Due Diligence for Sellers (Part 1)

Seller's Due Diligence Checklist Part 1If your exit strategy includes selling your business, you need to be sure you protect your interests and negotiate the strongest deal possible. Doing your homework up front – your due diligence – is the best way to ensure that the sale will work for you.

Your buyer will no doubt conduct a thorough investigation of your business to make sure he or she is getting their money’s worth. In the same way, you need to dig out details about the acquiring company and the specifics of the deal they are offering. This applies whether the proceeds of the sale will be cash, deferred payments, corporate stock, or a combination.

Organize your approach to due diligence by identifying and focusing on the most important issues. Knowing what you want to learn going in can also help keep you from making overly emotional decisions during the process. Among the most important issues to investigate are:

For a Cash Sale

If you are selling the assets of your business or your ownership interest for cash up front, your biggest challenge is going to be the tax implications of such a large infusion of cash at one time. Too many business owners congratulate themselves on negotiating a lucrative cash deal for their company, without realizing the tax consequences. The tax impact can vary widely depending on how long you’ve owned the business, and how the deal is structured.

If you are an S corporation, sole proprietorship, partnership, or LLC and sell corporate stock for cash, you’ll likely face a long-term capital gain tax, but at preferential federal rates. But beware: state and local taxes may take a substantial bite out of your proceeds.

If you are selling the assets of a C corporation with plans to then liquidate the entity, there is the possibility of facing double taxation. The corporation may owe corporate taxes on the asset sale, and you might then take a hit on your personal income tax when you receive the liquidation proceeds.  This double taxation may also apply at the state and local level.

Double taxation is generally not an issue for S corporations, partnerships, or LLCs. However, tax consequences can vary based on the nature of the assets you are selling.

These variables can be better managed and the tax impact minimized with proper planning, which you’ll need to do in advance.

For a Cash Sale with Deferred Payments

Many deals today are cash deferred or seller financed. This involves taking back a note receivable in lieu of part (or in some cases, all) of the sale price of the business. This involves greater financial risk to the seller, and places even more importance on conducting a thorough due diligence investigation before finalizing the sale. Some of the issues you’ll want to address are:

  • What is the buyer’s timetable for completing the transaction? Are they in an inordinate hurry? Why?
  • How much cash can the buyer provide up front? The more the better, as it lessens your risk of not receiving full value for your business.
  • Obtain a credit report and financial statement from the buyer to assess their credit status.
  • The buyer should be willing to pay a premium for the business. Make sure you get a higher sale price.
  • Charge interest on the deferred payments, and make sure the rate is high enough to reflect the financial risk of late or missed payments.
  • Obtain secured promissory notes and guarantees from the buyer as collateral. This collateral may consist of the assets of the business you are selling.
  • Get specifics on where the cash to make future payments will be coming from, and determine whether this cash flow will be sufficient.
  • Investigate the reputation of the buyer in the business community, among financial professionals, and within their specific industry. Google them! Look for any mention of legal trouble or unethical business practices that could jeopardize future revenues. Search public records for undisclosed litigation.
  • Consider purchasing a life insurance policy on the lives of the buyer, depending on the structure of the business and his or her importance in keeping it running.
  • Get a good sense of the buyer’s plans for the management of the business you are selling, as it may be the main source of cash for your future payments.
  • Negotiate a consulting contract for yourself, and perhaps other key managers in your business. This can provide additional cash for you and give you an opportunity to make sure your business is assimilated effectively.
  • Determine the potential tax implications of a deferred payment sale. In some cases the tax burden is “front loaded,” and requires careful advance planning.

Selling your business can be both an exciting and stressful event. Don’t let emotions or eagerness mask the potential risks, including the potentially significant short- and long-term tax implications. There is no such thing as “too much planning” with so much at stake.

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