Michael B. Lehner, CPA/ABV, CFE, ASA
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Creative ways to structure mergers and acquisitions

mergers and acquisitions

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Private business owners seldom give business value much thought until it’s time to sell or retire. They’re simply too busy with daily operations to stop and ponder: “What’s my business worth?”

A business valuation professional can help a seller understand what the business is currently worth based on current asset values, cash flow analysis and comparable sales. He or she also can discuss different ways to structure a deal, depending on the owner’s cash flow needs, priorities and aversion to risk.

What’s my asking price?

Most valuation assignments call for fair market value. In a nutshell, this standard measures what the universe of hypothetical buyers would agree to pay for a business interest. But strategic or investment value might be a more relevant standard in a merger or acquisition (M&A). Strategic value gauges how much a select group of qualified buyers might be willing to pay. Usually strategic value is higher than fair market value because acquiring the business may result in specific cost-cutting or revenue-enhancement benefits to the buyer.

If your business has been appraised in the past — say, for gift tax or divorce purposes — that value might understate the optimal asking price. Alternatively, it may overstate the asking price if, for example, the appraisal is several years old and your company was hard hit by the recession.

Setting a reasonable asking price is imperative. Aim too high, and you risk scaring away suitors. Aim too low, and you risk leaving money on the table. When establishing an asking price, consider a professional valuation that incorporates the cost, market and/or income approaches.

How can I attract buyers?

Economic turbulence and tight credit have changed the M&A landscape in recent years. In many transactions, buyers and sellers have been forced to consider creative alternatives to cash.

One of the more common solutions is seller financing. Here, a seller agrees to accept a down payment when the deal closes and the remainder over an installment period.

How do valuators support earnouts?

M&A parties might also consider an earnout. Generally used to mitigate the risk of achieving forecasted results, earnouts differ from installment sales. A portion of the sales price in an earnout is not only deferred, but is also contingent on future performance. Suppose a buyer pays $12 million for ABC Inc. at closing, plus an additional $6 million over the next three years — but only if ABC Inc. achieves its profit targets over the earnout period.

To support an earnout, a valuator can develop forecasts of what will be paid in the future under a variety of probable scenarios. Sensitivity analyses can help determine which assumptions create the greatest volatility in the payouts.

An earnout may require a seller’s ongoing involvement in the new entity, typically as a consultant. Such an arrangement eases the transition to new management. The IRS treats consulting agreements as ordinary income for the seller, subject to FICA. The buyer then can deduct the payouts as an expense in the current period. Sellers need access to accounting information to confirm their earnout payments, and many will require CPA verification of financial results.

Alternatively, a seller may be asked to “roll over” part of existing equity into an investment in the new entity. A seller, for example, might receive 80% cash and the remaining 20% of the asking price as stock in the buyer’s business. Especially popular in mergers with supply chain partners or competitors, these transactions require a valuator to appraise the expected value of the combined entity.

Why do I need an expert?

Business appraisers deal with M&A transaction data on a daily basis. This data eliminates guesswork by providing tangible market evidence to supplement an owner’s gut instinct.

Moreover, no universal deal structure works for everyone. Valuators keep current on deal trends and tax laws and can help buyers and sellers negotiate mutually advantageous terms.

 Sidebar: Asset sale or stock sale?

When negotiating a merger and acquisition (M&A) transaction, buyers and sellers need to decide whether to structure it as an asset sale or a stock sale. Consider the pros and cons:

Asset sales. Buyers generally prefer to cherry-pick the most desirable assets and liabilities in an M&A. Asset sales offer a fresh start because the buyer receives a step-up in basis on the acquired assets, which lowers future tax obligations. Depreciation starts anew. And the buyer negotiates new contracts, licenses, titles and permits.

But the seller pays capital gains on assets sold in an asset sale. If the seller is a C corporation, its shareholders also will pay tax personally when the company liquidates.

Stock sales. Sellers typically like stock transfers because they’re simpler and tax obligations are usually lower. But stock sales may be riskier for buyers because operations — including all debts and legal obligations — continue uninterrupted. In a stock sale, the buyer also inherits the seller’s existing depreciation schedules and tax basis in the company’s assets.

Michael Lehner

This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. In addition, any discounts are used for illustrative purposes and do not purport to be specific recommendations.