work on growing the business longer – because when THEY sell, they’ll be impacted by the same tax hit.
Business owners – whether they are the current owners of the future owners – are business sellers.
If a buyer has five, seven or ten-year plan, that buyer will look at any business for its potential for growth, factor his or her required rate of return and then establish a value that the business has to him or her. If capital gains taxes increase, the buyer has two options.
- Plan for a longer term of ownership
- Lower the value of the target business.
Obviously, the latter choice will put downward pressure on the valuations of – and thus prices paid for – businesses.
The Bottom Line
I’ve written often about The Silver Tsunami – the so-called Baby Boomer Business Sell-off. It is a real phenomenon that, until governments shut down various levels of the economy, was proceeding a full speed.
A spike in the capital gains tax could cause a noticeable slow down in this sell-off as owners realize that their net, after-tax proceeds are no longer adequate to fund their post-closing plans.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week!