Many sellers worry that employees might “hit the panic button” when they learn that a business is up for sale. Yet, mergers and acquisitions specialist Barbara Taylor thinks employees might welcome the news of a possible sale. In the article, “Selling Your Business? 3 Reasons Why Your Employees Will Be Thrilled,” Taylor cited the three reasons she believes employees might be excited by the prospect of a sale.
1. Job Security. Some employees may get nervous when they hear that a business is up for sale. When she was selling her business, Taylor said she was concerned that her employees might “pack up their bags and leave once we (the owners) had permanently left the building.” In fact, most employees did stay on after the sale. She wrote, “Our employees weren’t loyal to us, they were loyal to the business that we’d built: the brand, the reputation and values it represented, the quality of the product and service, the work environment and the customer base.”
While employees may worry that a new owner will “come in and fire everyone” the opposite is usually the case. Usually, the new owner is worried that everyone will quit and tries to ensure the opposite outcome. But business owners should assure their employees that a new owner will likely mean enhanced job security, as the new owner is truly dependent on the expertise, know-how and experience that the current employees bring to the table.
2. Opportunities for Career Advancement
The size of your business will, to an extent, dictate the opportunities for advancement. However, if a larger entity buys your business then it is suddenly possible for your employees to have a range of new career advancement opportunities. As Taylor points out, if your business goes from a “mom and pop operation” to a mid-sized company overnight, then your employees will suddenly have new opportunities before them.
3. New Growth, Energy and Ideas
A new owner is almost certainly going to bring in new energy to a business. Taylor worked with a 72-year-old business owner who confessed she was exhausted and knew “she wasn’t running the business on all cylinders.” This business owner believed that a new owner would bring new ideas and new energy and, as a result, the option for new growth.
How employees react to a business sale depends upon how information is presented. Don’t assume that your employees may panic if you sell your business. The simple fact is that if you provide them with the right information, your employees may see a wealth of opportunity in the sale of your business. A professional business broker can help guide you through the rights steps to take to assure a smooth transition when selling your business.
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By C. David Chambless, President Abraxas Business Services
Getting to the Closing Table to sell a business is a complex journey. At Abraxas, we often find that business owners let certain concerns and fears keep them from taking the first step toward a successful sale and a comfortable “next stage” of life.
Here are four common worries that we consistently encounter. As discussed below, each one could be overcome with proper planning and the right business advisor.
Business Owner: I’m too busy running the company to have time to sell it. The sales process will distract me from growing, or even maintaining, the current level of revenue. And how can I be sure that expenses are under control if I’m not paying attention every day? I’ll never get the valuation I need if I’m distracted by the sales process.
Business Broker: Business brokers know that the process of selling a business can seem overwhelming. Working with a business advisor can increase the likelihood that the transition will make it to the closing table. An experienced, knowledgeable advisor would put in place proven methodologies to manage the process so that the business owner can continue to appropriately oversee daily activities of the business.
Business Owner: I don’t understand the sales process. Who would buy my company? What are the steps I would need to take?
Business Broker: It is our job to clarify the sales process and to navigate the intricacies of a sale on behalf of the owner. We have the expertise and experience to deal with the unique challenges of each transaction. We are proactive during negotiations and manage any road blocks in a timely manner so as to not lose momentum as the deal heads to the Closing Table.
Business Owner: My business pays for many of my expenses. I’m afraid my finances are messy and won’t really reflect the value of my company.
Business Broker: Experienced brokers, such as those at Abraxas Advisors, understand that the financial expectations for one owner could be different for another owner. We help guide a business owner as he/she works with the company’s financial team and accountants to assure that the company’s profit-and-loss and cash flow statements accurately present the company’s performance and expense history. With clear and detailed information, a prospective buyer can easily value the opportunity the business offers.
Business Owner: I need to net $XX from a sale to feel good about exiting the business.
Business Broker: The market is the ultimate determinate of the sales price. Abraxas Advisors understand what the market will include in its analysis of the company’s value. We advise our clients during initial discussions as to how their particular sector is evaluated and suggest ways to potentially increase the sales price. Often, an owner knows a number of steps they would take to grow the company if they had additional capital and time. Abraxas uses this perspective to help a prospect understand potential growth opportunities should they purchase the company.
Chambless is a former GABB president and has has extensive experience in business development; finance; operations; sales; marketing; and international channel development and management. Abraxas Advisors are experienced, multi-disciplined professionals who, collectively, have had seats in every role at the Closing Table.Read More
New Tax Loophole May Allow Many Small Businesses to Claim Large Tax Write-Offs For Inventory In The Year Purchased! Can it be true? How do Companies Sign Up?
Senior Tax Manager at Frazier & Deeter (Atlanta, GA)
Congress, either intentionally or unintentionally, as part of the Tax Cuts and Jobs Act provided for a potentially huge tax write-off for many small businesses that have inventory –basically any company that has physical products they intend to sell to a customer. Prior to the new tax law (before 1/1/2018), if your company kept an inventory, you generally couldn’t claim a tax deduction for inventory until the inventory was sold. As a result of the Tax Cuts and Jobs Act (TCJA), savvy small businesses may be able to take advantage of a new loophole that could provide a large tax windfall by completely expensing their ending inventory in the year purchased starting with returns that are about to be filed in 2019 (for the 2018 tax year).
For taxpayers and CPAs able to piece together several sections of the Tax Code and Regulations, the new law creates a huge opportunity and marks a significant change from prior tax accounting for inventories that didn’t allow for tax deductions for inventory until sold. There are a number of hoops to jump through and hurdles to overcome before companies can write off ending inventory, but will likely provide immediate tax savings to a large percentage of taxpayers who keep an inventory with a cost of less than $2,500 per inventory item. According to Donna Beatty, CPA, we may even see those companies that are able to take advantage of this loophole manage their tax bill via purchase of inventory before the end of their tax year.
Cash Method Now Allowed For Small Business –Even Those With Inventory
It works like this. The Tax Cuts and Jobs Act generally effective as of January 1, 2018, provides that taxpayers, in general, with less than $25 Million in gross receipts (average of past 3 years gross receipts) can now use the cash method of accounting, even if they keep an inventory. This is a major shift from prior law that required many companies with inventory to use the accrual method of accounting. This rule alone does not provide that businesses under the $25 Million threshold can simply start expensing their inventory as purchased – there are several additional nuances before a cash basis taxpayer can expense inventory when purchased.
First, if you are under the $25 Million average gross receipts threshold and currently using the “accrual method” of accounting, and you think you qualify to expense inventory based on all other parameters below, or you just want to start using the cash method of accounting for some other reason, you will need to file a “change in accounting method” with the IRS to begin filing tax returns on the cash basis. If you are already using the “cash method” of accounting for tax purposes that’s great – you don’t need to file a change with the IRS. If you need to file with the IRS to change your accounting method, don’t worry, the IRS has provided for a simplified filing requirement for small businesses rather than forcing you to complete the normal Form 3115 with all of its required schedules and disclosures. After you change your company accounting method to the cash method with the IRS, you still ARE NOT home free! There are additional steps to take before you can expense inventory as purchased – keep reading.
Required Tax Elections
Once you are on the cash method of accounting one of the two keys that makes this work is what’s called the “de minimis safe harbor election.” If you want to get technical, the election can be found at Treasury Regulation Section 1.263(a)-1(f), and provides that items under $2,500 per unit can be expensed if this election is made and your company accounting records are also in compliance (see next heading). Before the Tax Cuts and Jobs Act, this election did not apply to inventory.
As a result of the Tax Cuts and Jobs Act, either deliberately or inadvertently, Congress provided that when small businesses meeting the $25 Million gross receipts test use the cash method of accounting they can also elect to treat inventory as “non-incidental materials and supplies.” What’s the big deal with this you might ask? When you apply the “de minimis safe harbor election” to “non-incidental materials and supplies,” companies can then expense all items under $2,500 per unit if properly accounted for. That’s right, the “de minimis safe harbor election” that allows all companies to expense items under $2,500 per item also applies to “non-incidental materials and supplies.” There are also a number of rules here that are highly technical in nature dealing with the definition of inventory and definition of items qualifying for the “de minimis safe harbor election” that are beyond the scope of this article. Companies should consult with a knowledgeable CPA about these.
The “de minimis safe harbor election” is a very simple election that companies can have their CPAs make on their annual tax returns. The election to treat inventory as “non-incidental materials and supplies” on the other hand is not so simple. This election requires a change in accounting method with the IRS on a Form 3115. Again, just as with the change from the accrual method to the cash method noted above, the IRS has provided for a simplified Form 3115 filing requirement for small businesses making this change.
Required Financial Reporting
Ok, your company is now on the cash basis for tax purposes, filed the change in accounting method to elect to treat inventory as “non-incidental materials and supplies,” and ready to include the “de minimis safe harbor election” on your annual tax return. You still aren’t home free! There are a few more considerations before you can claim that big tax write off for all the inventory you purchased last year (instead of leaving it out on the balance sheet only to deduct whenever it’s sold to customers).
The magic that makes all of the above work is a little bookkeeping and financial reporting. To expense all your company purchases under $2,500 per unit using the “de minimis safe harbor election,” the Regulations mandate that you also expense these items on your financial statements and not just your tax returns. If your small business has no requirements to issue GAAP basis financial statements (audit, review, compilation) there may be an opportunity to implement this strategy. If you are required to issue GAAP financials, or for some other reason can’t expense inventory as purchased on your financials, you will be prevented from using this strategy. GAAP will not allow a company to expense inventory; instead, ending inventory under GAAP must stay on the company balance sheet and be expensed as it is sold.
If your company is like many small businesses with no external stakeholders to be accountable to, and you don’t mind expensing inventory as purchased, you may have an opportunity to expense all inventory otherwise sitting on your balance sheet at year end. To clarify, the rules dictate that you expense inventory on your financials – they do not prevent you from tracking inventory as you always have for your internal management purposes. The unit cost of each item must be included on the invoice from your vendors as well. Best practice would be to create an internal written accounting policy to expense all inventory purchases. Additional rules apply to labor and materials of manufacturing companies that produce their own inventory for sale to customers.
Putting It All Together
As you can see, the expansion of using the cash method of accounting for small business coupled with allowing small companies to elect to treat inventory as “non-incidental materials and supplies” may provide a large tax benefit when coupled with the “de minimis safe harbor election.” According to Donna Beatty, CPA, the tax professional industry is anxiously waiting on further guidance on this issue. In fact, the American Institute of Certified Public Accountants (AICPA) submitted their recommendation on the above issue to tax policy makers in Washington in a letter dated July 23, 2018. The AICPA recommended that the IRS and Treasury permit a small taxpayer to make a “de minimis safe harbor election” that would allow them to expense inventory. Although still awaiting further guidance, the way the law is currently written, some believe many small business taxpayers will take advantage of this potential loophole and expense all of their inventory. For example, we may see many small local retailers with maybe $100,000 – $200,000 of inventory at December 31, 2018 completely expense those amounts using this strategy –that would provide an average Federal tax savings of $37,000 – $74,000 (even more considering state income tax). Companies with a bit larger inventory of lower priced items under $2,500 per unit would experience even higher tax savings –and may even create taxable losses.
There are a number of rules and items not mentioned in this article, especially how the above might apply to production labor and overhead costs applicable to manufacturing companies. Accounting method changes, tax elections, and tax returns all have deadlines and must be properly and timely filed and reported – that could all impact the strategy discussed above. As with anything tax related, there are probably other unique items related to your business that would affect the tax strategy discussed in this article. This is a highly technical area of tax law which is very fluid, and this article may not be cited as authority, and is no substitute for counsel with your tax attorney or CPA.
How Can Frazier & Deeter help? Involve Frazier & Deeter early in the process of working through this tax strategy to determine if you qualify, and help to quantify the tax savings and potential risks.
If you have questions regarding this strategy or any other tax planning strategies feel free to reach out to one of the Frazier & Deeter Tax professionals: Andrew Moore at 404-573-4336 (Andrew.Moore@FrazierDeeter.com) or Donna Beatty at 404-573-4098 (Donna.Beatty@Frazier.Deeter.com).Read More
How should the purchase of a business be structured? This is a point that you’ll want to address early in the sale process. For most people, buying or selling a business is one of the most, if not the most, important business decisions that they will ever make. Therefore it is vital not to wait until the last minute to structure your deal. Let’s turn our attention to the most significant questions that you need to answer when entering the sales process.
1. What is My Lowest Price?
Ask yourself “What is the lowest price I’m willing to take?” If your get an offer, you don’t want to sit around trying to decide if you can take a given offer at a given price. You should be ready to jump if the right offer is made.
2. What are the Tax Implications?
Seriously consider the tax consequences of any sale. Taxes are always a fact of life, and you need to work with a professional, such as an accountant or business broker, to understand the tax implications of any decision you make.
3. What are the Interest Rates?
If you get a buyer, what is an acceptable interest rate for a seller financed sale? Working with one of the GABB’s affiliate lenders is a great way to find the most attractive interest rate.
4. Are there Additional Costs Involved?
Do you have any unsecured creditors that have not been paid off? Additionally, you’ll also want to determine whether or not the seller is willing to pay for a part of the closing costs.
5. Will the Buyer Need to Assume Debt?
Finally, will the buyer need to assume any long-term or secured debt? The issue of long term and/or secured debt is no small issue. Be sure to clarify this important point well in advance. Also keep in mind that favorable terms typically translate to a higher sales price.
Business brokers are experts at buying and selling all kinds of businesses. When it comes time to structure a deal that benefits both the buyer and the seller, business brokers are invaluable. At the end of the day, working with a business broker is one of the single biggest steps you can take to ensure that your business is sold for the most attractive price and sold as quickly as possible.
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By Dan Browning, founder and President of DB Consulting, Inc.
This article is for educational purposes only. Nothing contained herein can be used against me in a litigation or other adversarial setting. Examples have been changed to protect the innocent (and not so innocent).
How do appraisers determine the value of a business? There are three value approaches that can be used, and each approach has various methods within it. The three approaches are:
- The Cost or Asset Approach
- The Market Approach
- The Income Approach
For most small, privately owned businesses, business appraisers typically do not use the Cost Approach. This approach is more applicable when a business is a very asset-intensive operation, such as a manufacturing company. Occasionally an Asset Approach could be called for, but the other two approaches are usually more indicative of value.
The Market Approach develops a value based on the amount at which other similar companies have been sold. The theoretical underpinning for the Market Approach is the principle of substitution, in that a hypothetical, disinterested, financially motivated willing buyer can evaluate many possible targets for acquisition and will not pay more for one particular business than for another comparable, similarly situated business.
For larger companies, appraisers sometimes use a Guideline Public Company Method, wherein the subject business is compared to publicly traded companies in the same or similar industries. Given the vast size differentials, most appraisers typically do not use this Method for smaller, privately owned businesses.
More suitable for smaller private companies is the Direct Market Data Method, wherein the appraiser will research private databases containing reported transactions of other smaller, privately owned companies. These transactions are often reported by business brokers. Some of the most common transaction databases include DealStats (formerly Pratt’s Stats), BizComps, and ValuSource Market Comps (formerly Institute of Business Appraisers database).
After researching and finding comparable transactions, the appraiser analyzes the data by looking at various ratios derived from the transactions (among other things). Some of the most common are the Price to Gross Revenues and Price to Earnings ratios. However, one must BE CAREFUL when using these transaction databases, because different databases have different measures and definitions of “earnings.” Sometimes the earnings include add-backs such as owners’ compensation, interest, and income tax expenses (as is the case with the ValuSource database), while others may add back depreciation, amortization, and interest expenses. The short answer is that you can’t simply use the “Price to Earnings” ratios from all databases combined into one calculation.
One approach to selecting which ratio(s) to utilize is to analyze the data sets to find which set of value indications is the most internally consistent (statistically speaking). This could be done by calculating the data set’s Coefficient of Variation (which is the standard deviation divided by the mean), or by using a regression analysis.
The Income Approach develops a value that includes all tangible and intangible assets of the company. In theory, whatever operating assets are required to generate the earnings are included in the value developed from applying the appropriate capitalization or discount rate. One of the keys to developing a reliable, reasonable value for the business lies in choosing the correct earnings base.
There are two essential steps to address when selecting a reasonable estimate of earnings – selecting the level of earnings, and forecasting the most reasonable estimate of stable earnings into the future. The earnings base is capitalized to develop a value for the ongoing business.
Two common methods under the Income Approach are the Single Period Capitalization method and the Discounted Cash Flow/Discounted Future Earnings method. If the earnings of the business are relatively stable, one can utilize the Single Period Capitalization method by building up a capitalization (“cap”) rate and applying it to a representative level of earnings. If, however, the earnings are not stable, the Discounted Future Earnings method is more appropriate, because this method allows one to forecast several years of revenues and discount the various revenue streams (including a reversionary value) back to present value.
That’s a basic overview of valuation approaches in business appraisal. Our next article will focus on common adjustments to reported revenues and earnings figures.
Dan Browning, a GABB Affiliate, has 20 years of experience as a business appraisal professional and holds the Master Analyst in Financial Forensics (MAFF) and Accredited in Business Appraisal Review (ABAR) designations from the National Association of Certified Valuators and Analysts (NACVA).Read More