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As an intermediary, I have many conversations with business owners about how much their business is worth. As these conversations progress, owners realize that it’s not how much they make, it’s how much they can keep that truly matters. The subject of the cost to sell a business, or what an owner could net after a sale, is important because many owners only know if they are ready to sell once they have a true understanding of what their total take home money will be.
Let’s explore the costs of selling a business through an asset sale by breaking down the common costs into transaction fees, due diligence costs, reconciliation adjustments, and of course, the taxes owed after the sale.
Transaction Fees Paid to Advisors
What is the Intermediary or Business Broker Fee?
While an owner can decide to sell their business without the assistance of an intermediary (Business Broker or M&A advisor), a skilled intermediary will earn his or her fee by obtaining a higher purchase price through creating competitive bidding conditions, steering the transaction to an optimal deal structure all the while enabling the owner to focus on maintaining the value of the business during the selling process.
If a business owner also owns real estate, they may also need a commercial real estate broker if the intermediary is not properly licensed to sell real estate; otherwise the intermediary can sell both.
Intermediaries and Business Brokers charge a percentage of the transaction at closing, sometimes with a down payment when going to market.
What is the Attorney Fee When Selling a Business?
All owners need to use qualified attorneys to complete business transactions. Qualified transaction attorneys and Mergers & Acquisition attorneys can work alongside intermediaries to negotiate deal structures, create and review agreements, search for liens and other encumbrances, and ensure that there are few surprises after the deal is done. Attorneys create or review the definitive purchase agreement, which is the central deal document, and essentially, the instructions for closing the deal.
Most attorneys charge a retainer to get started, then charge an hourly rate. The balance of the retainer and the hourly rate are due at closing, or when the deal falls apart. Attorney fees are not contingent on success so owners should be aware that when an attorney is working on their transaction, a fee will be required regardless of the outcome.
What is the Accountant’s Fee When Selling a Business?
Owners are used to the normal costs associated with bookkeeping, financial reporting and tax preparation. However, when an owner sells a business there will likely be additional requests for financial statements and other historical accounting and tax records. It’s not uncommon to spend more money than normal with these professionals when selling a business.
Although most bookkeepers and accountants bill on regular schedules depending on the needs of the business It’s not unusual for the buyer to require the accountant’s invoice to be paid by the seller at the closing table.
Should I Expect Landlord Fees When Selling my Business?
For owners who rent, landlords will often request an assignment fee for transferring a lease from one tenant to another. This fee should be defined in the lease being assigned, but even if it’s not the landlord may ask for the fee anyways. Furthermore, a condition of assignment will always include that any rent that is due be paid in full, often with penalties and interest. Finally, it’s important to know that landlords often have a “TICAM Reconciliation” adjustment which trues up any variances in estimates for taxes, insurance, and common area maintenance which happens once a year. Sometimes this adjustment will be prorated between tenants.
Many landlords will request the assignment fee as soon as the request for assignment of a lease is made. The argument is that the landlord will spend money on attorneys fees whether the lease is assigned or not. Some will allow the assignment fee to be paid at closing. Commonly any late rent, penalties, interest, and accumulated TICAM reconciliation charges will be due at the closing.
Other Costs Associated with Due Diligence
While there is no set fee for an owner associated with due diligence, it’s common for a buyer or an inspector to make some requests that require some investments by the owner as a condition of closing; similar to real estate due diligence. Often owners recognize they have put off some maintenance and understand when a buyer requests these as a condition to close, they address it. Examples include the repair of lighting fixtures or, in the case of a restaurant, a health inspector may decree that a kitchen requires a deep cleaning in order to be awarded a transitional health permit.
Owners will need to make the investments required after a due diligence checklist is agreed to, or when inspections are made, and they may be able to handle all of the diligence requests without outsourcing.
Closing Statement Reconciliation Charges Paid by the Seller
Ad Valorem or Property Taxes
Depending on the taxing authority, most businesses will get a tax bill for the assets owned by the business, even if they are renting property. In an asset sale, this tax burden will shift to the next owner, so it’s important to know if the tax bill has been paid yet for the year, and how much it will be. This tax will be prorated just like a real estate tax bill.
Ad valorem/property taxes will be included in the closing statement.
Inventory adjustment reconciliation
Only in the case where an owner advertises that a business will come with a specified level of inventory, and the inventory level differs at the date of the closing, would an inventory adjustment be due from the seller. There is a possibility that an owner may get a credit if the inventory exceeds the agreed upon amount.
Inventory adjustment reconciliations are also included in the closing statement.
Accounts Payable/Outstanding Loans
Because businesses sold as an asset sale are sold “free and clear, and without any encumbrances,” any monies due to vendors or other parties must be paid in full. Any debts such as SBA loans or credit card loans also need to be satisfied as well.
It’s common for the closing attorney to send wires to banks at the closing table to satisfy any outstanding loans of a business owner from the proceeds of a closing. Smaller bills should be paid before the closing or as soon as they are due.
Some owners end up collecting deposits for customers for products or services that the next owner will be fulfilling or servicing. In these cases, it’s important that clear records are maintained because some of these monies will need to be transferred to the new owner. How much of the total amount of money held for customers is a subject of negotiation, because the original owner spent resources to achieve and cue the sale. These accounts are to be recorded, negotiated, and noted in the asset purchase agreement, and then calculated up to the day of the closing.
With the formula to calculate the amount of money to be set aside for the buyer to cover customer deposits, the customer deposit reconciliation on the closing statement results in a credit to the buyer at the time of closing.
Taxes After the Sale of the Business
Capital Gains and Other Taxes Owed due to the Sale of a Business
There may be no larger cost associated with the sale of a business than the taxes paid to the federal and state government. This cost is likely the most challenging to calculate. And that’s because there are many factors to consider including the deal structure, the asset allocation, the assets’ tax basis, the seller’s personal income tax rate, and more.
Here’s a theoretical simplistic example of how capital gains are calculated when a business is sold under the asset sale method:
John sells his business for $1M, with a tax basis of s $250K, so his capital gain amount would be $750K. If his capital gains rate is 20%, he will owe $150K to the IRS. If John resides in a state which taxes capital gains transactions, he will be required to pay the state tax as well.
Here are a couple of examples that would change John’s federal tax bill:
If his business were sold with an asset allocation that included assets, such as equipment, furniture and fixtures, instead of all goodwill, his tax computation would need to consider the depreciation deducted prior to the sale. In such a case, the depreciation is recaptured and taxed at a flat rate of 25%.
If John receives payments for the business over the course of several years under an installment plan, he would only pay taxes on the income he receives in the years that he receives proceeds from his sale. For many business owners, the tax rate is lessened when an installment plan is used.
These examples highlight the need for John to work with great advisors who understand deal structure and its tax implications. It’s also vitally important for John to communicate with his advisors about what success may look like for him after his sale.
In most cases, the income taxes due on the sale of a business will be required to be paid to the IRS and the State on the 15th of April in the year that follows the sale of their business.
When a business owner tallies all of the expenses to sell a business, their excitement may wane. Not all is lost.
The business owner typically retains a few valuable assets. Current assets such as the cash in the bank, cash in the tills, accounts receivable from customers, security deposits paid to others, personal property, and more. Most importantly, an owner selling a business gets monetary consideration for their hard work and the time to embark on their next entrepreneurial adventure.
Understanding what an owner will net from the costs of selling a business is an important and complicated calculation. The balance sheet should be the road map to finding answers, so it’s important that the owner has detailed and accurate bookkeeping. The true answer can be determined if the business owner works with their accountant, their business broker or intermediary, their transaction attorney, and other trusted members on their deal team to ensure they are fully informed before they start the selling process.