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Introduction to Business Acquisitions. Introduction to Business Acquisitions. Introduction to Business Acquisitions. Overview. Course Assumptions: Arm’s-Length Transactions Corporations Profitable Transactions Reporting Gains Commercial Real Estate Excluded Standard References

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Introduction to business acquisitions

Introduction to Business Acquisitions

Introduction to business acquisitions1

Introduction to Business Acquisitions

Introduction to business acquisitions2

Introduction to Business Acquisitions



  • Course Assumptions:

    • Arm’s-Length Transactions

    • Corporations

    • Profitable Transactions Reporting Gains

    • Commercial Real Estate Excluded

    • Standard References

    • Assumed Tax Rates

  • The Changing Tax Environment

New tax rates 2013 and beyond

New Tax Rates – 2013 and Beyond

  • Maximum ordinary income – 39.6%

  • Maximum capital gain – 20.0%

  • Medicare Surtax – 3.8%

  • Earned income Surtax – 0.9%

Business transaction basics

  • Chapter 1

Business Transaction Basics

Scope size of transaction

Scope/Size of Transaction

  • Smaller (Micro) company: Up to $1 million revenue

  • Larger company (Middle Market): $1-50 million revenue

  • Major transaction: Over $50 million revenue

Seller s objectives

Seller’s Objectives

  • Optimize value of the business

  • Negotiate most favorable terms

  • Take advantage of economic/product life cycle

  • Identify buyers willing to pay a premium for the business

  • Structure to take advantage of favorable tax laws

Buyer s objectives

Buyer’s Objectives

  • Eliminate a competitor

  • Increased economies of scale

  • Expand into new territories/markets

  • Acquire business under favorable circumstances

  • Leverage acquisition company with complementary businesses

Seller s advisory team

Seller’s Advisory Team

  • Spouse/Family Members

  • Partners/Key Employees

  • Board of Directors

  • CPA

  • Attorney

  • Valuation Advisor

  • Financial Advisor

  • Industry/Business Associates

  • Business Intermediary/Investment Banker

Buyer s advisory team

Buyer’s Advisory Team

  • Attorney

  • CPA

  • Banker

  • Board of Directors

Common types of terms

Common Types of Terms

  • Escrow Account/Holdbacks

  • Seller Financing

  • Performance Payments/Earn-out Provisions

  • Non-competition Agreements

  • Employment/Consulting Agreements

  • Contingent/Unknown Liabilities

Introduction to due diligence and key documentation

  • Chapter 2

Introduction to Due Diligence and Key Documentation

Seller s due diligence

Seller’s Due Diligence

  • Develop an Exit Plan

  • Identify Your Advisory Team

  • Plan to Optimize the Business Value

  • Get the Business in a Position to be Sold

  • Preparation of Offering Memorandum

  • Consideration of Key Employees

  • Investigate the Buyer

  • Complete Seller’s Due Diligence Check List (Appendix 2A)

Offering memorandum

Offering Memorandum

  • Executive Summary

  • Strengths and Opportunities

  • Business Description

  • Financial Information

  • Appendices as necessary

Buyer s due diligence

Buyer’s Due Diligence

  • Identify Your Advisory Team

  • Think about the Ideal Acquisition

  • Identify Overall Structure of Deal

  • Consider Asset vs. Stock Acquisition

  • Identify Sources of Financing

  • Identify Sources of Negotiation/Terms

Buyer s due diligence1

Buyer’s Due Diligence

  • Review Legal Issues

  • Control Preparation of Legal Documents

  • Review Financial Information

  • Review Target Company Operations

  • Complete Buyer’s Due Diligence Checklist (Appendix 2B)

Common transaction documents

Common Transaction Documents

  • Confidentiality Agreement (Appendix 2C)

  • Confidentiality Agreement with Recourse(Appendix 2D)

  • Letter of Intent (Appendix 2E)

  • Offering Memorandum

  • Transaction Resolutions and Authorizations (Appendix 2F)

Common transaction documents1

Common Transaction Documents

  • Finance Documents

  • Business Broker Agreement (Appendix 2G)

  • Closing Checklist

  • Preparation of a Deal Book

Valuation considerations

  • Chapter 3

Valuation Considerations

Reasons for valuations

Reasons for Valuations

  • Selling to a Third Party

  • Transfer Ownership via Gifting

  • Litigation between Shareholders

  • Divorce

  • Estate Tax Determination

  • Installing an Employee Stock Ownership Plan and Trust (ESOP)

  • Acquiring a Business

Standards of valuation

Standards of Valuation

  • Fair Market Value (FMV)

  • Investment Value

  • Intrinsic or Fundamental Value

  • Fair Value

  • Emotional Value



  • Escrow/Holdback Provisions

  • Seller Financing

  • Contingent Payments/Earn out Provisions

  • Non-competition Agreement

  • Employment/Consulting Agreement

  • Contingent/Unknown Liabilities

Types of buyers and sellers

Types of Buyers and Sellers

  • Hypothetical Buyer and Seller

  • Financial Buyer

  • Strategic Buyer

  • Family Members

  • Inside Buyers (e.g., Management or ESOP)

Approaches to valuation

Approaches to Valuation

  • Income Approach

    • Discounted Future Returns Method

    • Capitalization of Earnings Method

  • Market Approach

    • Public Company Guideline Method

    • Transaction Guideline Method

  • Asset Approach

    • Cost Principle

Approaches to valuation1

Approaches to Valuation

  • Other Considerations

    • Ownership Attributes

      • Control Position/Enterprise Value – Mergerstat information

      • Minority Position

    • Liquidity Issues

      • Lack of Marketability

Analysis of asset based transactions

  • Chapter 4

Analysis of Asset-Based Transactions

Seller s goals perspectives

Seller’s Goals/Perspectives

  • Optimize Price

  • Bulk Sale and Transfer

  • Pass Liabilities to Buyer

  • When Favored by Seller

Buyer s goals perspective

Buyer’s Goals/Perspective

  • Obtain Increased Basis in Assets

  • Favorable Allocation of Proceeds to Asset Categories

  • Acquire Only Selected Assets

  • Limitations on Unrecorded Liabilities

  • Bulk Sales Laws

Buyer s goals perspective1

Buyer’s Goals/Perspective

  • Termination of Unfavorable Agreements

  • Avoid Minority Shareholder Issues

  • Higher Transaction Costs

  • Inability to Use Valuable Agreements

Tax considerations

Tax Considerations

  • IRC Sec. 1231

  • IRC Sec. 1221

  • IRC Sec. 1245

  • IRC Sec. 1250

  • IRC Sec. 197

  • Capital asset classification

Depreciation recapture

Depreciation Recapture

Allocation of price irc sec 1060

Allocation of Price – IRC Sec. 1060

  • Residual Method of Allocation

  • Seven Asset Classes:

    • Class I: Cash and other general deposit accounts

    • Class II: CDs, foreign currency, government securities, publicly traded stock

    • Class III: Assets “marked to market”-accounts receivable, certain debt instruments

    • Class IV: Inventories; property held for resale to customers

    • Class V: All assets not defined in Classes I, II, III, IV, VI, and VII

Allocation of price irc sec 10601

Allocation of Price – IRC Sec. 1060

  • Class VI: IRC Sec. 197 intangible assets other than goodwill and going concern value

  • Class VII: Goodwill and Going Concern Value

  • Allocate first to Class I, then Class II, etc.

  • Generally, allocate to class with shortest depreciation period

  • Report on IRS Form 8594 (Asset Acquisition Statement); attach to tax return

    • Buyer and seller can report differently

    • Less likely audit issue if buyer and seller report same allocation

  • C corporation considerations following asset sale

    C Corporation Considerations Following Asset Sale

    • Subject to Personal Holding Company Tax?

    • Liquidating distribution eligible for capital gains rates?

    • If only partial distributions, subject to dividend tax treatment?

    • Ability to walk away from the business; end filing responsibilities

    S corporation considerations following asset sale

    S Corporation Considerations Following Asset Sale

    • Shareholders may wish to terminate connection to business

    • Shareholders not faced with double taxation or personal holding company tax

    • If a former C corporation may be exposed to taxes on excess net passive income

    • Complete liquidation will qualify distributions for capital gain treatment

    • End responsibility for regulatory filings and tax reporting



    • Illustrated Asset-Based Transaction – Manufacturing Company

    • Illustrated Asset-Based Transaction – Service Company

    • Appendix 4A – IRS Tax Form 8594 – Asset Acquisition Statement under Section 1060

    • Asset Purchase Agreement – Appendix 4B

    Effective taxes from transactions

    Effective Taxes from Transactions

    • Service vs. Manufacturing Company

      • Service companies generally lower than manufacturing

      • Manufacturing companies – more equipment

        • Depreciation recapture

        • Recapture taxed at ordinary income rates

    S corporation built in gain

    S Corporation – Built-in Gain

    • Sale of assets of former C corporation

    • Normally, 10 year recognition period

    • 5 year recognition period for 2012, 2013

    Analysis of stock based transactions

    • Chapter 5

    Analysis of Stock-Based Transactions

    Seller s goals perspectives1

    Seller’s Goals/Perspectives

    • Optimize Price

    • Avoid Double Taxation as C Corporation

    • Stock Based Attributes May Shelter Some Gain

    • Pass Liabilities to Buyer

    Buyer s goals perspectives

    Buyer’s Goals/Perspectives

    • Favorable Agreements/Intangible Assets Remain in Place

    • Insignificant Unknown/Contingent Liabilities

    • Low FMV of Acquired Assets in Relation to Basis

    • Tax Attributes May Be Passed to New Owner

    • Too Many Assets for Seamless Transition

    • Seller Insists on Stock Transaction

    • Buyer May Elect to Treat as Asset Purchase

    C corp proceeds to selling shareholders

    C Corp. – Proceeds to Selling Shareholders

    S corp proceeds to selling shareholders

    S Corp. – Proceeds to Selling Shareholders

    Irc section 338

    IRC Section 338

    • Taxable Stock Purchase Treated as Asset Sale

    • Stepped-up Basis in Target Assets

    • Target Incurs Tax on Gain for Increased Asset Basis

    • Beneficial if Tax Offsets Exist to Absorb Additional Taxes

    • Section 338(h)(10) Election – Treat as Part of Selling Group

    Irc section 1042

    IRC Section 1042

    • Selling Shareholder in C Corporation

    • Sale of Stock to ESOP

    • Proceeds Reinvested in Qualified Replacement Property

    • Proceeds Received Tax Free (Carryover Basis)

    Irc section 368 tax free reorganization

    IRC Section 368: “Tax Free” Reorganization

    • Type A: Statutory Merger or Consolidation

    • Type B: Stock for Stock

    • Type C: Stock for Assets

    • Type D: Spin-Off; Split-Off; Split-Up

    • Type E: Corporate Recapitalization

    • Type F: Change in Identity, Form, or Place of Incorporation

    • Type G: Bankruptcy Proceedings

    Stock attributes net operating losses

    Stock Attributes – Net Operating Losses

    • Remains with Acquired Corporation

    • Limitations on Usage If Change in Control

      • Three-Year Testing Period

      • Greater than 50 percentage point increase in ownership by 5% shareholders

    • Annual Limitation = Value of Old Loss Corporation times Federal Long Term Tax-exempt Rate (IRC Sec. 382(b)(1))

    Nol limitation example

    NOL Limitation Example

    • Net Operating Loss Carryover$200,000

    • Value Old Loss Corporation$1,000,000

    • Long-Term Tax-Exempt Rate 7%

    • Current Year Taxable Income$100,000

    • Annual NOL Usage Limitation$70,000

    • $70,000 NOL Offset to Current Year Taxable Income

    • $130,000 NOL Carried Forward to Future Years

    Stock purchase agreement provisions

    Stock Purchase Agreement Provisions

    • Recitals

    • Terms of Sale/Acquisition

      • Agreement to Sell and Acquire

      • Purchase Price

      • Escrow Deposit

      • Seller Financing

      • Contingent Purchase Price

      • Consulting Agreement

    Stock purchase agreement provisions1

    Stock Purchase Agreement Provisions

    • Warranties and Representations

    • Covenants

    • Documents to be Delivered at Closing

    • General Provisions

    • Stock Purchase Agreement – Appendix 5A

    Transaction terms

    • Chapter 6

    Transaction Terms

    Contingent unknown liabilities

    Contingent/Unknown Liabilities

    • Protection for Buyer

    • Some Risk Covered by Business Insurance?

    • Build in Contingency Reserve for Unforeseen

    • Adequate Due Diligence Reduces Risk

    Holdback escrow accounts

    Holdback/Escrow Accounts

    • Quantified Amount

    • Available Liquidity for Buyer if Seller Representations Inaccurate

    • Negotiated between Parties

    • Buyer likes more; seller likes less

      • Escrow of Funds Agreement – Appendix 6A

    Seller financing

    Seller Financing

    • Subordinated to Bank Debt

    • Period of Note Should Be Reasonable

    • Qualify for Installment Sale Treatment?

      • IRC Sec. 453

      • Depreciation/Amortization Recapture

      • Report on IRS Form 6252 (“Installment Sale Income”)

      • Ineligible transactions: Loss transactions, related party, inventory

    • Seller Look for Security/collateral

      • Seller Financing Note and Loan Agreement – Appendix 6B

    Contingent payments earn outs

    Contingent Payments/Earn-Outs

    • Carefully Defined to Avoid Future Disputes

    • Best Practice to Compute Based Upon Verifiable Data

    Non competition agreements

    Non-Competition Agreements

    • Typically 3-5 Years

    • To Buyer: IRC Sec. 197 Intangible Asset

      • 15 Year Amortization

    • To Seller: Ordinary Income (not FICA)

    Employment consulting agreement

    Employment/Consulting Agreement

    • Typically 2-4 Years

    • To Buyer: Current Period Deductible Expenses

    • To Seller: Ordinary Income (subject to FICA)

      • Consulting Agreement – Appendix 6C

    Buyer groups

    • Chapter 7

    Buyer Groups

    Likely buyers

    Likely Buyers

    • Family Members

      • Gifting

        • Annual exclusion increased to $14,000/donee

        • Lifetime exclusion $5 million ($5.25 million indexed for 2013)

    • Family Limited Partnership

  • Inside Buyers

    • Managers

    • Employees (ESOP)

  • Strategic Buyer

    • Familiar with industry and company

    • Often competitors/industry insiders

  • Likely buyers1

    Likely Buyers

    • Financial/Investment Buyer

      • Looking for returns on investment

      • Little interest in day-to-day management

    • Initial Public Offering

    • Liquidation

    Closing and attributes of successful transactions

    • Chapter 8

    Closing and Attributes of Successful Transactions

    Seller best practices

    Seller Best Practices

    • Have an Exit Plan

    • Clean Up Financial Statements

    • Keep Running the Business

    • Add Advisors

    • Know the Buyer

    • Understand Business Valuation, Tax and Cash Flow Implications of the Transaction

    Buyer best practices

    Buyer Best Practices

    • Benchmark to Your Ideal Acquisition

    • Control the Preparation of Documents

    • Do Thorough Due Diligence

    • Have Financing in Place

    • Plan to Integrate the Target into Existing Businesses

    • Understand Business Valuation

    Cpa advisor best practices

    CPA/Advisor Best Practices

    • Facilitate Being a Transaction Quarterback

    • Know Buy Side and Sell Side Issues

    • Master Communications

    • Be Professional

    • Understand Teamwork

    • Be an Advisor on Negotiating Strategies

    • Think Strategically beyond the Transaction


    • Chapter 9


    Introduction to business acquisitions3

    Introduction to Business Acquisitions

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