Business exit strategies can take many forms. However, there are really only two primary objectives in any deal. One, the buyer wants to MINIMIZE the consideration paid relative to the after-tax cash flow of the purchased assets or operations, and two; the seller wants to MAXIMIZE the after-tax cash proceeds from the sale. Since both objectives are essentially opposite, having the right exit strategy plan puts the business owner in the driver’s seat. It will not matter if the deal is an asset sale or a stock transaction, as long as the entrepreneur has contemplated and implemented the best business exit strategy.
There are various exit strategies, so determining which is best depends on the entrepreneur’s goals and the successful implementation of a business plan designed to achieve those goals. In a stock deal, liabilities are assumed by the buyer and the existing asset’s basis remains the same. Depreciation continues for the remaining life of the assets and accounting methods don’t change. Licenses and contracts are easier to transfer and are often the key to the future value of the business. In an asset transaction, liabilities are limited and often left for the seller to eliminate. Buyers generally only accept “free and clear” title to the assets they purchase, which gives them a fresh start when establishing an asset basis, usually at fair market value. Asset depreciation starts over with a new asset life, and different accounting methods may now be implemented. However, licenses and contracts may be more difficult to transition.
Under either method, valuation is critical. Purchase price determinations are often based on “multiples” such as a multiple of EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization). Sometimes a purchase price is a multiple of revenue, net income, or even tangible net worth. There are many ways to calculate a purchase price. One critical measurement is the discounted cash flow of the company. A buyer will most certainly want to calculate the future cash flow to help determine the cash value of an acquisition, and the seller will want to know what that value is in today’s dollars. However, at the end of the day, the only thing that matters is the fair market value of the business as determined by what a willing buyer will pay a willing seller. Entrepreneurs can put themselves in the best position to negotiate valuation if they have done their homework on their business exit strategy.
Are you ready to sign the papers? Not so fast! If you have not analyzed the future impact of the deal, the terms, and the on-going obligations, you are not ready. Buyers will conduct some form of due diligence and sellers, yes, the sellers, should also do their own due diligence on the buyers. There will be representations, guarantees, and covenants made by both the seller and the buyer. It is important for each party to thoroughly review and understand the post-closing commitments. Perhaps most critical to the buyer’s success in a deal is the post-purchase integration plan. A plan that clearly integrates the business, the people, and the assets is crucial, especially if the seller has any interest, monetary or not, in the future of the business. Clearly understanding the terms of the deal, the post-closing commitments, and the plan of integration will also prepare the parties in the event disputes arise.
Once a price is determined, a business exit is not complete without the payment. While it may seem like cash is the most common form of purchase, and the one that the seller wants the most, a buyer will often structure a deal using cash, stock, or a combination thereof. Often buyers want sellers to take structured deals, sometimes in the form of earn-outs, earn-ins, notes and performance contingencies. This is where tax strategies are critical. IRS rules change frequently and the creation of goodwill, non-competes and other intangibles have many business and personal tax consequences. Only a solid business plan that contemplates a pre-determined business exit strategy will include these issues.