You have questions. We have answers.
Our list of Frequently Asked Questions was compiled over the years using the most common questions we heard as M&A transaction advisors. These represent just some of the issues that were raised as we completed over 200 transactions. Use them to help find the answers you need. Don’t see the answer to your question? Call us today and learn how we can help.
What is goodwill and how is it calculated?
Goodwill (or “Blue Sky”) is the amount of consideration over the fair market value of an asset.
What is the difference between a business broker and an acquisition intermediary / advisor?
Business brokers are generally very adept at selling smaller companies, where confidentiality and deal complexity are not as great a concern. But the benefit of maximizing value by identifying multiple strategic buyers, having the confidence to work with large companies or Private Equity Groups (PEG’s) wherever they may be and having the years of experience to move a deal forward when it gets “stuck,” are all advantages to using an M&A intermediary / advisor.
What are earn-outs, holdbacks and an equity stake, and why are they beneficial?
These are deal points that can increase the amount a Seller can receive, but limit the risk for a Buyer. An earn-out generally pays a Seller more if projections are exceeded over a certain time after the closing. A holdback (generally around 10%) is often “held back” to make sure that any contingent liability that is waived in the reps and warranties can be protected. After the time window for contingent liabilities is over, the holdback is paid. An Equity Stake is the technique of offering a piece of the new entity as consideration. In the right hands, this equity stake can often become a highly valued asset in the future, allowing for even greater returns for the Seller. All of these tactics are beneficial because they can increase the consideration paid in the long run and shift taxation to future years, thereby avoiding additional tax in the year of sale.
What is a working capital peg?
This technique can help limit risk for buyers. For instance, an offer for a company may come with a working capital peg that offers a way to pay less, pay more or not change a deal based on working capital staying within a range dictated by the Buyer. As an example, an offer might require a 10% working capital peg. If Working capital (Current Assets – Current Liabilities) of a company has historically been $1M, a Buyer might pay slightly less if working capital is 10% higher, or pay slightly more if 10% lower, or no change at all if it stays within the range. The general time frame for a working capital peg is 12 months, based on the previous 6 months of historical financial results.
What is the difference between a merger and an acquisition?
A merger happens when two companies combine assets, and post-closing, both entities have an interest in the new entity. An acquisition is essentially a sale, in that consideration in which consideration is given, assets are transferred and the old entity is dissolved.
Why would someone pay more for my company?
There are two basic reasons Buyers pay more for a company:
Significant opportunity for growth; or Limited risk.
Knowing this is the key to positioning your company for sale or finding the right Buyer. Strategic buyers look for opportunity, but at the same time, they need to limit risk. Anything you can do to limit risk for “the next owner” will pay huge dividends when it comes time to sell.
When is the best time to sell my company?
Simple. Before you need to. Trying to time the market for the best economic cycle is next to impossible, just as it is in the stock market. Instead, looking at your long term goals and coordinating the sale with those plans, diversifying your holdings to reduce the amount of risk or simply taking advantage of an opportunity all make sense. The worst time to sell is if you have to.
How do I pick a merger and acquisition advisor?
An experienced M&A advisor should:
- Have years of industry or deal specific experience
- Not charge a fee up front, unless there are extenuating circumstances
- Have access to strategic buyers and contacts who respect their work
- Add value to the transaction, not simply “list” a business for sale
- Be willing to work with your existing team of advisors, or suggest new ones if needed
What are the benefits of organic growth vs. acquisition?
Organic growth generally comes from a company’s successful implementation of their business plan, which requires working capital, talent and most importantly, time. An acquisition can serve to jump start growth and is sometimes preferred if the window to capitalize on an opportunity is short. An acquisition can often provide new talent, assets and / or customers more quickly than organic growth.
What is recapture tax and why should I care?
In general, the amount of recapture tax owed at the time of sale is the difference between the fair market value of an asset being sold, and the net book value (original purchase price less accumulated depreciation) shown on the company books. This difference is taxed at ordinary income rates. Often, company owners or shareholders use depreciation as a way to lower their tax burden. This helps reduce the amount of net income and therefore the amount of tax due at year end. Taking depreciation on an asset is considered “bonus depreciation” and benefits a company’s cash flow. When an asset is sold in the future, the depreciation benefit taken during the life of an asset is “recaptured” and taxed at ordinary income rates. If an asset was purchased five years ago for $100,000 and depreciated over a 5 year life, it has zero book value. However, the fair market value at time of sale may be $40,000. The difference between net book value ($0) and FMV ($40,000) is considered taxable income for recapture purposes. For a seller in the highest 39.6% tax bracket, this means recapture tax of $15,840 (39.6% of the $40,000) may be due at the time of sale. Sellers often misunderstand that some of the benefit of taking depreciation may need to be repaid when that asset is sold. Therefore, it’s “not what you get that matters, it’s what you get to keep.” A team of professionals working together with the assistance of an experienced M&A advisor, can help maximize what you take off the table at closing.
How does an M&A Advisor get paid?
Generally, an M&A advisor is paid when the transaction closes, and not until then. While some Professionals require retainers or send an invoice for hourly work, Affinity Ventures is paid at closing. The fee schedule depends on the transaction, but is generally some percentage or algorithm of the Enterprise Value.
What is Enterprise Value and how is it calculated?
Enterprise value is generally the total amount of consideration paid for an acquisition or project, including both tangible and intangible value. Since creative allocation of the purchase price can help both parties with their post-acquisition goals, it pays to consider allocations to leases, separation of assets and other strategies that can minimize the tax consequences of a transaction. The experienced M&A advisor expects to be paid in full for this work, regardless of the final structure of the deal.
What is “Purchase Price Allocation?”
The purchase price paid by the acquirer must be allocated among the assets acquired. The allocation has significant tax consequences to both the seller (seeking to minimize tax) and the acquirer who is trying to preserve the present value of tax deductions in the future. The purchase price of the acquired assets consists of consideration paid, or the sum of the payments made, liabilities assumed, and acquisition costs. Both the purchaser and seller are required to report the purchase price allocation to the IRS on Form 8594, Asset Acquisition Statement, which is filed by both parties for the year of purchase. Assets purchased are categorized in a seven-class system:
Class I: Cash
Class II: Actively traded investments
Class III: Debt, accounts receivable, and other short term assets at fair market value
Class IV: Inventory or property held primarily for sale to customers at fair market values
Class V: All assets other than those in Classes I, II, III, IV, VI, and VII. Examples include machinery, equipment, and real estate at fair market value.
Class VI: All IRC section 197 intangibles, other than goodwill and going concern value
Class VII: Any amount remaining after allocations to classes I-VI is allocated to goodwill and going concern value [Treasury Regulations section 1.1060-1(c)].
Should I sell stock, just assets or participate in a merger?
Buyers purchasing the stock of a company get assets at the depreciated value and automatically assume all liabilities as well. In an asset sale, the buyer purchases both tangible and intangible assets. Usually the Buyer creates a new entity that will own the newly purchased assets post closing. Certain existing agreements may not be automatically transferred, such as sales contracts, employment agreements, and territory or lease agreements. A merger simply “merges” the assets of one company into another, including any agreements. Therefore, each technique offers a different set of benefits and concerns. Deciding on a purchase method in advance of selling your business can severely limit the number of qualified offers. It is better to request all offers and review each one with your professional team to see if it satisfies your goals post closing.
What is an Asset Sale?
In an asset sale, the buyer purchases the tangible and intangible assets of the business and often pays an additional amount for “goodwill.” This could include equipment, inventory and real property as well as intangible assets such as contract rights, leases, copyrights, patents, trademarks, etc. This type of transaction generally favors the buyer because it limits contingent liabilities and offers a way to step up fixed assets to fair market value. Consequently, this type of sale can create significant recapture tax for the seller.
What is a Stock Sale?
This type of sale generally favors the Seller because the amount paid over the equity value of the corporation is taxed at more reasonable capital gains rates. However, the Buyer assumes almost unlimited liability in this type of transaction and may not get the step up in value for assets. Therefore, most savvy buyers prefer to not buy stock if they can help it.
How long does it take to buy or sell a company?
The average marketing time to close the sale of a company is around 9 months. This includes time to strategically assess the best way to approach the market, develop a list of potential buyers to contact, prepare company specific materials such as the Confidential Information Memorandum, solicit and review offers, complete due diligence, negotiate any deal points, prepare the closing documents and sign the agreements at closing. While there are always exceptions, to do it right takes time.
What is a 338(h) election?
This is a tax election done post-closing that allows the acquirer of a company’s stock to “step up” the value of assets to their fair market value. The election allows the Buyer access to bonus depreciation in the subsequent tax years that may not be otherwise available. Note: The 338(h) can create recapture tax liability for the Seller and will be taxed at ordinary (vs. capital gains) rates.
What is “structured facilitation?”
This process involves the creation of a targeted list of buyers, confidentially presenting the offering, soliciting a first round of offers and reviewing them with the Seller. From there, a handful of offers are selected for the next round. The experienced acquisition advisor then talks with each party to determine if they are willing to enhance their offer. This process can often increase the amount paid because it focuses on the synergy and not the financial aspect of a deal.
What is a synergistic buyer vs. a financial buyer?
Financial buyers are generally looking for low priced opportunities in which they can acquire and then turn over for a profit in a short time frame. As such, they often do not present the highest offers. A strategic buyer is looking for opportunities that can benefit their existing portfolio. They look for situations in which 2+2 = 5, not 4. Because of this, they may value a company much higher than a financial buyer might, based on their idea of the deal synergies. Helping find the right synergistic buyer and moving them forward is the major benefit of using an experienced acquisition advisor.
I already have a CPA, Lawyer, Financial Planner, Real Estate agent, etc. – Can’t they sell my company for me?
Yes, but these professionals often specialize in just a piece of the transaction. The typical professional usually understands your business, but may not have the contacts or experience to get the best deal. For instance, your CPA is necessary to help prepare financial information and answer questions during due diligence and help with tax planning after the close. Your attorney helps review documents, suggests changes and participates in some of the negotiation. A qualified financial planner can help determine what to do with the sales proceeds so that your goals are met post-closing. However, preparing an offering package, creating a list of synergistic buyers, soliciting offers, suggesting creative strategies to help keep a deal moving forward, coordinating the activities of multiple buyers, sellers and professional advisors on each team is the job of an experienced acquisition advisor.
Why would someone be interested in buying my company?
Generally, acquirers are interested in growing their own company. To do so, management can either grow through internal efforts – often limited by access to working capital, talent, products and geographic reach – or look for a suitable acquisition target.
Why would I consider selling my company?
The benefits of an acquisition include:
- Obtaining quality staff or additional skills, knowledge of your industry or sector and other business intelligence. For instance, acquiring a business with good management and process systems could help improve your existing operation.
- Access to capital or new assets. Generally, expanding an existing operation is often less expensive to buy than to build. Buyers look for targets that are marginally profitable and have unused capacity which can be bought at a small premium to net asset value.
- An under performing business. For example, those companies struggling with regional or national growth may find it less expensive to buy an existing business than to expand internally.
- Access to more customers or increased market share. Target businesses may have distribution channels and systems that can be easily integrated.
- Diversification. An acquired business may have new products or services which can be sold through their existing channels.
- Reducing your costs. Operating synergies often drive acquisitions, with an emphasis on shared budgets, increased purchasing power and lower costs. Note: These acquisitions are more likely to fail post closing, due to inefficiencies and customer service issues.
- Reducing the competition. It may be cheaper to acquire new customers by purchasing the company that services them than paying for traditional marketing and sales efforts.
- Accelerating growth. Multiple businesses in the same sector or general location can often combine resources to reduce or eliminate duplicated expenses and increase revenue.