By Gina Bongiovi
Of the 15 million privately held businesses in the US, sixty percent are owned by baby boomers. As time marches on, a staggering number of these 9 million businesses will need to transition ownership somehow - to family, key employees, third parties, etc. That's what experts more creative than I have dubbed the "silver tsunami." These transitions will happen one way or another. In our practice, we've unfortunately seen too many "involuntary" transitions, where the owner passes away suddenly without a succession plan and the family and employees are left adrift. Let's explore ways to take control over your transition and prepare yourself for a voluntary, lucrative, and graceful exit. Beware, the following will attempt to simplify a process that takes at least a handful of years and a team of advisors to properly execute.
If you're the sole owner of your business, you might be surprised to learn that the financial power of attorney packaged with your estate plan or that you downloaded off the interwebs will likely NOT grant your successor access to the company bank account so that business can continue in the event of your disability or death. You'll want to verify with your bank, but each of a half dozen banks I surveyed confirmed that they would grant access only to a successor named in an owner's agreement that's filed with the bank. Trouble is, most sole owners forego an owner's agreement - "what am I, going to have a meeting with myself?" Maybe. Maybe not. But keep in mind the lack of an owner's agreement which authorizes someone to act on behalf of the business in your stead will lead to the company's affairs grinding to a screeching halt until you can act, or until the matter winds its way through probate court, at which point your invoices are long overdue, your payroll hasn't been made, and there are potential legal claims against the company.
Beauty is in the Eye of the Buyer
Based on the economic principle of supply and demand, each of these 9 million businesses needs a successor, which means over the next fifteen years far more businesses will be for sale than buyers or successors to take them over. Most business owners believe that their businesses build a better mousetrap, have better employees, and are therefore worth more money than their competitors' companies. No one wants to call your baby ugly, but the truth is, the attractiveness and value of your business are based not on your opinion, but instead on what a buyer is willing to pay. That's why it's crucial to begin, as soon as possible, the process of making your business the prettiest heifer at the county fair.
Asset Purchase or Stock Purchase
A business sale to a third party often takes one of two forms – an asset purchase or a stock purchase. What's the difference? I use this analogy quite a bit, but it's fitting. On the show Storage Wars, the host will raise the door on an abandoned or seized storage unit and begin taking offers, auction style, from onlookers. These prospective buyers haven't had an opportunity to inspect the contents of the storage unit – they can only see what's visible from about ten feet away. They bid on the unit and get everything that's inside, from the rare Faberge Egg someone forgot about to the dead rat decomposing on grandma's burnt orange sofa.
A stock purchase agreement is like buying a storage unit without inspecting what's inside. You get it all, even if you don't want some of it. It can be a simpler transaction because the buyer simply steps into the seller's shoes as the owner of the entity. Often, no changes need be made to accounts with banks, vendors, etc. which makes it somewhat attractive to buyers. It's great for the seller because they wash their hands of the entire entity. It's not so great for the buyer for a number of reasons. First, even with a young company, a seller might not have a firm grasp on all the contracts, all the accounts, all the potential liability the buyer should be aware of and consider before proceeding with the purchase. Second, regardless of any clauses in the purchase agreement that might limit the buyer's liability, a third party with a claim against the company isn't going to care who's behind the wheel. Acme Company wronged me and by golly, Acme Company is going to pay.
In contrast, an asset purchase can be likened to a different version of Storage Wars where the prospective buyers have ample time to inspect every item in the unit and cherry-pick only the items they want to buy. All the unknown liability is left behind, and the buyer knows exactly what's in the deal.
With either type of purchase, a prospective buyer will be able to conduct due diligence, which means they will inspect everything in your company's metaphorical storage unit. The more organized the items, the cleaner and more polished they are, the more the buyer is likely to pay for it. Conversely, the more stuff you have crammed in there without an inventory of what's inside, the more spider webs and water damage the buyer sees, the less the buyer will be willing to pay.
Managing your company "hygienically" means keeping personal and business expenses separate, avoiding commingling of finances and assets, properly documenting any loans or other movement of money, keeping copies of agreements, and maintaining records that clearly connect dots all the way back to the company's inception. By way of example, I currently have a client interested in a 20-year-old entity. Though we are awaiting delivery of the books and records, the seller has already told the prospective buyer that he has frequently "moved money" among the target entity and several others he also runs. He's also claimed the business generates close to a million dollars a year in profit but is unable to produce any financial statements to confirm. I am actively pressing the buyer to remain open to walking away if the seller is unable or unwilling to share adequate information for my client to make an informed decision.
As another example, I represented the buyer in an asset purchase of an ice cream shop. We requested financial statements from the seller that, no joke, came in the form of handwritten notes on notebook paper. The seller responded to my request for tax returns only with Square tax reports which raised another red flag because the deposits were going directly into the personal checking accounts of the two owners. Because my buyer was undeterred in pursuit of his dream of owning this particular ice cream shop, we closed the deal but with a significant drop in the purchase price.
IRS agents, please skip to the next section. Okay, let's be honest. One of the perks of business ownership is the benefit of running expenses like car allowances, cell phones, and health insurance through the company. These would otherwise be considered personal expenses, to be properly paid from personal bank accounts. However, many of us, with the advice of our CPAs, will ratify decisions to pay these expenses out of the company coffers. While this may not be improper, it casts an inaccurate light on your income and expenses and is often the very first thing a prospective buyer looks at during the due diligence period.
Failure to adhere to corporate formalities, a lack of documentation of loans and transfers of cash or assets, an inability to produce reliable financial statements, gaps in the company's "story" not filled with contracts or agreements or minutes concerning ownership or major decisions - all compromise the attractiveness of a business to a prospective buyer and put downward pressure on the purchase price, if not deter buyers altogether.
When to Start?
It's never too soon to start planning for your company's succession. Even if you're transitioning to a business partner, key employee, or family member, it's important to have a plan in place. This type of planning is also not done in a vacuum. It's wise to enlist the help of your lawyer, your CPA, and your financial advisor, at a minimum. Each of us plays a different but complementary role in helping plan and execute a succession plan and working collaboratively always ensures a better result for you, the business owner.
Managing Partner of Bongiovi Law Firm, Gina is a Las Vegas native and holds a JD/MBA from UNLV. The company, which just celebrated its tenth year in business, serves as outside counsel to small and medium-sized businesses.
Gina is a recurring speaker at a legal technology conference on topics such as Process Automation and Technology Planning startups and small businesses.
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