Legal Matters | Archive

Selling or transferring your business

by David Faulders
for Virginia Business
February 2007

When you are formulating a long range plan for your company, one of the crucial elements to consider is the company’s exit strategy. The traditional exit strategies for businesses include:

Selling or transferring the business upon the owner’s retirement or death, or selling or offering an initial public offering when the business reaches a certain size;

- Bringing in additional owners with the intent that the new co-owners will eventually buy out the original owner; and

- Merging two established businesses to achieve faster growth or diversification and to provide an exit to one of the parties to the merger.

All these exit strategies envision the ultimate sale or transfer of the business. One of your goals in the transfer of the business should be to maximize shareholder value, which requires careful consideration of the structure of the transaction and how to increase the value of the company prior to its sale.

The sale of a business takes one of two distinct forms: (i) the shareholders selling or exchanging their stock or equity, or (ii) the company selling its assets. Buyers like to buy assets, because they can usually write them up and thereby increase depreciation or amortization on the books, thus reducing future taxes. But sellers usually pay more taxes when they sell assets.

Asset Sales
The acquisition of a corporation’s assets generally does not carry with it the liabilities of the selling corporation. The buyer acquires a cost basis in the purchased assets equal to the purchase price paid for the assets and begins a new tax history for the assets. From the seller’s point of view, a sale of the assets of a business is more complicated. The seller is concerned with accurately determining the tax consequences that accompany the sale of the business assets, including recapture, the tax effect of liquidating the corporation or continuing its existence, and dealing with assets that the buyer did not purchase.

Stock Sales
In a stock sale, all the liabilities of the acquired company are transferred to the buyer. For the seller, the transaction is relatively simple to complete — it simply delivers the endorsed stock certificates to the buyer. Generally, the selling shareholders will realize capital gain or loss on the transaction, measured by the difference between the selling price of the stock and the shareholders’ basis in the stock. For many buyers, a stock transaction may not be satisfactory because the buyer obtains a basis for the stock equal to the amount paid as the purchase price, and the company retains its basis in the assets. This results in the buyer’s economic investment being “allocated” entirely to a non-depreciable asset (the stock), not the underlying business assets.

Maximizing the Value of your Company
Getting your company ready to sell means sprucing up operations and mimicking the professional standards of public companies — first-class financial statements, budgets, business plans and management that's not dependent on one person. If your exit strategy involves an initial public offering or the sale to a public company, then it will add value if your company complies with the requirements of the Sarbanes-Oxley Act. At the very least, running your business as if you were preparing to sell it will improve your management practices and increase the value of your company.

Financial statements are the best indicator of the future performance of your business, and audited financial statements are much more reassuring to a buyer — and to the bankers financing a purchase — than unaudited ones. Audited numbers strengthen your hand in the negotiations and allow you to demand better terms.

Management depth adds value. A business that is excessively dependent on the owner is risky for a prospective buyer. Appointing a second-in-command and department managers enhances a company's value by alleviating that risk.

Focus on the strengths of your business. Eliminating weak product lines should increase your overall profit margins and improve your return on assets. Buyers don't want diversified businesses; they want resources concentrated in your strongest activity.

Over time, most businesses transition to a point where its sale or transfer is in the best interest of the owners. Advance planning to maximize your company’s value and properly structuring the transfer are vital to your reaping the rewards of your hard work with the company.