Selling Your Business in a Merger & Acquisition Transaction - Part 4

By Jack Lyons, Mergers & Acquisitions Advisor and Certified Exit Planning Advisor (CEPA)

In a merger & acquisition transaction a professionally prepared information package can create the best possible impression right from the beginning. After that, keeping an M&A buyer interested in your company will require selling yourself, your company, your company’s future, your organization, etc., as well as the ability to provide mergers & acquisitions due diligence materials in a timely manner.

Before you begin or very early in the mergers and acquisitions sales process, it is wise to assemble the due diligence documentation a buyer will need to close the transaction. Make copies of everything the buyer will need for merger and acquisition due diligence; you will need this later as supporting documentation in the M&A purchase agreement. Responding quickly to mergers & acquisitions due diligence document requests builds buyer confidence in the company that he or she intends to acquire. As mentioned earlier, untimely conveyance of due diligence materials can put a merger & acquisition transaction at risk. Don’t underestimate the task of gathering this information. It is literally a full-time job that can take weeks to finish. Many times, a seller will want help putting the materials together due to the magnitude of the task. Although the merger & acquisition due diligence list is different for each buyer, some of the items you will need are:

  • Company articles of incorporation and all amendments to them
  • Company bylaws and all amendments
  • All stock transfer records
  • All shareholder agreements, stock option plans, profit sharing plans, etc.
  • All shareholder meeting minutes
  • Fiscal year-end and quarterly financial statements for the last three years
  • Interim financial statements (YTD)
  • Trend information
  • Revenue by product line or business type
  • Auditors’ opinion letters for the last three to five years
  • General ledger trail balances as of the most recent fiscal year end and most recent interim period
  • Bank reconciliation statements for the most recent year end and month
  • Future years’ income forecasts, expense projections and supporting documentation
  • All tax-related materials, including income tax and payroll tax information; other business taxes; any tax audits and settlement documents; and state tax information by state, including a list of states where employees have worked and where the company is registered to do business
  • Equipment leases, fixed asset lists, prepaid expenses list, etc.
  • An accounts receivable aging
  • A list of accounts payable as of the most recent year end and fiscal period
  • All employee benefit plan documentation
  • A list of employees and their hire dates, positions, salaries and bonus information, and who is covered by the various company benefit plans
  • Company employment, non-compete, consulting and secrecy agreements
  • A list of key personnel and an organizational chart
  • Property lease or ownership documents and, if the property is owned, an up-to-date environmental report as well as all written communication with environmental agencies
  • Permits, licenses, applications and authorizations from any public government agency
  • A complete list of all open lawsuits, proceedings or threatened actions
  • All agreements relative to company borrowing
  • A list of all oral agreements
  • All agreements with major customers
  • Any joint venture agreements
  • All licenses and permits
  • Property deeds, appraisals, etc.
  • All insurance policies
  • Information regarding patents, trademarks and copyrights
  • All unemployment claim information

The above is just the beginning. A mergers & acquisitions real due diligence list is much more exhaustive. As you can see, this is the most confidential information about your company. It should be released to the M&A buyer only once it appears that a merger & acquisition transaction can happen and certainly after the M&A buyer has signed a confidentiality agreement.

The tax implications of a merger & acquisition sale transaction are complex and confusing. Both M&A buyers and sellers need expert tax advice at this time to avoid later regret. The form of the merger and acquisition transaction, whether it is a stock or asset sale, is often an issue between the M&A buyer and the seller because the federal tax code and IRS regulations are designed to create opposing interests between M&A buyers and sellers relative to the basic structure of a sale. Most sellers would prefer a sale of stock. Most M&A buyers would prefer a purchase of assets. Taxation favors the seller in a sale of stock. On the other hand, tax regulations favor the M&A buyer in an asset purchase because the buyer can book the assets at the purchase value and take advantage of depreciation deductions. In a stock sale, the seller doesn’t have to deal with canceling contracts, terminating employment or reconciling vendor accounts. In an asset purchase, the M&A buyer gets more of a fresh start with vendors, employees and customers. Sometimes a stock sale is dictated by outside factors such as maintaining long-term contracts, preserving a special status with either the federal or state government, or keeping a license active. However, an asset sale is usually a cleaner and safer way for an M&A buyer to acquire a business and is the most common form of mergers & acquisitions sale transaction.

Sometimes the corporate tax structure will dictate whether a seller can afford to complete a mergers & acquisitions sale transaction. Remember, there can be federal, state and local taxes assessed on the sale of a business. An asset sale of a C corporation is heavily taxed: proceeds are taxed at the corporate level and again at the individual level. Corporate tax structures such as S corporations, limited liability corporations and partnerships are generally able to avoid this double taxation. However, that is not a given if the company has converted from a C corporation to another form of corporation.

Real estate ownership can be a complicating factor in a mergers & acquisitions sale transaction. Although a building can be an asset that an M&A buyer can leverage, it can also be a hindrance in selling. An M&A buyer may not be able to afford the cost of the real estate or may want to lease it or even relocate the company. Or the seller may want to lease the property for long-term income, which may not correspond with the M&A buyer’s vision for the future of the company. If the property owner is acting as both landlord and tenant, this could produce a conflict when the time comes to sell.

By the time you decide to sell your company in a mergersMerger and Acquisition & acquisitions sale transaction, it is usually too late to change your tax structure. It is always better to have tax advice before beginning the sale process, and participating in careful planning years in advance can save substantial taxes at the time of a merger & acquisition transaction. If you are just beginning your transition planning, now is a good time to ask your tax advisor about setting up the most favorable corporate structure for a mergers & acquisitions sale.

Asset allocation is often an issue in the sale of a business. The IRS requires that an asset allocation form (Form 8594) be filed with the transfer of a business. The form organizes the sale price into a  number of asset classes, which may cause different levels of taxation; therefore, allocating the purchase price to specific assets is an important part of the mergers & acquisitions sale negotiation. Agreement on asset allocation should occur as early in the M&A process as possible and should always be done with expert advice to avoid a later surprise. Purchase price assignment to assets may trigger depreciation recovery, which is taxed as ordinary income, and if you have converted from a C corporation in the last 10 years (7 years under the Obama tax plan), you may also be subject to the built-in gains tax. For asset allocation advice, be sure to consult with a tax professional who regularly handles merger & acquisition sale transactions.

There are three main sources of financing for a business purchase: the buyer’s own capital, third-party (such as a bank) financing and seller financing. It is common for a merger & acquisition sale transaction to have financing provided from all three sources.

Jack Lyons is a Mergers & Acquisitions Advisor, a Certified Exit Planning Advisor (CEPA) and president of Lyons Solutions, LLC. He can be reached at 203-642-4141 or at jlyons@lyonssolutions.com.

Copyright 2010 Jack Lyons. All Rights Reserved.