Selling Your Business – Calculating What You Get to Keep – Part Three

Who cares what you sell your business for? How much of it do you get to keep? This is the final in a three-part series explaining the math behind selling your company.

Part 1 – Enterprise Value
Part 2 – Equity Value
Part 3 – Net Proceeds – Asset Sale vs. Share Sale

Net Proceeds – Asset Sale vs. Share Sale

Enterprise Value of an operating business is typically estimated without consideration of the eventual mechanism of sale, that is an asset sale or a share sale and the associated impact on the tax attributes of the business in the buyer’s hands.

A buyer will typically have a preference for an asset sale as there may be positive tax attributes available (increased depreciation expense allowed in future) from writing up the acquired assets to fair market value. There is also a perception of lower risk since the buyer is not assuming risk for the existing corporation and its historical operations.

Sellers in Canada who qualify for all or a portion of their lifetime capital gains exemption of $750,000 per person on shares of a Canadian controlled private corporation will have a clear preference for a share sale. The magnitude of this tax exemption benefit is such that a share sale becomes a virtual requirement on the sale of a small or medium sized enterprise owned by two or more individuals who qualify, as it is very difficult to bridge the tax exemption benefit gap by any reasonable price increase in an asset purchase offer. Sellers in this position can expect that a buyer will want to discount the purchase price by at least the amount of the lost tax attributes if they are willing to proceed by way of a share purchase. It is customary for the seller to obtain an estimate of the Net Present Value (NPV) of the lost tax attributes for the buyer from their accountant so that they are well prepared for negotiations. Share sellers can also expect a higher holdback against representations and warranties to be required. This holdback may be 15% of the purchase price for 18-24 months to offset the additional risk assumed by the buyer.

Purchase offers drafted by buyers are often specific on price, but are usually deficient in outlining how that price will be paid and the mechanism(s) for any adjustments. Any ambiguity in this regard should be addressed by further communication with the buyer before you and your professional advisors invest time in analyzing the offer and considering a possible acceptance or counter offer.

Asset Purchase offers are more difficult to analyze in that there are unlikely to be any numbers you can directly compare to your expectations on Enterprise Value and Equity Value. The proposed purchase price will typically be for all or a select group of assets and may or may not include provision to assume select liabilities and contracts. It is then necessary for you to estimate the additional proceeds you are likely to realize from the disposition of assets that are not included. A typical example of assets that might not be included would be accounts receivable, as buyers do not like to take the collection risk on past sales. The next step is to consider the extent of balance sheet liabilities (for example accounts payable) you will be required to pay out of the purchase price that would typically have been assumed by the buyer in a share purchase. You will also have to estimate the costs for severance for employees or the exit from contracts such as premise leases the buyer is not assuming. These costs would typically be assumed by the buyer in a share sale. You will then be able to estimate the implied Equity Value after considering any surplus cash, redundant assets and interest bearing debt; the impact of which was reviewed in Parts 1 and 2 in this series.

A Share Purchase offer is easier to analyze as the purchase price will be directly related to Equity Value since the buyer is buying your equity in the company. You will still have to consider any proposed adjustments, excluded assets and excluded costs. Keep in mind the Equity Value (and typically the purchase price) includes all bonuses payable to the owners, shareholders’ loans, related party debt, preferred share capital, common share capital and retained earnings.

Shareholders’ loans, related party debt and share capital represent tax paid money. The following discussion on taxation is relative to the balance of Equity Value arising from retained earnings and any gain on sale.

In the case of an Asset Sale, you will retain your corporation and have the opportunity to continue to use it as a holding company. There is significant complexity in tax legislation and calculations and you will need specific professional advice. It is typical for the total corporate and personal taxes to move the funds to your hands will be 30-40% of the Equity Value arising from retained earnings and any gain on sale.

In the case of a Share Sale, any gain above the cost base of your shares will be taxable as a capital gain. Capital gains are taxed at half rates. If you qualify for all or a portion of the $750,000 lifetime capital gains exemption, then the amount you qualify for will not be taxed. The balance, if any, would be taxed at the favourable 50% of normal rates applicable to capital gains.

An example that is value neutral to the buyer may be helpful. Transaction costs which are likely to be similar for the two options are excluded for simplicity. We’ve assumed a sale involving two shareholders with availability of the maximum exemption of $750,000.

Note: If the vendor were to net $1,724,900 in an asset sale the purchaser would need to pay an additional $882,000.

Lesson learned

It truly is all about what you get to keep and not just what you sell your business for.

Our Corporate Finance team can help you figure out this math and present it to you in a language you can understand. We promise. Why? Because we are business owners, too.