Starting a business is an exciting and challenging endeavor. But it takes more than a brilliant idea and zeal to achieve success; it requires establishing a robust business structure that can sustain you in the long run. One crucial aspect of business structure is deal structuring, which can determine the fate of your venture.
Why deal structure matters
The importance of deal structure cannot be overstated when it comes to buying or selling a business. It’s the foundation upon which the entire transaction is built, and it determines how the parties involved will benefit from the deal. A well-structured deal takes into account the interests and objectives of both parties, protecting them from any potential pitfalls and ensuring a smooth transaction process.
A well-crafted business deal can reduce your financing expenses while ensuring that the transaction is within reach for both parties involved. The structure of your business deal can also have a considerable impact on the tax implications. Structuring your business deal can go a long way in minimizing your tax obligations.
The way you structure your business deal has a significant long-term impact on your business. It can even determine whether your business’s day-to-day operations will improve, stagnate at some point, or deteriorate, thus affecting your ability to make profits in the future.
Deal structures: Choosing the right one for your business
Are you contemplating acquiring another business, selling your own, or merging with another company? Before you make your move to buy, sell, or merge, you have three basic deal structures to choose from: asset sales, share sales, and mergers.
Asset sale
Asset sales are when a buyer decides to purchase specific assets of a business instead of buying the whole thing. So, you get to pick and choose which parts you want to buy, like inventory, equipment, real estate, or even intellectual property. The best part? You won’t be responsible for any of the seller’s problems or debts that aren’t outlined in the asset-structured business deal.
Buyers often prefer asset sales because they offer more flexibility. You get to pick and choose only what you want, without any added baggage or liabilities that the business fosters and you don’t want to carry. This is especially great if the seller has any outstanding debts or legal issues that you don’t want to take on.
Asset sales can also bring other benefits to the seller beyond just financial gain. By selectively selling particular assets, the seller can maintain the operations of the remaining parts of the business or gradually dissolve it without having to deal with any negative repercussions.
Furthermore, the seller can potentially increase their profits by selling individual assets separately instead of bundling them into a larger sale. This approach allows for more personalized and customized deal structuring that caters to the unique needs and preferences of the parties involved.
Share sale
In a share sale, the buyer purchases all the ownership shares from the current shareholders. In this type of deal structure, the buyer takes over not just the company’s assets but also its liabilities, which include legal and financial obligations.
Share sales allow for a complete transfer of ownership and control without all the hassle of restructuring or transferring individual assets. Plus, they’re especially attractive to buyers who value the business’s reputation and goodwill over its physical assets.
A share sale is a straightforward transaction in the sense that you sell your whole business in just one transaction. Plus, if you’re a shareholder in a corporation, you might be able to get some juicy tax benefits that you wouldn’t get in an asset sale.
However, share sales also come with risks. The buyer is assuming all of the legal and financial obligations of the business, which can include hidden liabilities or legal issues that may not be apparent at the time of the sale. Due diligence is critical in a share sale to identify and address any potential risks or issues.
Mergers
A merger is a type of deal structure in which you combine your business with one or more other businesses to form a new, larger company. In a merger, the companies involved pool their resources and share their assets and liabilities to create a new, more substantial entity.
In mergers, the possibilities are endless — think economies of scale, reduced costs, and increased market share. And let’s not forget about the exciting new markets, technologies, and resources that a merger can bring to the table. It’s like a match made in heaven!
However, mergers can be intricate and full of risk. Uncovering and addressing potential issues that may arise is crucial. These issues can range from differences in culture and management styles to corporate governance concerns.
Companies can merge in different ways, depending on their goals. You have horizontal mergers (where similar businesses merge), vertical mergers (where different stages of production merge), and conglomerate mergers (where unrelated businesses merge).
Deeply contemplate and deliberate upon the aims and objectives of the merger while also being cognizant of the potential hazards and obstacles to guarantee a successful business deal. Seeking the guidance and counsel of proficient legal and financial experts is highly recommended when deal structuring a merger.
Variables in deal structuring
Let’s delve into some of the most crucial factors to consider when structuring a deal.
Price: You have to figure out what’s fair and reasonable by taking into account the value of the business or assets being sold while also keeping in mind any potential liabilities or risks that come with the deal.
Payment terms: This is all about how and when you’ll be making the transaction. It could be cold hard cash, some kind of financing deal, or maybe even a creative earnout arrangement.
Contingencies: It is imperative to consider contingencies in order to finalize the deal, such as fulfilling regulatory requirements, conducting due diligence, and meeting other prerequisites.
Timing: It’s not just about making sure payments are on time but also considering the closing date and other deadlines. These elements can make or break a deal, so it’s crucial to keep them in mind to ensure everything goes smoothly and according to plan.
Allocation of risk: When deal structuring, we have to make sure to spread out the risks and liabilities among everyone involved. This means we might need to throw in some warranties or indemnifications to keep things fair and square.
Governance: Governance refers to the structure and management of the new or combined business entity resulting from the transaction. For instance, this could be the roles and responsibilities of the management team, as well as any governance provisions or restrictions that may be necessary.
Employee considerations: Employee considerations are essential when structuring a deal, particularly if the transaction involves a change of ownership. It’s essential to consider how the transaction will impact employees, including any potential layoffs or changes to compensation and benefits.
Deal terms for structuring deals
Deal terms are the specific provisions that govern a business transaction. These provisions can be discussed and adjusted by the parties involved and are commonly documented in a written agreement after deal structuring. Below are some examples of these terms.
Assets or shares: The first deal term is whether the transaction will comprise the procurement of assets or shares. This decision holds significant weight in any structured business deal.
Representations and warranties: When you’re buying a business, the seller makes promises about it in writing; these promises are known as representations and warranties. They make sure everyone is on the same page about what’s being sold or merged. Representations and warranties also help determine who’s responsible if something goes wrong.
Indemnification: Basically, when a breach of representation or warranty occurs, the seller must compensate the buyer for any losses or damages that arise. This provides a sense of security for the buyer, knowing that they won’t be left out to dry.
Escrow arrangements: Some deals are made more secure through escrow arrangements. Basically, a portion of the purchase price is held until certain requirements are met. This helps ensure all parties involved have their contingencies covered before funds and assets are transferred.
Noncompete provisions: This clause ensures that the seller cannot compete with the buyer’s business for a certain period, safeguarding the buyer’s interests. It’s a strategic move to prevent potential competition and maintain a smooth transition of ownership.
Confidentiality provisions: These crucial provisions serve to safeguard sensitive information pertaining to the business being sold. It’s imperative to incorporate nondisclosure agreements and other confidentiality requirements in the purchase agreement to accomplish this.
Closing conditions: In order for the deal to be completed, it is necessary to fulfill certain closing conditions. These may entail obtaining regulatory approvals, meeting financing requirements, and satisfying other criteria specific to the transaction.
Tax implications to consider
The structure of the deal can have significant tax consequences for both the buyer and seller. What are some tax implications you should keep in mind? Let’s take a look and explore the various tax implications that could come into play.
Asset sale versus share sale: When it comes to structuring a business deal, choosing between an asset sale and a share sale can heavily impact your tax liabilities. In an asset sale, the buyer purchases only the assets of the business he or she specifies, while the seller retains ownership of the business entity. In a share sale, the buyer acquires a portion of the shares of the business, and the seller relinquishes ownership of the entity. The tax implications of either choice can vary, depending on the value or nature of the assets involved.
Tax basis: The tax basis of the assets involved in the structured business deal can impact the tax cost of the deal. Tax basis is the value of the assets for tax purposes, and it can impact the taxation cost owed by the buyer and the seller.
Capital gains tax: Capital gains tax is a tax that’s applied only to funds that were generated as profit from the sale of an asset. It affects both the buyer and the seller. The tax rate can vary depending on different factors, such as what type of asset it is and how long the seller has held onto it.
Depreciation recapture: This is a tax that can hit the seller pretty hard if the assets they’re selling have already been depreciated. The amount of tax owed is calculated based on how much depreciation was claimed on those assets.
State and local taxes: Depending on where you are, you might be dealing with sales tax, transfer tax, and other sneaky taxes that could seriously impact your business deal.
Tips when structuring a deal
- Understand the value of the business.
Before diving into the nitty-gritty of deal structuring, it’s essential to take a step back and assess your overall business strategy. What are your long-term goals, and how does this deal fit into them? What are your immediate needs, and how will this deal help you meet them? Answering these questions will help you determine the type of structured deal you require. - Identify and prioritize the critical deal terms.
This involves identifying and prioritizing the most important aspects of the transaction and negotiating favorable deal terms that meet your interests. Whether it is pricing, payment terms, or other key provisions, it is important to clearly communicate and agree upon these terms. - Be willing to compromise.
Remember that rarely will both parties agree on every single term, so it’s important to be willing to negotiate and make concessions where necessary. The ability to find common ground and come to a mutually beneficial agreement is crucial to the success of any structured deal. Try to find ways to meet your needs while still being flexible in other areas. - Seek professional advice from an attorney, accountant, or business broker.
These distinguished professionals are well-versed in navigating complex transactions and can provide invaluable insights into the structure of the deal, its terms, and any potential pitfalls.
– An attorney is equipped to assist in crafting and perusing legal documents, ensuring that the agreement safeguards your interests while remaining legally binding.
– An accountant can offer guidance on the financial implications of the deal, including tax obligations and financial reporting requirements.
– Meanwhile, a business broker can provide expert advice on market conditions, valuation, and effective negotiating strategies.
Ensure that all parties understand the deal structure and terms.
This can ultimately prevent any misinterpretations or conflicts in the future. It’s crucial that we thoroughly communicate all facets of the structured deal.