Who Doesn’t Love a Discount?

Who Doesn’t Love A Discount?

If given the option to pay full price or receive a discount, it’s safe to say the majority of individuals would prefer a discount, regardless of what they’re purchasing. Why would this be any different when it comes to your business?

When valuing a minority interest in a business (an ownership interest of 50% or less), it’s typical of buyers in the marketplace or a valuation analyst to apply minority discounts, which are more technically known as a discount for lack of control (DLOC) and a discount for lack of marketability (DLOM).

We know what you’re thinking: what are these discounts and why do they matter? Here’s a look at each type:

A DLOC is an amount or percentage deducted from the operating value of an entity to reflect the absence of some or all of the powers of control. When someone holds a minority interest in a business, they lack the ability to:

  • Implement business and operational characteristics;
  • Appoint and remove management;
  • Control the timing and amount of distributions;
  • Put the entity’s assets to their highest and best use.

In other words, the person buying into the business is receiving a discount because they are not receiving the full benefits of control.

A DLOM is an amount or percentage deducted from the operating value of an entity to reflect illiquidity (inability to quickly convert to cash) in privately-held entities when compared to public companies. In the valuation world, we refer to liquidity as “cash in three days”, which is expected when selling publicly-traded stock. However, when it comes to selling private companies, it takes much longer than three days to receive cash, which is why a DLOM is appropriate.

Discounts are extremely important to understand when negotiating transactions with investors. Investors’ primary way to receive a return on their investment is through distributions, which are primarily dependent upon the company’s financial stability, and diversification among the services and/or products and geography of the business.

Going back to the concept of “cash in three days”, investors will also look at the obstacles they could encounter if they decide to sell their interest in the future, which could potentially be affected by the company’s transfer restrictions and redemption policy. Therefore, appropriately discounting a minority interest is important as it could potentially make or break a deal.

Of course there are some risks that should be considered on the sell-side of a transaction. The amount of time it takes to complete a transaction, accounting and administrative fees incurred and the probability that the actual sales price could be much less than the asking price are some sneaky issues worth keeping an eye on.

Not only are discounts important to consider when searching for outside investors, but they are also a strategic tool that can be helpful when exiting a business. In fact, if you’re planning to sell your business, there’s a good chance you might encounter these discounts. It’s important to understand them so you know what price you can realistically expect from the sale of your business.

It goes without saying that buyers appreciate discounts to the share price, but sellers may not. After all, everyone wants to get top dollar for their business. Buy-sell agreements are commonly used to allow a company or its shareholders to purchase the interest of a shareholder who decides to withdraw from the company for a specific price or by using a set formula to determine a price. However, instead of preparing for a smooth exit, many buy-sell agreements tend to cause more issues as the use of a set price or a formula may not consider the current economic and financial condition of the company, which could lead to legal (and expensive) issues.

An effective buy-sell agreement should include an explanation of relevant discounts and the requirement for an appraisal from a certified appraiser to determine the current fair market value of the company. A well written buy-sell agreement will help minimize misunderstandings and disagreements, ensure proper discounts are appropriately applied to the company value and make for a smoother transaction among all parties involved.

Buy-sell agreements and all pieces of the puzzle can be difficult to put together. Luckily, our business valuation team is trained and ready to help you conduct a successful business transaction. If you need help, just ask!

 

State and local tax issues when buying or selling a business

You’ve always dreamed of owning a business. Now you’ve found the perfect one to purchase. You ask all the questions you can think of, come to an agreement on price and now you’re ready to go, right?

One major thing that sometimes gets overlooked is something called “successor liability.” This is the idea that when you buy a business, or the assets of a business, you generally also inherit all the liabilities associated with that business or the assets.

Some of these liabilities are pretty easy to figure out, but others may be hidden and difficult to know about or quantify. For instance, you can be audited for periods before your ownership and you can be assessed for sales or other taxes owed by the last owner.

Don’t believe us? Here are some common examples of successor liability discovered after the purchase of a business:

So what are some issues that could create tax exposures for you and your new company?

  • Company had the duty to file but failed to do so
  • The return was filed, but tax was not remitted
  • Company failed to pay use tax
  • Company did not have all the correct exemption certificates
  • Local taxes were ignored

So what can you do to reduce your risk when purchasing a business? Perform the proper due diligence. Due diligence can take a number of different forms, but generally includes reviews of the following:

  • Is the seller filing in the states where it has a duty to?
  • Are the returns accurately and timely?
  • Are taxability decisions correct?
  • Is the proper tax rate being applied?
  • Are exemption certificates accurate and up-to-date?
  • Has the seller been audited or received inquiries from any state?

Hiring a professional to assist you with a due diligence study can help you properly assess the potential liabilities and arrive at a more informed decision. Plus, it will hopefully save you some headaches later on.

But due diligence doesn’t just apply to buying a business. Let’s say you’ve finally made it to retirement and want to sell your business. Performing a due diligence study can help you be sure you have handled all these tax issues correctly and nothing will pop up unexpectedly that may scare away a potential buyer.

No matter what side you’re on, a little additional work upfront could potentially prevent some difficult, timely and expensive mistakes later.

Inspiring Confidence with Financial Statements!

Yes, you read that title right. Financial statements do a lot of things (we’re hoping you’ve learned that from this blog). But can they inspire confidence? Absolutely!

You may be thinking that financial statements are just numbers and nothing more. In a literal sense, you’re right — financial statements are a set of numbers. But when you understand them, they tell a story of where your business has been and where it’s going.

This story has many important tales to tell, and it is important to pay attention as your business grows and changes. It can also give you warning signs of disaster, and can help you stay on track to avoid this.

While working in the mergers & acquisitions department, I’ve come to understand the value of financial statements and that they can really instill confidence. Let me tell you a little secret friends: buyers WANT to feel confident when they write a check for millions, and financials play a big role in the confidence they feel.

A healthy bottom line gives buyers the warm fuzzies about their future with your company, but what else do financial statements provide?

  • Cleanliness | You have to have cleaned up financials before you decide to sell your business. A myriad of adjustments to wade through can raise some serious red flags and, frankly, make people wonder what’s really going on behind the scenes.
  • Timeliness | Being casually late works at times, but not all the time. When July’s financials are not ready to review until October, this gives some very negative signals to buyers. Its shows missed opportunities and the inability to react to the market … both of which will keep your buyers up at night.
  • Processes and procedures | No one wants to buy a circus, so make sure you have processes and procedures in place to get things done. If things are three to four months late, it’s an indication that maybe your buyer should run or reduce the offer.

And in case you’re wondering, we’re not talking a one-time thing. The sales cycle for business can take anywhere from 6-12 months, so the buyer will get a chance to really see how things are done and make assessments along the way. It’s best to always have your best foot forward so your buyers get the true picture of your business.

At the end of the day, your financial statements should help you run or sell your business, not hinder you. Let your financial statements give you confidence and tell the story of your hard work and success by making sure they’re up-to-date, cleaned up and timely.

Shameless plug: If you don’t understand your financial statements and what they mean … or have no idea what this blog is talking about, we can help.

Successful Succession: Starting Early

You may have just gotten started or are barely getting going. So why would you need to think about a succession plan early on?

Succession planning is the process of identifying and developing people inside your organization to fill key leadership and ownership positions. It’s also commonly known as transition planning, as you’re looking at how you’ll transition the business to the next leader(s).

Succession planning is important to the sustainability of your business. According to Harvard Business Review, “some 70% of family-owned businesses fail or are sold before the second generation gets a chance to take over.”

For many small businesses, leadership has been in place for a number of years, and with that comes a substantial amount of knowledge that could potentially leave your organization. Further, without a solid plan in place, until the very end, you’re leaving your business’ future to chance.

So how do you get started?

Come up with a plan. Start with the owner, which may very well be you. Talk through what you want your company’s end game to look like. Do you want to sell out for the highest price? Do you want to reward employee loyalty and hand over the company to one of your hard working professionals? Do you want to keep it in the family? And then there’s the question of timing … how soon do you want any, or all, of this to happen?

Then, look at your leadership goals. Where is there talent in your organization? Is there a particular group or individual that has the support of others? Will this succession change your organizational structure? Who do you want to incentivize to stay long term?

Also, remember talent might not present itself in picture perfect form. So do you have a diamond in the rough that will take some mentoring and coaching, but in the end will be a truly great leader for your organization?

Hint: You also need to be thinking about employee retention here. You don’t want to put a lot of time and effort into someone who ends up leaving before the transition. So make sure you think through an employee retention strategy.

Throughout this entire process, make sure you are COMMUNICATING. Ensure you have buy-in from any and all stakeholders in your organization. This will include investors and key personnel.

Make a date with your business advisor. It’s important to ensure you have a plan in place that serves the culture, mission, vision and people of your organization. But it’s also vital to have outside help.

You’ll need a full cast of business advisors to ensure your succession plan is successfully in place. These characters will include:

  • Attorney to help you walk through buy/sell agreements and transaction documents.
  • Financial Advisor to help you determine that your ownership lifestyle is met, as well as help you raise funds for your buy/sell agreement.
  • Tax Professionals to help you understand the tax implications of transitioning your business.
  • Appraiser in order to help you value the business for transition, gifting or sale.
  • Estate planner, who will help you see past the sale of your business and into retirement.

Be strategic. It’s important to be strategic as you prepare your succession plan and not just look at the current state of your operation. Succession planning should focus on growth, retention of talent and improve processes.

And one final thought … if all of this seems like a lot of work, that’s because it is. So don’t start at the end. Start early so you’re prepared to go forward with the end in mind.

 

YOUR END GAME: The Importance of Sales Tax

One thing we find is that businesses are really excited to start. You have great ideas and you’re ready to make your dream a reality and introduce a product that will change the world … or at least the way we’ve always done something.

What few businesses add to their mounting to do lists when they start is to think about how they’ll END. Your end game is critically important to consider at the beginning because it helps you chart your course.

Here are a few questions you should be asking right from the beginning:

  • What is your business goal?
  • How do you plan to grow your business?
  • What happens when it comes time for you to exit your business? Who takes over?
  • How do YOU want to exit your business?
    • Merger?
    • Acquisition?
    • Sale?
    • Retirement?

These are just the beginning of numerous questions you can ask. And these don’t take into account a critical component to your end game: SALES TAX. Yes, the current sales tax laws at the time of a buy/sell transaction have an implication on your business. And for you serial entrepreneurs out there, it also has an impact on businesses you buy.

Buyers need to be alert to unpaid or unknown taxes in advance. Otherwise you may be in for a world of hurt when you acquire hidden liabilities. Sellers have to demonstrate you have addressed things like sales and use tax, nexus and payroll tax … to name a few. The way these items are handled can impact the purchase price and what can be done to successfully close the deal.

Now before you freak out, RELAX. We can help. Join us as we discuss how sales tax laws play into business transactions and things you should watch for. You can find us in Mankato on August 2, Sioux Falls on August 3 and Fargo on August 4. We’ll even give you lunch.

P.S. Check out these different considerations when talking about Your End Game. Just make sure you start talking about it early.

 

 

The Importance of Valuation

Do you know how valuable your company is? No, we’re not talking about how much you think it’s worth. We’re talking about an independent appraisal of the worth of your company and how much it would potentially sell for. Welcome to the world of business valuation.

Why does this matter?
Now you may be thinking, I just got going in this. I’m not ready to sell my business so a valuation isn’t important to me. Well, we respectfully disagree and we’ll tell you why.

For one thing, it’s beneficial to have a qualified appraisal of the Company’s stock to provide stockholders with an estimate of their shares and their investment in the Company.

Further, a valuation is important for any stage business because it prepares you for a transaction triggering event, even when you don’t see one in your near future. Plus, you know what they say about best laid plans …

What do we mean by transaction triggering events? Here are just a few ideas:
• Shareholder/employee quits
• Shareholder/employee is fired
• Shareholder retires
• Shareholder wishes to sell stock
• Shareholder becomes disabled
• Shareholder death
• Shareholder divorce
• Company bankruptcy

When these types of things happen, they can cause a shift in your business and its future. It’s amazing how quickly your plans for your business may change when affected by these types of events. That’s why we recommend you consider including a well-defined valuation process in your buy-sell agreement.

Fine, tell me more about this valuation business.
One way to go about this is to choose a single appraiser now (not when the transaction triggering events have already occurred). Then have the appraiser conduct annual or periodic valuations of your business. This enables all shareholders to know and understand the value of your business throughout its lifecycle.

Why choose an appraiser early on? Well …

  • Selected appraiser will maintain independence with respect to the process and render future valuations consistent with terms of agreement and with prior reports.
  • Appraiser valuation process is known by all parties at the outset.
  • All parties know what will happen when a trigger event occurs, rather than scrambling to put together a game plan.
  • Because the appraiser must interpret the ‘words on the pages’ in conducting the initial appraisal, any issue regarding lack of clarity or terms would be resolved. Subsequent appraisals, either annually or at trigger events should be less time consuming and expensive than other alternatives.
  • Parties should gain confidence in the process.
  • Parties will always know the current value for the buy-sell agreement (this is helpful for planning all-around).
  • Appraisers’ knowledge of the company and its industry will grow over time.
  • This process creates a means of maintaining pricing for other transaction, enhancing “the market” for company shares.

Why do I have a feeling there’s more …
Because there is. Other things you should probably be consider but haven’t probably thought about include:

  • How are shares of your company purchased or funded? Where will the money come from?
  • Who buys the shares? Other shareholders? The company? A combination?
  • The Company has a number of life insurance policies. Is the insurance adequate?
  • Are there other financial resources available to buy the shares?
  • What are the terms of the transaction? (down payment, interest rate, security, etc.)
  • Are there any restrictions on share payments under the company’s loan agreements?

As you can see, there are a number of potential issues that could result in your buy-sell agreement being a “ticking time bomb.” So it’s important to discuss these issues early and often with your shareholders and your business advisors.

 

 

The Path to Buy/Sell Happiness

You’re going along, building your empire and running your company when all of a sudden, there’s a knock on the door. You open it to find someone asking to buy your business. You’re honored, flattered even. After all, someone just showed interest in the thing you’ve poured your blood, sweat and tears into. But in addition to the spring in your step, you also feel an ulcer coming on … what’s next? Where do I go from here?

Yes, the above situation is slightly exaggerated. But someone reaching out, completely out of the blue, with an offer to buy your business does happen. So it’s best to be prepared. Selling your business is more than a tour of the office, a handshake and exchanging a check. It’s complicated, often messy, and intense. We’re talking six months (yes, you read that right) of data gathering, negotiations, analysis and emotional upheaval.

Now, before you freak out, let’s take a step back and walk through the process. Consider it like a relationship.

First, let’s talk about the parties involved. The buyer is the person who wants to buy your company (clever right). They really want to date the seller (that’s you).  Other parties can include financial advisors, transaction advisors, banks, lawyers, etc. (otherwise known as the peanut gallery).

Step One: Getting to Know You

Once interested, a buyer will need information to determine the price they are willing to pay. After all, they want to be prepare for the date, not just fly blind. It’s up to you as the seller to decide how much information to give them and when. While this question is enough to constitute its own blog post, here’s the short answer: NOTHING.

You should give a potential buyer NOTHING until they sign a non-disclosure agreement (NDA). This is a legal document that protects your information as the seller and ensures the buyer is only going to stay on the up and up (read, use the information you give only to formulate their offer).

Only after a NDA is signed should you (with the help of your trusted business advisor), formulate a plan to give the buyer the information they need to understand your company. Note, this does not mean just giving them everything they ask for, but instead enough for them to submit a range of value offer.

Step Two: A Promise

After preliminary due diligence (using the information you have supplied them with as well as other research), the buyer will typically give a range of value in the form of an Indication of Interest (IOI).

Consider it like this. You’ve had some initial dates and things went well. The IOI is like a promise ring in your relationship with the buyer. It’s not always done or necessary, but it signals you’re ready to move to a more serious place, without making any concrete plans related to time, date or dollar amount.

Step Three: Opening Up

 If you like the indication of interest made by the buyer, you accept the promise ring and let your guard down a little more, allowing yourself to be more vulnerable. This means you give the buyer more access to information surrounding your company. This information may include key contracts or agreements, customer lists or more detailed financial information.

Step Four: The Engagement

This vulnerability or sharing of information allows the buyer to see a cohesive picture of your business and hone in on a more precise value. These terms are then laid out in the Letter of Intent (LOI). The LOI can be compared to the sparkling rock that accompanies the proposal in a relationship.

At this point, you both largely agree to the terms put forth. The LOI typically covers the purchase price, the structure of the deal, whether it is an asset or stock sale, the escrow parameters, the working capital allowance and other details that your advisor can help you understand. As a note, while the LOI is a very intentional document, it’s non-binding.

Step Five: Going to the Chapel …

After negotiation, review of legal terms and final due diligence, it’s time for your big day. Cue Canon in D and begin your walk down the aisle because you’ve made it to the marriage portion of the journey. Known as the Purchase Agreement, this binding agreement is agreed upon by both parties and will be a road map for how thing play out once the deal is closed.

The Selling Relationships (1)

This blog illustrates high level the transition through the selling journey. There will be bumps along the way (similar to a relationship), but it’s important to remember a few things as you go through:

  • Know your end game. This business is yours and you’ve put a lot of hard work into it. So know what you want from your business and a potential sale, as well as what you don’t.
  • Engage the peanut gallery. Don’t enter this relationship alone. Get advice from trusted business advisors and people who have gone through these situations before. They’ll help you navigate the bumps along the way and make sure you go down the aisle with confidence.