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!

 

Meet the Team: Amber Ferrie (@berferrie)

fgo_ferrie (2)What is my role? My role is to help business owners write the next chapter in their lives and their business’ adventures. That may be selling, transitioning to a management team or a succession plan involving family. When businesses are going through transitions, I come in to help guide them through.

Why are numbers important for business? Numbers tell the story of where you have been, where you are and where you are going. Understanding the numbers associated with your business can help you capitalize on certain opportunities and/or avoid disasters that may be lurking. Buyers always want to hear the story of your business, but they also crave the numbers and love metrics. Understanding these for yourself can help your business have a huge advantage.

Why do I enjoy what I do? Selling your business is a huge deal (no pun intended) not only from a financial perspective, but also from an emotional stand point. Being a CPA, this is one area that you can use more than just your love for numbers. You also see the personal side of transitioning a business and I find that incredibly interesting. Nothing in the M&A world is black and white. Each situation between a buyer and a seller is unique and has its own characteristics and challenges. Seeing all of those play out can be really fun.

#MidwestIsBest The majority of my work is actually not in the immediate area, but that doesn’t mean I don’t feel the love around here. The Midwest in general is an underserved market in the M&A world, and I see a lot of opportunity to serve these fabulous businesses. I truly believe these people and businesses are the best, and Eide Bailly is lucky we get to work with them.

 

Exit Planning: Identifying Objectives & Goals

As a reminder, these seven steps are based on BEI’s Seven Step Exit Planning Process

Last week, we introduced a new blog series on exit planning. There are many things to consider when you’re getting ready to exit. Today’s topic? Identifying owner objectives and goals.

In order to successfully begin exit planning, you need to identify goals and objectives to guide you through the stages of exit planning. These goals act as a roadmap and, let’s face it, trying to navigate without a roadmap is a difficult task that can take you in circles and get you lost.

When a man does not know which harbor he is heading for, no wind is the right wind” – Seneca

This quote, although a classic, still holds true today, especially in the world of exit planning. In the context of exiting a business, no goal means no style. There will be no smooth transition or easy transaction; the process will be bumpy and difficult. In 2015, Securian Financial Group conducted a study which found that 72% of small to midsized business owners don’t have an exit plan, and aren’t taking action toward getting one. If goals are so important in exit planning, why are so many people not setting them?

The main reason, according to Business Enterprise Institute, is because many owners find it emotionally exhausting. From the idea of separating themselves from an entity they have created, nurtured and watched succeed, to the time and energy needed to create a successful exit strategy, many owners just simply feel they cannot handle the pressure. However, by setting goals and objectives, some of this stress can be alleviated, as these goals are the guidelines for the strategy.

John Brown of the Business Enterprise Institute notes there are five central elements needed before a comprehensive exit plan can be created. These elements include:

  • setting a departure date
  • conducting a financial needs analysis,
  • choosing a successor
  • determining the preliminary valuation of the company
  • estimating the company’s future cash flows

Although all five elements are highly important, the first three embody the key universal objectives in developing a successful exit strategy.

Setting a Departure Date

The first step in creating an exit plan is setting a date for departure, as this will be the basis for your plan. You might be wondering how in the world it’s possible to simply pick a date. Many people plan around a significant life event, such as a child’s graduation or reaching retirement age. Other owners may just throw a date out there that sounds appealing. However you decide to choose your departure date, it is important to note that nothing is set in stone, and a rough estimate is better than nothing at all.

Financial Needs Analysis

Conducting the financial needs analysis will, in the most basic sense, tell you how much money you need from the sale of your business in order to live comfortably. To conduct this analysis effectively, a business owner must look at his or her current lifestyle choices, and determine how they expect this lifestyle to look in the future and how much it will cost. Then, many factors, such as inflation rate, life expectancy, after tax income rate and income variations, must be considered. Once all of these items have been factored together, the owner can come up with the bottom line amount needed from the sale of the business.

Choosing a Successor

Choosing a successor may be one of the hardest steps in exit planning. In this step, the owner is faced with a choice of who will take the reins once he or she makes their exit. There are many types of successors (some of them are mentioned here) that owners must consider, but the five that are the most common on include:

  • children/family
  • co-owners
  • key employees
  • an unrelated third party
  • an ESOP
  • Each of these choices have advantages and disadvantages (more on that down the road) that must be taken into account when making the choice. It is important to make sure you don’t let emotions get in the way; it is often best to follow your gut feeling – if it’s wrong, this can possibly be tweaked. It is better to have made your choice, and maybe even included a backup option, than have nothing at all.

This first step in exit planning helps owners clarify and prioritize objectives, facilitate progress, control the exit planning process and focus energy on the reason they got into business in the first place.

Next up: business valuation and future cash flows. Stay tuned!

Exit Planning: An Introduction

Chances are, as a business owner, you have heard of exit planning. But have you ever sat down and considered it in all its glory? Exit planning is a crucial step to any business, no matter what stage. In fact, the earlier you consider it, the more time you have to create an effective exit strategy that will ensure your business stays successful even after you are no longer in the driver’s seat.

Did you know that exit planning and succession planning often get confused? While the two sound similar and have some common themes, they are actually different.

  • Succession Planning – Focuses on identifying successors within a business and preparing them to replace the existing business leaders; Focuses on transfer of leadership from one generation to the next
  • Exit Planning – Analyzes all of the factors that impact a business owner, including current and future planning; Identifies strategies and steps that are most likely to allow the business owner to reach their goals

In this next series of blogs, we will be discussing a framework for exit planning and what you, as a business owner, need to know to keep your business running smoothly after you exit.

The steps we’ll be discussing are based on BEI’s Seven Step Exit Planning Process. They include:

  • Identifying Owner’s Objectives & Goals. This step will focus on identifying primary planning objectives, such as desired business departure date, who you want to leave the business to and more.
  • Quantifying Business and Personal Financial Resources. In this step, we will talk about valuation and cash flow. This will include asking yourself how much you know about the worth of your business, and how much it is expected to bring in future cash flows.
  • Business Value Enhancement. In order to make the business more appealing to your ownership interest, you must know how to increase value.
  • Ownership Transfer to Third Parties. To make sure that a smart transfer is made to a third party, this step will ensure you know how to sell to a third party in a way that will maximize your cash while minimizing your tax liability.
  • Ownership Transfer to Insiders. If you are considering transferring the business to someone on the inside, such as family, this step will be of high importance to you. This step can also help you decide whether an inside or third party transfer is right for you.
  • Continuity Planning. This step will help you ensure you have all the necessary precautions taken to be sure your business continues on if you don’t.
  • Personal Wealth and Estate Planning. It is imperative to have a plan in place to provide for you and your family post-business sale. This step will help make sure you are on the right track for financial security.

Prepare to join us over the course of these next seven blogs to learn a framework on successful exit planning and how it can benefit you and your business now, as well as in the future.

 

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.

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.