December 7‚ 2011
Thinking Ahead: Preparing to Sell the Privately
The Smith family has been manufacturing widgets for over
forty years. The business, operated through a “C” corporation called Smith
Co., has been in the family for generations. Six years ago, the family
decided to diversify the business and began manufacturing waggles.
Fast-forward to today. The Smiths receive an attractive offer
for the widget business. A stock sale makes the most sense for the Smith’s
from a tax perspective. But what about the waggle business? They decide to
transfer the assets and goodwill of that business to a subsidiary of Smith
Co. and distribute the stock of that subsidiary to the stockholders of
Smith Co. prior to the sale of the widget business. Simple, right?
Perhaps, but this spin-out could have adverse tax
implications for the Smiths. First, the distribution of the subsidiary’s
stock is likely to be treated as a sale subject to taxation at the Smith
Co. level, affecting the price the buyer may be willing to pay for the
Company. Second, the distribution of the stock will likely be treated as a
dividend to the recipients.
These adverse tax consequences may have been avoided had the
Smiths considered the possible ramifications in advance. For example, if
the Smiths considered the possibility that a future sale may involve either
the widget or the waggle business without the other, they could have effected the separation of the two businesses a year or
more in advance of a sale (and before a specific counterparty was
identified) and perhaps avoided any tax.
Whether or not one ever plans to sell a privately-owned
business, recent changes in income and estate tax laws, health care
requirements and other regulations affecting privately held businesses make
the present an opportune time to consider a number of issues:
Do you have the most efficient structure from both a tax
and liability perspective? Does it make sense to conduct different
lines of business in different corporate or other entities? See the Smith
example above. Similar issues may arise with regard to specific assets that
may not be included in a sale such as real estate or intellectual property.
What is the current ownership structure? Has it
changed through the years (i.e., younger generations acquiring an equity
stake in the business)? Are all changes properly documented?
Have you mapped out a sound succession plan? Is it in
writing? Does this plan involve changes in ownership? Does your plan take
into account the tax ramifications of any such changes?
Do you have evidence of ownership of all of the important
assets relating to the business? Have you sought patent or trademark
protection for important intellectual property? If the business has
expanded geographically, does seeking protection of important inventions
and marks in foreign jurisdictions make sense?
When is the last time that you reviewed the terms of
material contracts? What is the remaining term of each of these
contracts? Would a sale trigger any particular provisions in an important
agreement such as the assignment provisions? Are you or the counterparty
inadvertently in breach of any of the terms of a material contract?
Has the business expanded geographically in recent years?
Is it qualified to do business in each jurisdiction (both domestic and
foreign) in which it operates? Is it in compliance with applicable import
and export laws and all certification and other requirements imposed by
each jurisdiction in which its products are manufactured or sold?
Are the business’ financial statements audited? If
not, this may impact the ability of many public companies to purchase the
business, thereby reducing the pool of potential buyers and eliminating
those who, because of their financial strength and strategic interest, may
be able and willing to pay the highest price.
Have you adhered to proper corporate formalities?
Incorporating a business is not enough. If the principals fail to take
steps to respect the existence of the corporate entity (such as maintaining
separate accounts and obtaining board and/or stockholder approval of
material transactions outside of the ordinary course of business),
creditors may “pierce the corporate veil” and pursue the principals
Depending upon the nature of the business, other areas, such
as environmental compliance and employment practices, should be reviewed well
in advance of a possible sale.
Every business has a unique profile that will dictate the
steps that should be taken in advance of a sale and, equally as important,
when they should be taken. In the example above, the Smiths would have been
well served to consider a restructuring a year or more before the sale. As
with most business decisions, planning ahead for a possible sale makes
sound business sense.
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