Name: Exit Strategies Group, Inc.
Address: 531 E Washington St, Petaluma, CA, 94952, US
Telephone: 707-778-2040

Welcome News for Business Owners: Five-Year Built-in Gains Tax Recognition Period Permanently Extended

March 2, 2016/in Exit Planning, Sell a Business /by Al Statz

The Protecting Americans from Tax Hikes Act (PATH), enacted in December, makes selling a business easier for some.

Since most sales of SME’s will be asset (versus stock) sales, double tax for C-corp owners and built-in gain tax (currently 35 percent federal) for owners of recently converted S-corps are very real impediments to selling a business.

C-corporation owners face a “double tax”, where gains on a sale of assets are taxed at the corporate level and subsequent liquidating dividends are taxed at the shareholder level; whereas in an S-corp there is no federal corporate level tax. However, when a C-corp converts to an S-corp, a “built-in gain” is determined, based on the Fair Market Value of the corporation’s assets (both tangible and intangible) less the tax basis in the assets on the date of conversion. Essentially, built-in gain is the gain that would have been taxed had the C-corp sold its assets on the conversion date. A sale of assets by an S corporation during the “recognition period” triggers the built-in gains tax, as does a sale of stock in a deemed asset sale under Section 338(h)(10). Congress’ enactment of built-in gains (a.k.a. “BIG”) tax back in 1986 was intended in part to prevent C-corp owners from making an S election just before selling their companies’ assets to avoid corporate-level taxes.

From 1986 until 2009, the BIG recognition period was 10 years. Then between 2009 and 2014, Congress acted sporadically to reduce it to between five and seven years on a temporary basis. This uncertain tax environment made sale planning for C-corp and recently converted S-corp owners difficult.

The Protecting Americans from Tax Hikes Act (PATH), enacted on December 18, 2015, made permanent the five-year recognition period for S corporations. This is welcome news for owners of C-corps, and S-corps that recently converted from C Corp status, who are considering selling their companies.

Whether you expect to sell your business now or five or ten years from now, I urge you to work with a competent and objective CPA to assess and clearly understand the tax implications of a sale of your company. And then reevaluate your entity structure from an overall tax efficiency perspective.

Begin with the end in mind. Exit right, retire well!

For further information on this topic or to discuss a current business valuation, sale, merger or acquisition need, Email or call Al Statz 707-781-8580 at Exit Strategies Group, Inc.

Think Like a Buyer

February 24, 2016/in Exit Planning, Sell a Business /by Roy Martinez

Entrepreneurs spend their entire career thinking like an owner. They don’t need to pay any attention to the value of their business. They may have a vague notion of its value based on anecdotal industry revenue or profit multiples that they heard bandied about at an industry conference they went to years ago in Orlando. But, at the end of the day, during the operating years, what is important to an entrepreneur is the bottom line: how much cash can I take home and/or invest in the business for future profitability?

Then, when they are ready to exit, they flip a switch and start to think like a seller. They ask: how much my business is worth? Or more precisely, how much cash can I get out of selling the business?

That is when they come to us. They are ready to sell. They remember those multiples they heard, and they ask us to sell their business, with those multiples in mind. Typically, our first job is to advise the client on how to price the company. We look at ACTUAL market comps based on ACTUAL transactions. We look at the market value of their hard assets. And we analyze the business cash flows, growth prospects and business risk — from the point of view of a BUYER.

But, how is a buyer’s perspective different? Thinking like a buyer means considering what their risks are if they buy your company, what their synergistic opportunities are, and what their investment alternatives are.

An industry buyer may have synergies with the company they are targeting, and they may be willing to pay more than the asking price. We recently helped a building services company sell to an industry strategic buyer at an incredible market multiple. On the other hand, a buyer may be scared about client retention when the seller leaves. A dentist selling her practice may think she is selling a business with $2 million in revenue. But, dental practice buyers know that up to 20% or more dental patients leave upon a practice transition. So, from their perspective, they are buying a business with $1.6 million in revenue or even less. (Source: “Retaining Patients Following a Dental Practice Sale”; DentalTown; Adams, Bill DDS) Or, the industry buyer may believe that they can duplicate the target company (or whatever part of it they are interested in) and get a better return on investment.

Basically, buyers are concerned not just with revenue and profitability, but also about risk. There are many, many sources of risk. Client retention is only one example. Business owners tend to downplay risk. They downplay risk to themselves, and inevitably to business brokers, buyers and lenders. And since most buyers enter a business with substantial debt financing, their ability to withstand risk and volatility is usually less than that of the seller. Rather than downplay business risk, an owner is far better off facing facts or setting to work on reducing it.

As business brokers, we ask seller clients to not only think like owners and sellers, but also to start thinking like a buyer!

For more information on thinking like a buyer when planning a business sale or when engaging in a sale process, contact Roy Martinez.

Build, Transfer, or Protect

February 4, 2016/in Exit Planning, Sell a Business /by Exit Strategies

Research indicates that most business owners have 60-80% of their wealth tied up in their businesses. Yet in our experience few owners have a clear idea about the value of their business and few have done much thinking or strategizing about how to build, transfer, or protect years of hard-earned wealth. Let’s examine these options.

Build means to invest for growth.

This involves time and money. As you near retirement, it may be less prudent to invest in the business and time to think about diversifying assets to lessen your overall risk. Personal considerations are often in play so they must also be assessed. This transition period requires a shift in mindset. Owners often have a hard time distinguishing between accumulation (growth) and distribution (preservation) years. Failure to recognize this transition can leave you exposed to untimely risks that have real consequences for your lifestyle and how long your money may last.

Transfer options depend on several factors — some within your control, some not.

A few considerations include the marketability of the business; the current market for privately held businesses; is there a key employee(s) or family member(s) with the skills, motivation, and capital to be successors? A third party buyer, if an option, may allow for a larger payout with more cash down in the deal structure, or perhaps a full payout. Each of these options involve different risk, return, and timing. Getting your tax and legal advisers involved early is always advised so more proceeds remain in your pocket.

Protect means preserving what you have built so that it can fund your lifestyle or next venture.

The question is will it be enough? De-risking may involve altering the business model or operations. Examining the various contingent risks that could destroy years of wealth accumulation is something every owner needs to be aware of. The potential for high liability, low probability events needs to be examined.

These strategies aren’t mutually exclusive. They require deliberate thought and a process to ensure that you strike the right balance so you can meet your goals without undue risk. We can help you quantify the tradeoffs and design an effective long-term strategy consistent with your goals.

To confidentially discuss your business valuation needs or exit strategy, please contact one of Exit Strategies’ senior advisors.

Good Exit Planning: First and Foremost, A Valuation of the Company

December 28, 2015/in Business Strategy, Exit Planning, Sell a Business /by Bob Altieri

With the baby boomer generation retirement rush beginning to take hold, many business owners lack sufficient information about the value of their business for retirement planning purposes and don’t foresee the deal killers that await them. A Deal Killer is a condition that, if undetected and unresolved before the sale of a business, will kill the transaction. The purpose of pre-sale planning is to maximize sale proceeds (as well as to achieve other non-financial goals), and it includes efforts to neutralize these Deal Killers.

The most common and avoidable Deal Killers are:

Owners’ long-held belief that they can automatically one day sell their businesses for enough money to satisfy their financial independence needs and wants.
Owners’ failure to reconcile their need for value with the market’s perspective of value before going to market.
Owners’ exclusive focus on top-line sale price.

Owners are usually optimistic about the value of their businesses. Many of them dwell on the efforts and sacrifices they made from the onset of the venture. As a former entrepreneur, I know this well; however, optimism can result in owners consistently and often dramatically overvaluing their businesses.

In addition to company valuation, owners must factor into the likely sales price such factors as deductions for IRS taxes on the sale, debts that the company owns, transaction fees (escrow) and advisor fees (legal, CPA, Broker, and etc.). Business owners who jump into the sale process blinded by sale price optimism, or without consideration of the reductions to sale price, spend considerable time, money and energy only to find their glass half empty, if not shattered altogether.

At Exit Strategies, our job is to incorporate an understanding of marketplace reality into an owner’s pre-sale planning. We know that successful exits can require years of value-building efforts, but owners who insist that their businesses are worth far more than buyers do, either don’t realize this or are unwilling to face reality.

It is critical to the ultimate success of your exit that you get help to understand likely sale price and after tax proceeds and address deal killers well before your planned departure date. For further information contact Bob Altieri.

Why M&A Deals Fail

December 21, 2015/in Sell a Business /by Jim Leonhard

Companies that make multiple acquisitions are much more likely to have successful merger and acquisition (M&A) transactions than companies that have made one or less acquisitions in the past five years, according to a recent Boston Consulting Group (BCG) article. In fact, over 50 percent of all M&A transactions result in negative shareholder returns.

The main culprits appear to be related to post-merger integration, especially:

Poor integration of the target organization
Higher complexity than anticipated
Difficult cultural fit
Synergies that fail to materialize

2016 Promises to be a Banner Year for Mergers and Acquisitions

December 14, 2015/in Sell a Business /by Al Statz

Deciding how and when to retire is one of the toughest decisions in a business owner’s life. Selling to a strategic buyer, investment group or management team represents the culmination of years of hard work and investment. Going to market when the owner is personally prepared, and the business is ready, and market conditions are conducive offers the best opportunity to maximize results.

M&A activity in 2015 has been strong and 2016 market conditions look promising. Here’s why:

Economy – Expectations are for a continuation of the recovery that began in 2009. Buyers make acquisitions and pay more when they can reliably forecast future earnings growth.
Strong public stock market – Public companies with high valuations enjoy a lower cost of capital with which to make acquisitions, and many are on a buying spree.
Abundant cash – Corporations have strong balance sheets and private equity groups have cash to deploy. They are competing for acquisitions.
Debt financing – Debt is used in most acquisitions. Commercial banks are lending, debt ratios have returned to pre-recession levels, and even though the Fed may raise interest rates this month, rates are should remain attractive.
Valuation multiples – Multiple studies and databases confirm that private company earnings multiples are at pre-recession levels.
Moderate tax rates – Individual capital gains tax rates are still only 20% compared to 28-35% for most of the past 50 years. Government spending is at all-time highs and a recent budget deal removed the Federal debt limit. Sellers can expect higher taxes in the future.

Businesses offered for sale by Exit Strategies in 2015 received the best response we’ve seen in years, resulting in:

more buyers looking at each deal,
multiple offers per deal,
more offers in the upper valuation range,
higher percentage in cash,
more seller-friendly terms,
shorter time-on-market, and
buyers that did not win these deals hounding us for more opportunities.

How long the good times will last is anyone’s guess. At 78 months, the current economic expansion is already longer than 29 of the 33 expansions in the U.S. economy since 1854.

Al Statz is CEO of Exit Strategies Group, Inc., which provides M&A brokerage and business valuation services to companies in the Western U.S. He can be reached at alstatz@exitstrategiesgroup.com or 707-778-2040.

Defending Your Price

November 15, 2015/in Sell a Business /by Don Ross

A critical component in any business transaction, whether it be a simple sale of a used car or a complex transfer of ownership of a business, is usually PRICE. The art of “the deal” is dependent upon the two parties arriving at a price they can both live with. In both cases, each party must persuasively defend their price.

Market valuations are often based upon a multiple of past and future earnings. Multiples usually fall within a market-tested range for a particular type of business. Many factors influence the multiple and ultimately the price that both parties will accept for a specific business. Here are several common factors:

The nature of the owner’s involvement. Can the owner easily be replaced or is the business a “one trick pony”? In cases where the owner IS the business, the indispensability will negatively influence the future performance of business and the fair market price. The same holds true for the staff that may or may not be transferring with the change of ownership. Are there certain key employees that would be a challenge to replace?
Consistency of Performance. Does the business have consistent monthly revenue and cost margins or are there seasonal peaks and valleys where negative cash flows obligate the owner to take on large lines of credit?
Processes in Place. Does the business have a time tested modus operandi that can easily transfer to a new owner and staff? Intuitive management and loose organization may have served the present owner well but it doesn’t transfer well.
Client and Supplier Concentration. Limited sources of supply or a small client base can be problematical. When you have all of your eggs in one or two baskets, you really have to watch those baskets.
Capital Expenditures. Businesses that generate a lot of revenue and profits with minimal capital assets requirements sell for higher multiples. Conversely, businesses that have consistently high outlays for new equipment, rolling stock, and other capital assets, sell for lower multiples. Take a close look at the depreciation schedules to determine the future ‘life expectancy” of the assets and the costs to replace them.
Regulations. Businesses that require new licensing, background checks, certifications, prior industry experience can present a hurdle to a new owner.

Just as in selling/purchasing a used car, once you have consulted the “Kelly Blue Book” and arrived at a price range, further examination into the drivers of value and risk of the business will serve you well when it comes time to defend your price.

Where’s the Seller Tsunami?

October 27, 2015/in Exit Planning, Sell a Business /by Al Statz

The Wall Street Journal published an article this month titled “The Missing Boom in Small-Business Sales — An expected rush in sales of small firms by the baby boomer generation has yet to materialize.”

The article points out that despite predictions that a flood of private businesses would be coming up for sale as baby boomers reach retirement age, many of these owners are holding on longer than expected. We’re seeing the same thing here at Exit Strategies. We’re experiencing steadily rising deal flow, but not the massive seller tsunami that’s been predicted for the past ten years.

The article posits several reasons, all of which we agree with:

The recent recession hit retirement asset values hard, causing many owners to invest additional personal funds in their businesses; therefore postponing retirement for those who plan to live off of their assets in retirement
People are living longer and enjoy the challenge of working later in life
Younger people seem to be less interested in taking over the family business (particularly when good jobs are plentiful)

Read the entire Wall Street Journal article.

We are definitely seeing more interest in selling (and stronger demand for) companies valued over $2.0 million dollars. Owners of smaller businesses seem to be holding on longer, perhaps because they also have fewer retirement assets to rely on.

So, the tide of exiting baby boomer owners is rising, but the crest of the wave is still approaching.

Being personally prepared to sell is a key element of a successful business sale. Owners who are personally ready should seriously consider going to market now, while business performance is strong and market conditions are conducive. For help determining if the time is right for you and your company, feel free to contact Al Statz.

The Significance of Disclosure in a Business Transaction

October 9, 2015/in Acquire a Business, Sell a Business /by Don Ross

Full disclosure by buyer and seller is a vital component in any successful business sale/purchase transaction. In a small business transaction, buyer and seller disclosure statements are customarily exchanged and reviewed before or during the due diligence process. Hopefully there are no significant surprises at that point and the transaction proceeds smoothly.

When the buyer is an individual, the buyer’s disclosure statement generally focuses on the buyer’s personal, professional, and financial background and reorganization plans. However, the seller’s disclosure statement is broader and is often organized into these categories:

Business Conditions
Regulations
Other Considerations
General

Business Conditions encompass internal aspects of the business. Any financially adverse conditions such as prior bankruptcy, undeclared income or expense, client or vendor concentration, future promises to current employees or independent contractors, current or anticipated conflicts with landlord(s), deferred maintenance issues, unpermitted work performed on premises, equipment in need of repair, anticipated increases in worker’s compensation insurance due to recent claims, and existence of hazardous materials must be disclosed and addressed should they exist.

Regulations focuses on required licenses and permits, zoning, tax compliance, and local, county, state or federal law violations or investigations of any kind.

Other Considerations may include union or employment agreements, employee stock ownership plans, underfunded pension liabilities, accrued back wages, vacation pay or sick leave, equipment leases, pending or threatened litigation, unresolved insurance claims, unpaid local, state or federal tax, etc.

The General category raises one all-encompassing question: is the seller aware of any other facts or conditions not disclosed in the three prior categories that may adversely affect the operation of the business, a buyer’s decision to purchase it, or the price that a buyer might pay for it?

Should any of the aforementioned conditions exist, it is critical that they be acknowledged and explained to the buyer before they buy. A significant business weakness or risk revealed early in the discovery phase is usually a manageable hurdle or a point to negotiate around. That same information revealed during due diligence becomes a catalyst for buyers to reexamine other data, lower their price, or walk away. In our experience, appropriately exposing warts early in the M&A process builds trust and credibility with buyers, which is an advantage in negotiations, and helps ensure that sellers avoid disputes and keep all of their proceeds after the sale.

Ultimately, the best advice is: Disclose, Disclose, Disclose.

For further information on disclosures in the business sale process contact Don Ross.

SBA Loans: Capital for Small Business Acquisitions

September 23, 2015/in Acquire a Business, Sell a Business /by Bob Altieri

So you’re thinking of selling your business and prefer to be cashed out rather than be paid in installments over time. Uncle Sam wants to see your business continue as a job creator, and hence, works with lenders to make attractive loan terms available to business buyers, on loans up to $5 million.

US Small Business Administration (SBA) loans come in two types: business loans – type 7(a), and real estate loans – type 504. According to Bob Porter of Plumas Bank in Auburn, CA, who has been in the SBA lending business for a very long time, the “lending formula is complicated,” but here are typical loan terms:

7(a) Loans [Business]

Loan-to-value ratio is typically 70-85% of the business purchase price.
Term is typically 10 years.
Interest rates are typically Prime rate plus 2.0-2.75%. Prime as of this writing is 3.25%, so interest rates are currently 5.25% to 6%. Interest typically adjusts quarterly.
Banks may loan up to $5 million under the 7(a) program.
Terms are competitive among banks and vary with perceived business risk and the creditworthiness, outside collateral and business experience of the borrower.
Loans over $250,000 (and smaller loans when the business is being transferred between related parties) require a fair market value appraisal by a certified business valuation expert.
To help offset risk, banks typically like to see a 4 times debt-equity ratio (80% debt; 20%cash [equity]) to the appraised value of the business, because if the business is priced at fair market value it should have the ability to service the SBA debt payments. If the buyer is paying more than appraised value, the loan amount will be reduced accordingly.

504 Loans [Real Estate]

Loan-to-value ratios are typically 90% for general purpose properties like office and warehouse buildings, and 85% for specialized/dedicated properties such as restaurants, bowling alleys and gas stations.
Two loans are actually made: a 50% First Trust Deed held by the bank with a term of 20 to 25-years and a fixed or variable interest rate (currently around 5%), and a Second Trust Deed from the SBA with a 20-year term and a fixed rate (currently 4.9%).
Although rare, SBA 504 loans can also be used to purchase equipment such as printing presses, tractors, or machining equipment.

In cases where a business is being purchased with real estate, banks may offer the borrower a blended term 7a loan, or break the transaction into both a 7(a) loan for the business purchase and 504 loan for the real estate purchase.

Bob Altieri, Certified Business Appraiser (CBA), regularly conducts business valuations for SBA business acquisition loans and serves lenders throughout California. For further information on this topic call or Email Bob Altieri in our Roseville, California office.