Selling Your Business – Calculating What You Get to Keep – Part Three

March 20, 2012 - by Jarrett Davidson

Who cares what you sell your business for? How much of it do you get to keep? This is the final in a three-part series explaining the math behind selling your company.

Part 1 – Enterprise Value
Part 2 – Equity Value
Part 3 – Net Proceeds – Asset Sale vs. Share Sale

Net Proceeds – Asset Sale vs. Share Sale

Enterprise Value of an operating business is typically estimated without consideration of the eventual mechanism of sale, that is an asset sale or a share sale and the associated impact on the tax attributes of the business in the buyer’s hands.

A buyer will typically have a preference for an asset sale as there may be positive tax attributes available (increased depreciation expense allowed in future) from writing up the acquired assets to fair market value. There is also a perception of lower risk since the buyer is not assuming risk for the existing corporation and its historical operations.

Sellers in Canada who qualify for all or a portion of their lifetime capital gains exemption of $750,000 per person on shares of a Canadian controlled private corporation will have a clear preference for a share sale. The magnitude of this tax exemption benefit is such that a share sale becomes a virtual requirement on the sale of a small or medium sized enterprise owned by two or more individuals who qualify, as it is very difficult to bridge the tax exemption benefit gap by any reasonable price increase in an asset purchase offer. Sellers in this position can expect that a buyer will want to discount the purchase price by at least the amount of the lost tax attributes if they are willing to proceed by way of a share purchase. It is customary for the seller to obtain an estimate of the Net Present Value (NPV) of the lost tax attributes for the buyer from their accountant so that they are well prepared for negotiations. Share sellers can also expect a higher holdback against representations and warranties to be required. This holdback may be 15% of the purchase price for 18-24 months to offset the additional risk assumed by the buyer.

Purchase offers drafted by buyers are often specific on price, but are usually deficient in outlining how that price will be paid and the mechanism(s) for any adjustments. Any ambiguity in this regard should be addressed by further communication with the buyer before you and your professional advisors invest time in analyzing the offer and considering a possible acceptance or counter offer.

Asset Purchase offers are more difficult to analyze in that there are unlikely to be any numbers you can directly compare to your expectations on Enterprise Value and Equity Value. The proposed purchase price will typically be for all or a select group of assets and may or may not include provision to assume select liabilities and contracts. It is then necessary for you to estimate the additional proceeds you are likely to realize from the disposition of assets that are not included. A typical example of assets that might not be included would be accounts receivable, as buyers do not like to take the collection risk on past sales. The next step is to consider the extent of balance sheet liabilities (for example accounts payable) you will be required to pay out of the purchase price that would typically have been assumed by the buyer in a share purchase. You will also have to estimate the costs for severance for employees or the exit from contracts such as premise leases the buyer is not assuming. These costs would typically be assumed by the buyer in a share sale. You will then be able to estimate the implied Equity Value after considering any surplus cash, redundant assets and interest bearing debt; the impact of which was reviewed in Parts 1 and 2 in this series.

A Share Purchase offer is easier to analyze as the purchase price will be directly related to Equity Value since the buyer is buying your equity in the company. You will still have to consider any proposed adjustments, excluded assets and excluded costs. Keep in mind the Equity Value (and typically the purchase price) includes all bonuses payable to the owners, shareholders’ loans, related party debt, preferred share capital, common share capital and retained earnings.

Shareholders’ loans, related party debt and share capital represent tax paid money. The following discussion on taxation is relative to the balance of Equity Value arising from retained earnings and any gain on sale.

In the case of an Asset Sale, you will retain your corporation and have the opportunity to continue to use it as a holding company. There is significant complexity in tax legislation and calculations and you will need specific professional advice. It is typical for the total corporate and personal taxes to move the funds to your hands will be 30-40% of the Equity Value arising from retained earnings and any gain on sale.

In the case of a Share Sale, any gain above the cost base of your shares will be taxable as a capital gain. Capital gains are taxed at half rates. If you qualify for all or a portion of the $750,000 lifetime capital gains exemption, then the amount you qualify for will not be taxed. The balance, if any, would be taxed at the favourable 50% of normal rates applicable to capital gains.

An example that is value neutral to the buyer may be helpful. Transaction costs which are likely to be similar for the two options are excluded for simplicity. We’ve assumed a sale involving two shareholders with availability of the maximum exemption of $750,000.

 

Note: If the vendor were to net $1,724,900 in an asset sale the purchaser would need to pay an additional $882,000.

Lesson learned

It truly is all about what you get to keep and not just what you sell your business for.

Our Corporate Finance team can help you figure out this math and present it to you in a language you can understand. We promise. Why? Because we are business owners, too.

Negotiate Better

November 4, 2010 - by Joel Lazer, CA, CIRP

Originally published on April 13, 2006

Negotiating is something we all do. We start negotiating as children. All children negotiate bed times, what’s for dinner and whether they will eat it, and so on. As an adult we have a much broader range of negotiation partners. They can include relatives, friends, co-workers, employers or employees and strangers. Sometimes we get the assistance of professionals and sometimes we do our own negotiating.

Herb Cohen, author of You Can Negotiate Anything, has a piece of advice worth repeating here. Herb says, “Never negotiate with your children.” His belief is, you cannot win a negotiation with your own children and so don’t start.

There are many principles of negotiating, as well as many styles and tactics. My personal belief is, we are all better off if we can get to win/win solutions and look to increasing the pie as opposed to viewing the world as a zero sum game. Sometimes that is hard to accomplish, yet, like many difficult things, the reward is worth the effort.

Being empathetic is of utmost importance if you are to be a successful negotiator. Empathy is the ability to understand and feel for the other side. The ability to see and understand the other side’s issues, interests and hot buttons will allow you to navigate the unknown with surprising ease. It is relatively easy to see our side; we live it. It’s also important to differentiate your position from your interest. A position is a stance you take on a particular issue believing it will get you what you want or satisfy your interest. Your interest is what you want which may be satisfied by your position or some other position you may not have considered.

There it is. If you can determine the other party’s interest and satisfy it with a position that is not in conflict with your interest, you have the makings of a successfully negotiated deal. In order to determine the other party’s interest you must be able to see where they are coming from, what might be acceptable to them, and what cannot be negotiated.

We all pay attention to the big items. To get their interest, pay attention to the little things. Inquire about what they tell you. Ensure there is no uncertainty. When they say they need a particular position ask them to explain why. Do it so you can understand where they are coming from. You must question without being judgemental and without disagreeing with their position. They believe they have valid reasons and your disagreement on that will only spread your positions farther apart. Even when you think you know their interest, keep enquiring. Do this to ensure you have got it right and to determine of there is a secondary or tertiary interest that might come into play. After you have the interests, test out some solutions that will satisfy your interest as well. Remember your interest, too, may be satisfied with a position you had not previously considered.

My favourite negotiation exercise is the one where both parties need an orange and there is only one. Each side takes the position that they need the orange. It turns out that one needs all the juice and the other needs all of the peel. It is rather easy to resolve once the interest of each is discovered. The exercise is enlightening.

If I can assist with any of your negotiations or you would like to discuss theory I would be glad to hear from you.

Quality of Negotiation… Quality of Life

September 23, 2010 - by Joel Lazer, CA, CIRP

Originally published on February 22, 2000.

If I were to suggest a bit of advice for successful negotiations it would be, build trust. If someone trusts you then they will listen to your communication. If they do not trust you then it does not matter what you say or do, it will be viewed with suspicion. On the other hand if someone has complete trust, even if they do not believe what you say, they will look for ways to believe – “It just might be…”

Trust is something you merit. People must give it to you. People make assessments of all your actions and words. If the things you do and say are consistent with their views, they are more likely to trust you. If they have had previous successful dealings with you, they are more likely to trust you. If they have known you for a long time and have had no bad experience, they will more readily trust you. If they have no information, then you start with no trust. They may check with others if they do not know you to see what their experience has been. Trust is delicate. It is so easy to lose. Never be casual with someone’s trust in you.

My second bit of advice is, listen. Listen again. Now listen some more. Are you listening? All too often in a negotiation we fail to listen to what is important to the other side. We think we know what their interests and problems are and we try to satisfy them. Even if you are bang on with your pre-negotiation research it still pays to verify that research. By listening. Listening will show the other side that you are interested. It will allow you to respond to their needs and interests. It will help you not to negotiate with yourself. If you think the other side is after lower prices, you’ll reduce yours to satisfy them. If you’re right, great. But what if faster response time was their concern? Now you have to produce a faster response and at a lower price. Because of course once you have offered a concession you cannot take it back. Listening in the first instance will have saved you a lot. Tying in with my first bit of advice, listening also builds trust.

Listening does not mean you have to be passive. By speaking first you will direct the conversation. By asking open-ended questions you will get to know what is on their mind. Asking yes/no questions will result in yes/no responses; not much to listen to there. Compare, “You like our new flange model, don’t you?” with, “What is it that you like about our new flange model?” You’ll learn more with the second question.

Finally, utilize your team. Team could include all internal people or it could include outside resource people or a combination. TEAM – Together Each of us Achieves More. It’s true. To do any negotiation without the assistance and benefits provided by your team is unwise. Together there will be a variety of ideas and viewpoints. It will be easier to see the other side’s point of view. Together there is less likelihood of overlooking something. In the above example, perhaps faster response will cost more. Your team could discover and discuss this before, not after, the negotiation. Others will also provide objectiveness. Perhaps you are too close to the subject matter. If so you will need assistance in the meeting itself. Your team can help, but you have to let them.

Now here’s the best part. Building trust, listening, utilizing your team – consider them in negotiations, consider them also in life. Apply each one of these in your family and friend relationships, in everything you do, and you can’t help but reap the benefits. It’s a win-win situation.

Negotiation and mediation are favourite topics of mine. I would be delighted to discuss the theory, your particular views, and your negotiation successes. I’ll listen – trust me.

Considering Selling Your Business? Wear a Buyer’s Hat!

April 28, 2010 - by Steven Stang, B.Sc. (Hons), MBA

Many business owners are planning to sell their business within the next 5 to 10 years.  If you’re one of them, using your business skills to think like a buyer can help you increase your exit proceeds.  Consider the following buyer tactics and issues in your sales process.

WAIT AND SEE.  Buyers adopt a wait-and-see approach to get the best price when you need to sell.  As a seller, then, you’ll need to contact multiple potential buyers and manage the time line for a competitive sales process and timely outcome.

TOO BUSY.  Buyers have limited time to determine if an owner is serious about selling, to identify the value in the business, and to do their due diligence.  You can increase the number of potential buyers by clearly identifying the value in the business, preparing an effective sales package, and having material contracts readily available.

BUY LOW.  Buyers like to take advantage of negative trends and buy low.  You will increase value when you time your exit to coincide with growth and good market conditions.  It is better to sell your business before you reduce your time commitment and take your foot off the gas.

LOWBALL OFFER.  It is human nature for buyers to lead with a lowball offer.  You will need to convince the buyer of the value of the business rather than to react emotionally and walk away.

VENDOR TAKE-BACK.  Buyers prefer vendor take-backs to reduce their equity requirements.  You will need to attract multiple buyers to insist on cash offers.

DEAL FATIGUE.  A business sale typically takes 3 to 12 months to conclude and deal fatigue can easily set in.  Be responsive to information requests and maintain a positive focus on closing a transaction.

 At Lazer Grant Corporate Finance Inc. we are used to assisting our clients in wearing both buyer and seller hats.  We would be pleased to assist you, too.