Buying and Selling Businesses: The CPA's Role

Become the key advisor to your client or employer that is buying or selling a business. Your advice will impact your client for years to come! Lead the team of advisors with a keen overview of the transaction in addition to specific tax and accounting technical advice. Buying and selling a business involves more than calculating a transaction gain or loss; it must be valued, due diligence must be conducted, and various stakeholders will be impacted.

OBJECTIVES

• Understand deal factors and become acquainted with the team of advisors involved with the transaction
• Familiarize oneself with due diligence procedures and transaction documentation
• Understand the basics of alternative valuation methodologies
• Analyze the gain/loss of asset-based or stock-based transactions
• Identify key buyer groups and the impact of a sale on them
• Structure compensation alternatives for buyers and sellers

PREREQUISITE Experience in business taxation.

In this video, Scott D. Miller, CPA, president of Enterprise Services, Inc., a Wisconsin-based firm providing guidance to businesses on strategic transition planning, discusses the sale of a business with Karin M. Gale, CPA, CM&AA, Shareholder of Schenck Business Solutions in Milwaukee, WI; Dennis Roberts, ABV, CVA, Chairman of the national investment bank The McLean Group LLC in McLean, VA; and Andrew J. Sherman, J.D., Partner in the Corporate & Finance Practice at the law firm of Dickstein Shapiro LLP in Washington, DC and author of Mergers and Acquisitions From A to Z: Strategic and Practical Guidance for Small- and Middle- Market Buyers and Sellers (AMACOM).

*(145-min. video) The DVD disk contains the video presentation and a viewable copy of the Manual.
**The Additional Manual is for group study training only. Unlike other formats, it has no exam answer sheet and cannot be used to earn self-study credit.

Accepted for CFP(R) credit

Overview

Course Goal

This course is intended to provide insights into the often complex world of business transactions. Due to the myriad details typically accompanying such transactions, the CPA's technical training, objectivity, and orientation to detail qualify most professionals as valued advisors in this arena.

The materials in this course span the spectrum of issues related to business transactions ranging from the exploration of the reasons why the business is sold; how to value the company; due diligence for the buyer and seller; financial planning and tax efficiency.

Introduction

All closely held businesses will be sold or transition from one owner or group of owners to another at some point. It is only a matter of time. Indeed, one could argue that closely held businesses are in the perpetual process of transitioning and evolving. This dynamic process compels the business to adapt to the changing nuances of the market. Eventually, the process of transitioning will result in a transaction of some form. For our purposes, a "transaction" is generally defined as a change in the controlling ownership of the business.

There are a wide range of transaction options available to business owners. The progressive and enlightened business owners will embrace the transition process and elect a transaction structure of their choosing. Other business owners will elect to resist the inevitable and fail to plan adequately for the transition process. In such cases, those business owners will almost certainly be very disappointed with the transaction results. This course is largely aimed at business owners and their professional advisors that embrace the transition process. Anticipating the process and mastering its demands will result in the attainment of goals.

Since the world of buying and selling companies is so complex, a number of key assumptions are stated to place into perspective the general scope of these materials. This course is intended to illustrate the most common transactions. The following assumptions apply:

• Arm's-Length Transactions - This course generally addresses a transaction between arm's-length parties. This assumption is important because there are very complex rules and regulations that apply to related parties. In most cases we will assume that the business is being sold to an independent third party. We will briefly consider the full range of buyers in Chapter 7 to address major issues with each group.
• Corporations - We assume that the subject company is a corporation, either an S corporation or a C corporation. Since S and C corporate transactions are typically treated differently under the tax statutes, we will highlight material differences. We will not consider partnerships, limited liability companies and other pass-through entities since such legal forms are often highly dependent on state and local regulations.
• Profitable Transactions Reporting Gains - We generally assume that the subject company is profitable and that the proposed sale will produce taxable gain to the selling shareholders. We will address stock transaction attributes with a brief consideration of Net Operating Losses (NOL) in Chapter 5, but the topic of applied NOLs is exceedingly complex and beyond the scope of this course.
• Commercial Real Estate Excluded - The examples in this course generally exclude commercial real estate. The regulations and depreciation rules for commercial real estate are very complex. Most business owners, if they have received thorough financial planning advice from their CPA, should exclude real estate from their operating company and not comingle the two. Longer term, there are compelling financial reasons to separate commercial real estate from the operating company. For the purposes of this course, the "operating company" refers to the core purpose of the business.
• Standard References - There are many examples in this course, and there is always a target company. For expedience, we will refer to the corporation that is for sale as Seller Company, Inc. ("Sellco" or the "Seller"). We will refer to the corporation that is purchasing the target as Buyer Company, Inc. ("Buyco" or the "Buyer"). Generally, if we are discussing an individual, such as a shareholder, we will use a generic name like "Smith" or "Jones." We will be gender neutral whenever practicable, and will mix references such as Mr. and Ms. periodically throughout the materials. Finally, the Internal Revenue Code will be referred to as IRC.
• Assumed Tax Rates - For illustration purposes, the following tax rates are assumed. The Federal C corporation rate is 35%; the Federal capital gain rate is 15%; and the effective Federal individual income tax rate is 38%. We will not formally consider nor attempt to quantify state and local tax rates. We know that state and local tax rates are typically an integral part of the planning process, but such planning is often discrete to the individual state or locale. Where applicable and when such taxes are material we will indicate that state and local taxes need to be considered.
• Use of Example Documents and Documentation - In many of the chapters sample documents have been provided for learning objectives. These documents are included only for learning purposes and are not intended to be used as actual transaction documentation. Actual transactions require the engagement of experienced legal counsel and other applicable professional assistance. Only experienced and appropriately licensed professional assistance should be engaged for an event as important as the sale of a business.

If a CPA aspires to be a strategic advisor to the business owner of a closely held company, a wide range of business knowledge is required. One important practical area of expertise is transition planning. All businesses are in transition, and over time the process of transitioning will result in a business transaction. We have defined the business transaction as a change in control of the company. The following list includes a number of the important reasons for a CPA in either industry or public practice to understand transactions:

• Transactions are inevitable - Being prepared for this eventuality is an important aspect of your professional development.
• Optimize the business owner's transaction negotiating strength - For CPAs in public practice, knowledge of the transition process that eventually results in a transaction is a very high added value service that can be provided to clients. In business, you do not get what you deserve, you get what you negotiate. This axiom especially holds true in the transaction environment. You are typically in the strongest position to negotiate when you have viable options. When considering transactions, knowing the range of alternatives to structure possible deals is important in developing viable strategies.
• Transactions often involve succession planning - Transactions often involve succession planning where the control of the business is passing to a new generation of leaders. With proactive involvement by the public practice CPA, you may have a significant impact on being able to articulate succession alternatives that result in preserving the client relationship. Transactions involving family members, company management, or an Employee Stock Ownership Plan and Trust (ESOP) are common examples of situations where the client relationship is retained. Knowing the attributes of successful transactions involving these principles is often a key aspect of retaining the client relationship. If no succession guidance is provided, business owners may opt to sell the company to a third party with catastrophic results for maintaining an ongoing relationship.
• Transactions that do not relate to succession planning - Other transactions will focus on acquiring or divesting a business for operational reasons not typically related to succession planning. If you bring to the client relationship table a strategic understanding of deal structure, this high level of service is a candidate for appropriate compensation and cementing a long term client relationship.
• Knowledge of structuring business transactions helps mark the CPA as a valued strategic advisor - All CPAs in public practice and industry with knowledge of this complex area of application will be regarded as valued strategic advisors. Transactions are typically very complex situations with a host of behavior considerations along with the myriad complexities of regulatory and tax constraints.
• Business transactions may be related to operations - For the CPA in industry, business transactions often represent one of the most fascinating and rewarding activities of the CFO function. Clearly, involvement at this level marks the industry CPA as an invaluable member of senior management.

Chapter 1 - Business Transaction Basics. This first chapter sets the stage for the analysis of the transaction environment. Several important concepts are emphasized, such as understanding the nature of the negotiating environment; gaining negotiating strengths to facilitate a more desirable outcome; assembling a team of advisors and realistic expectations for getting the transaction closed.

Chapter 2 - Introduction to Due Diligence and Key Documentation. Almost immediately with the consideration of selling a company, there is the challenge of discharging due diligence. We begin with the seller's due diligence, which is basically to help themselves by listening and learning. We strongly believe that the seller should proactively embrace the transaction process and attempt to be in control as much as possible. This typically means understanding and accepting best practices in developing a comprehensive exit strategy. From a purely legal perspective, the seller typically does not have the same due diligence obligations as the buyer. From a financial perspective, the seller has everything to gain by developing an exit strategy. The buyer has the major obligations under due diligence to insure that what is being acquired is as represented. Due diligence check lists are provided for both the seller and the buyer. Selected sample documents and agreements are introduced in this chapter for learning purposes. A partial listing includes a seller and buyer due diligence check list; confidentiality agreement; nonbinding letter of intent; corporate resolutions and closing documents check list.

Chapter 3 - Valuation Considerations. This chapter on valuations is included largely as an enhancement to the transaction arena. The primary focus of the materials is on the fundamentals of buying and selling companies, but providing some insights into how the transaction amount is determined is an integral step to having CPAs become essential advisors. In this chapter a careful distinction is made between smaller companies and larger corporations. Smaller companies are arbitrarily defined here as entities with under $1 million in revenue and less than 10 employees. Conceptually, such smaller companies have essentially provided employment to the owner under the most favorable circumstances where the owner determines salary and benefits. Valuing the business under this working definition is often beyond the scope of classic valuation and capital market theory as the business is too small. We have found that the valuation of such smaller entities is complementary to time-honored rules of thumb. Our resources on providing insight into the operative rules of thumb will be disclosed. Larger companies by way of revenues and employees will be far stronger candidates for traditional valuation approaches. We will offer overall insights into the most common valuation approaches as an enhancement to gaining transaction understanding.

Chapter 4 - Analysis of Asset Based Transactions. Closely held companies will typically transact as an asset based sale. There are compelling tax and legal issues that favor this type of transaction structure. We begin with a brief consideration of the inherent bias toward assetbased sales. We also examine the asset allocation requirements under IRC Section 1060, and the reporting of those results in tax returns. We also consider the financial results of selling assets in an example manufacturing company and an example professional services business both from the perspective of a C corporation and an S corporation. Strategic tax planning considerations are emphasized throughout the chapter. To the unprepared, there may be some unpleasant tax surprises if there is no advanced planning. This chapter includes an example asset purchase agreement and a number of other appropriate legally oriented exhibits.

Chapter 5 - Analysis of Stock-Based Transactions. Sales of stock between independent parties are far less common for closely held businesses. When they do occur, they are typically less complicated than asset-based transactions. There are tax incentives for business sellers to prefer stock sales, but those reasons are often outweighed by negative aspects to the buyer. This chapter also considers the financial results of selling stock in an example manufacturing company and an example professional services business both from the perspective of a C corporation and an S corporation. We also briefly consider tax attributes such as the broad application of Net Operating Losses; electing a tax deferred tax transaction by selling to an Employee Stock Ownership Plan and electing IRC Section 1042 status; along with IRC Section 338 transactions, whereby stock sales are taxed as an asset transaction. This chapter includes an example stock purchase agreement.

Chapter 6 - Transaction Terms. All of the examples in Chapters 4 and 5 assume that the sale of the target corporation is accomplished in a single moment for cash. Of course, this assumption exists only in the world of academic illustrations for teaching purposes. Such transactions seldom exist in the real world. The universe of business transactions is a highly negotiated environment, and typically a full range of details will be decided by the parties. For the sake of expedience, anything beyond an all-cash price relates to the terms of the deal. This chapter will explore the most commonly encountered terms. Such items include escrow accounts; seller financing; installment sale parameters; performance based contingent payments (earn-outs); employment or consulting agreements; non-competition and non-solicitation agreements; broker fees and transaction costs. This chapter contains a number of example documents, such as an escrow account agreement, seller finance documents, consulting agreement, and a brokerage agreement.

Chapter 7 - Buyer Groups. Generally, the example transactions focus on arm's-length results. This chapter examines the spectrum of candidate buyers. We begin with a consideration of "inside" buyers, most commonly family members. There are Federal regulations that address potential conflicts of interest between related parties which are very complex in many instances. We also consider buyer groups such as key employees and an Employee Stock Ownership Plan (ESOP). Key employees often represent the sentimental favorite as a buyer, and ESOPs enjoy substantial tax related incentives. Outside buyers are divided into two groups. The first group is the strategic buyer, typically representing an entity already familiar with the business, such as a competitor, key supplier or an important customer. The second group represents a financial buyer, or an entity that has the ability to pay the transaction price but brings few if any strategic advantages to the transaction. The option of an Initial Public Offering (IPO) is briefly considered, but it is rarely a real option for most closely held businesses. Finally, we consider the option of liquidating the business.

Chapter 8 - Closing and Attributes of Successful Transactions. This chapter reviews what is typically required at the date of closing. In this regard, the importance of a transaction quarterback becomes very apparent. In most instances, the transaction quarterback is a law firm with extensive transaction experience with an important assist from the CPA. Typically, the last few days prior to the close are a period of tremendous energy as all the applicable documents must be readied for signatures. Finally, we review our experience with regard to the best attributes leading to a successful sale.

Chapter 9 - Resources. This seminar is intended to provide an overview of the most common transactions typically involving closely held companies. This chapter identifies a number of resources for further reading and research.

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