Planning the purchase or sale of a closely held business - Wisdom from Wharton

Chief Executive, The, June, 1993 by Robert J. Chalfin

* After calculating the value of the business, this number should be examined closely for the following items: appraisal values that depend on the buyer making large down payments; and valuations based on apparently unreasonable projections of future growth in cash flow, since it depends on reduced expenditures or increased revenues.

Remember, for a sale to be successful, it has to benefit both the buyer and the seller. One party cannot expect to reap all the rewards.

USING TIME TO ADVANTAGE

In today's economy, one of the biggest problems facing closely held businesses is the difficulty of borrowing funds from banks and other traditional sources. As a result, if the buyer lacks the necessary funds and cannot borrow due to insufficient collateral and established cash flow, the seller must be prepared to receive the purchase price over time--generally in the form of a purchase money note or mortgage. Assuming the absence of adverse economic conditions and the presence of an honorable buyer who is capable of operating the business, this is not a bad alternative for the seller. Here's why: The tax liability on the sale is deferred over the period that the note payments are received, and the interest earned on the note frequently will be higher than what the owner would receive from a bank or money market fund. Part of the difference in the interest rate is to compensate the seller for the risk assumed.

Once the buyer and seller agree on the purchase price and terms of the sale, a smooth transition will work to everyone's advantage. The seller should work with the buyer to transfer supplier or agency contracts, to introduce the buyer to customers and suppliers, and to foster the development of these and other key relationships. It is in everyone's best interest for the business to prosper under the new owner, especially if there is a seller-financed sale. Accordingly, if the sale price and note payments are too high, the buyer will be unable to meet his obligations to the seller, and any benefits the seller might have anticipated from the sale will go up in smoke.

Often, the seller is required under the purchase agreement to work as a consultant for a stated period. Also, except in very extraordinary circumstances, he should always provide a covenant not to compete.

If the business is being sold to a key employee(s), the principles mentioned above apply, except that the transition may be quicker and easier due to the familiarity gained through existing employment. Also, both parties know each other, the buyer(s) has experience in the business, and the risk to all usually is reduced.

In certain situations, the buyer must decide whether or not to sell stock to an Employee Stock Ownership Plan. Although there are many initial and ongoing requirements associated with this procedure, the benefits in terms of tax savings, increased employee morale, enhanced recruitment, and improved productivity can outweigh the costs if the right circumstances exist.

THE AMERICAN DREAM