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Sales of unprofitable businesses are common in some industries. Even in other industries, Corporate Consultants can help you prepare your money-losing business for sale to increase the level of buyer interest.

Revenue-based Sales

Businesses in certain industries sell at prices that reflect sales revenues more than profits. For example, if you sell an alarm service firm to a bigger company in the same industry, the acquirer knows how much your revenues will produce in profits based on their own business model and economies of scale. This will determine the multiple of revenues they’re willing to pay, and they offer approximately the same multiple to any seller.

Companies that buy up numerous businesses in the same industry are called “consolidators.” Besides alarm companies, other examples of industries where this occurs are telecom services, pest control, real estate brokerage, property management, insurance agencies, medical billing and waste collection.

Financial Statements

If you are not fortunate enough to be in an industry targeted by consolidators, there are still steps we can take to increase buyer interest in your firm. First, the financial statements, tax returns or both should be up to date. You may be losing money, but the buyer will want to know the magnitude of the loss, the size of the revenue stream they’re buying, and whether the revenue trend is up or down.

Corporate Consultants will prepare a schedule of adjustments to the income statements – usually covering the last three years – adding back items like owner salary, owner benefits, depreciation, interest expense and one-time expenses. We will communicate to the buyer that a substantial part of the firm’s reported loss may consist of discretionary items like your salary and your car lease.

Assets

When you’re unprofitable, the buyer may view the transaction as the purchase of the specific assets of the business rather than a cash-flow stream. Therefore, it is particularly important to prepare an accurate list of furniture, fixtures and equipment (FF&E) that are included in the sale. Also, you should know the value of your product inventory and have a quick and accurate way of updating it.

Your customer list is likely to be a key element of the sale. A buyer will pay more if the list is automated, either in an accounting program like QuickBooks or a database like Access. You don’t need to disclose customer names to the buyer, but be prepared to show him a sample customer record, so that he knows the information is easily transferable and of use to him.

Corporate Consultants will also document other intangible assets that may be valuable. For instance, you may have an exclusive territory agreement with a sought-after distributor. If so, we will need to know the conditions under which the agreement is transferable.

Financing

You may need to consider seller financing. Generally speaking, a buyer can’t get bank financing to purchase an unprofitable business. You’re the only possible source of financing. Remember that a seller note is usually secured by both the assets of the business and the buyer’s personal guaranty. You have the right to request both a personal financial statement and a credit report from the buyer before making a decision about this, so you can make sure you’re dealing with a reasonably strong buyer.

Will the sale of your business be treated as a stock sale or an asset sale? The great majority of transactions involving privately held companies are asset sales. This blog explains the reasons, the exceptions, and the tax consequences.

A CPA may advise their client to sell the stock of their corporation, since a stock sale will generally result in capital gains taxed at a 15% rate. Realistically, however, most buyers won’t agree to a stock sale. Buyers prefer instead to form a new corporation and then purchase itemized assets of the selling corporation, which can include both tangible and intangible assets.

There are two reasons why buyers prefer asset sales. First, they avoid the unintentional assumption of liabilities from the seller’s corporation, such as product liability, back taxes, employee claims, or practically any type of litigation involving past operation of the business. Second, they desire to “write up” the value of the assets purchased so that they will have greater tax deductions for depreciation and amortization. If a buyer purchases the stock of a corporation with assets that are fully depreciated or consist primarily of goodwill, there will be no opportunity for tax savings from depreciation and amortization deductions.

The assets that are usually transferred in asset sales include inventory, fixtures and equipment, the trade name, and goodwill. Accounts receivable may or may not be included in the transaction. Liabilities are usually not transferred, although a buyer who wants to acquire the accounts receivable may also agree to take accounts payable that are not past due. Cash is seldom included, although in middle-market transactions, a level of “working capital” required to operate the business may be defined in the purchase documents and included in the sale.

There are some instances in which buyers realize advantages to stock transactions. The business may have government licenses or product distribution agreements that are not transferable to a new corporation. For example, a buyer of a business that holds a Medicare reimbursement license will probably agree with the seller to structure the transaction as a stock sale. In this instance, there will be “representations and warranties” written into the purchase documents to protect the buyer from events that occurred during the seller’s period of ownership and visa versa.

Does the seller in an asset transaction lose favorable tax treatment? Not entirely. The buyer and seller must agree to an allocation of the purchase price to specific categories of assets and each report that allocation to the IRS on Form 8594, Asset Acquisition Statement. The part of the purchase price that is allocated to intangible assets such as goodwill still qualifies for capital gains treatment at a 15% rate.

The part of the price allocated to either not-to-compete agreements or equipment is likely to result in gains taxed at ordinary income rates. The buyer will prefer to weight the allocation toward equipment in order to benefit from five- to seven-year depreciation versus the 15-year amortization that applies to intangible assets.

Keep in mind that the transaction is only taxable to the extent that the sale price exceeds the seller’s cost basis. If a large part of the sale consists of inventory or equipment that has not been depreciated significantly, the seller’s gain on the sale will be considerably less than the sale price.

If it is of paramount importance for the seller to obtain 15% capital gains treatment on the entire sale, it may be possible to negotiate this with the buyer. For instance, the seller could respond to a buyer’s purchase offer by stating “I will accept a price of $X for an asset sale or a price of $Y for a stock sale.”

Both parties need to be aware that closing costs will be higher for a stock sale, since the transaction documents need to be drafted carefully by attorneys both to avoid issues with federal and state securities laws and to indemnify the parties from cross-ownership claims.

Some buyers choose to look only at businesses with tax returns. While it is understandable that a buyer wants to verify the past income of the business, there are legitimate reasons why tax returns may not be available or may not accurately reflect income. Buyers who limit themselves to businesses with tax returns are likely to miss some excellent investment opportunities.

Many businesses for sale are owned by individuals or companies that own several enterprises. If all of these are included on the same corporate tax return, the return would actually show income that is too high for the business being sold.

The real question in this case should be: Are business financial statements available with sufficient transaction detail to verify their reliability? If the target firm uses QuickBooks or another computerized accounting system, the financial statements are likely to be as accurate, if not more accurate, than tax returns. The transaction detail can be spot checked during the due diligence process in order for the buyer and his advisers to form an opinion about their reliability and accuracy.

Keep in mind that many small businesses file their tax returns on a “cash basis.” If this is true and the financial statements are prepared on an “accrual basis,” the financial statements are likely to be more accurate. Generally accepted accounting principles require the use of accrual accounting.

There are two common instances in which the last three years’ tax returns are absolutely required. First, if the buyer wishes to obtain a Small Business Administration business acquisition loan through a commercial lender, the rules require three years of tax returns. (Banks may have this requirement even for non-SBA loans, if they are available). Second, if the buyer is a foreign national using the purchase of the business to obtain an immigration visa (typically an E-2 visa), the U.S. Department of State requires three years of business tax returns as part of the visa application.

We’re often asked this by prospective sellers. There’s never a bad time to sell a business if you are ready to retire, are shifting your focus to other ventures, or are simply burnt out. It’s much better to sell before your lack of enthusiasm causes the business to suffer.

We are actually experiencing a “seller’s market” if you consider the relatively small number of quality businesses on the market. There are far fewer business for sale listings on the Business Brokers of Florida MLS system than there were a few years ago – even a couple years ago.

At the same time, there is a healthy supply of buyers. Some of these buyers were “downsized” by corporate employers and left with severance packages that provide the resources for a transition to business ownership. Many former corporate employees have 401(k) accounts. Corporate Consultants refers buyers to financial experts who can convert these 401(k) accounts to retirement account vehicles that can invest in the acquisition of small businesses.

Our firm targets “corporate” or “strategic” buyers as another important source of demand. Many businesses are having difficulty generating adequate internal growth in a slow economy. The managements of these firms often look to small-business acquisitions as a way to grow market share, expand geographically, or enter related fields. For example, we have recently worked with Florida air conditioning firms looking to acquire other firms in their industry.

What if your sales revenue and net income are lower than they used to be? As long as your business conditions have stabilized and it is reasonable to expect future growth, buyers will still invest. Savvy buyers realize that it’s better to buy on the way up than on the way down. Realistic buyers understand that the great majority of small businesses faced economic challenges in the last five years.