If you are considering selling your business in the future, the best time to prepare for a potential sale is now. It is best to discover deficiencies and non-compliance before a potential buyer enters the picture, as it provides the seller with the opportunity to correct issues and increase the value of the business.
Here are key factors to consider as you prepare your business for a future sale:
- Due Diligence: Reverse due diligence, also known as sell-side due diligence, involves having a third party assess your company the same way a buyer would, allowing you to understand the company’s strengths and weaknesses prior to taking it to market. The reverse due diligence report will include a quality of earnings, quality of assets, tax due diligence, commercial due diligence, and operations. This will provide the seller with an opportunity to explain or correct issues, assist in preparing for questions and document requests, and minimize the potential for surprises from the buyer’s due diligence.
- Nexus studies: A nexus study documents the businesses activities in a state and whether it creates nexus for that state. In addition, the study determines the tax-filing requirements in that state such as sales & use tax, income tax, franchise tax, employee withholding tax, etc. Each state has a different set of nexus laws and over the past few years, nexus laws have changed frequently due to the Wayfair decision, COVID-19, remote employees, and switching from physical presence to economic nexus. Companies that are continually expanding their footprint need to be proactive when it comes to nexus so they can assess the impact on their business and avoid the risk of costly state audits.
- Tax planning: Lastly, you should consider the desired structure of the sale transaction and the after-tax proceeds. Typically, businesses are either sold as an asset sale or a stock sale.
In an asset sale, the seller retains possession of the legal entity and the buyer purchases individual business assets that make up the company. An asset sale is more commonly utilized in smaller transactions and more advantageous to a buyer. The asset sale allows a buyer to receive a favorable “step-up” in the business assets, thereby allocating a higher value to fixed assets in the purchase price. The buyer can immediately expense these assets utilizing bonus depreciation. On the flip side, sellers tend to avoid asset sales because a portion of the gain may be subject to ordinary recapture on previously depreciated and amortized assets. In addition, the gain may be taxed in multiple states.
In a stock sale, the buyer purchases the seller’s stock directly, thus obtaining ownership in the seller’s legal entity. The buyer loses out on the “step-up” and cannot re-depreciate the assets. However, the buyer would retain any carryover attributes, such as net operating losses. The stock sale is treated as selling a capital asset subject to the current 20 percent capital gains rate. With the ever-changing tax landscape, the buyer should consider tax planning using multiple scenarios to best understand the after-tax proceeds and most beneficial outcome.
There are many strategies and items to consider when contemplating the sale of your business. It is best to prepare as far in advance as possible, and it is important to consult with legal counsel and accounting professionals to fully understand the issues and reach a decision that will produce optimal results.
Emily Wahl is a Manager in Kreischer Miller's Tax Strategies Group. Contact her at Email.
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