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 personally.
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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
