Mergers and Acquisitions

New Tax Law Makes Asset Deals More Attractive for Family Business OwnersBuyers often prefer to structure family business acquisitions as taxable asset purchases. In a taxable asset purchase, the buyer is entitled to write up the basis of the seller’s assets to fair market value, and then going forward, receive a tax benefit by depreciating the assets. In addition, a buyer is entitled to amortize goodwill (i.e., the portion of the purchase price in excess of the fair market value of the purchased assets) over 15 years.

Under prior tax law, selling assets was often cost-prohibitive for a family business taxed as a C-corporation. The combined federal rate under prior tax law was 48 percent (resulting from a 35 percent corporate tax rate combined with a 20 percent tax rate on dividends received by non-corporate shareholders). When buyers insisted on an asset purchase and the owners of the seller were unwilling to pay half of their sales proceeds in taxes, the deal was likely to fall apart.

Under the new Tax Cuts and Jobs Act, the corporate tax rate was permanently reduced from 35 percent to 21 percent. The lower rate makes asset sales more attractive for sellers. Now, the combined federal rate is 36.8 percent, as compared to 48 percent under prior law. Asset sales are no longer as costly as they were for family business sellers.

Under the new tax law, there is also an additional incentive that makes buyers even more likely to favor asset acquisitions. The Tax Cuts and Jobs Act now allows for full expensing of most types of “qualified property” acquired after September 27, 2017. Significantly, “qualified property” includes used property acquired from any unrelated party. Because full expensing applies to used property, asset purchasers can now deduct the portion of the purchase price allocable to qualified property.

The lower corporate tax rate, together with immediate expensing of qualified property, makes asset deals more attractive for buyers and sellers.

Portrait of Father and Son EntrepreneurIf you sell your family-owned business to a private equity buyer, the buyer will most likely pay a portion of the purchase price with equity in the buyer’s new company, rather than with cash. The equity that you receive in the buyer’s new company in exchange for a portion of the equity in your existing business is commonly referred to as “rollover equity.”

Rollover equity stakes typically range from 10 to 20 percent of the buyer’s new company. Rollover equity is beneficial to the buyer because it reduces the cash portion of the purchase price and aligns the seller’s interest with the success of the new company.

While the rollover equity component reduces the amount of cash that the seller receives at closing, rollover equity can also benefit the seller. If the equity rollover is structured properly, the seller will not pay tax on the value of the rollover equity until there is a future sale or liquidity event with the buyer’s new company. Rollover equity also gives the seller a potential “second bite at the apple.” If the buyer grows the acquired business (either organically or through additional acquisitions), the seller will participate in the future growth of the business and will profit from a future sale or IPO of the new company.

In our experience, private equity buyers may also allow family-business owners to hold their rollover equity in a trust or a family limited liability company or partnership, which creates opportunities for future gifts and estate planning.

It is important to carefully consider the rights and restrictions that will be attached to your minority equity position in the new company. For example, your rollover equity may be in the form of common equity in the new company, while the private equity buyer owns preferred equity with financial and governance rights superior to yours. There also will be restrictions on your ability to transfer your equity in the new company. In addition, the buyer will likely have “drag-along” rights that will enable the buyer to require a sale of your rollover equity in a future sale or liquidity event approved by the buyer (even if you don’t like the deal).

While there are a number of tax, corporate and estate planning issues to consider and negotiate, including a rollover equity component in the sale of your family-owned business can be mutually beneficial to the buyer and the seller.

How Much Should I Expect to Pay An Investment Banker To Sell My Family-Owned Business?In our last blog post, we highlighted the benefits of retaining an investment banker for the sale of your family-owned business. As you might expect, investment bankers do not work for free. In today’s blog post, we outline the typical fee structure for a middle-market investment banking firm that you might retain in the sale of your business.

Investment bankers typically charge a success fee or transaction fee, along with a retainer fee. The success fee is usually a percentage of deal value. The deal value includes the amount of cash and the fair market value of securities or other assets that you receive in the sale (and would include, for example, the amount of debt of your business that is assumed or paid off by the buyer at closing). Deal value also customarily includes the amount of any installment note payments, releases from escrow, or earnout payments made by the buyer after closing, but you should not pay a success fee on post-closing payments unless and until the payments are actually made by the buyer.

The percentage of deal value may be fixed (such as 2 percent or 3 percent), but can also be structured as an adjustable, formula-based success fee where the percentages change at certain amounts or “break points.” For example, the success fee might be structured as 1.5 percent for deal value up to $20 million, 2 percent for the portion of deal value in excess of $20 million up to $30 million, and 3 percent for any portion of the deal value in excess of $30 million. The success fee is typically subject to a minimum fee that the investment banker must be paid at the closing. In our experience, the minimum success fee usually required by experienced, middle market investment bankers is $500,000-700,000.

Investment bankers try to lock in the success fee and protect themselves against your terminating their engagement before the closing occurs. The engagement letter will likely include a “fee tail” period that remains in effect for nine to 12 months after the engagement is terminated. If you terminate the engagement before closing and then later complete a transaction on your own (or with another investment banker) during the fee tail period, you will still owe the success fee to the first investment banker. You may be able to negotiate certain exceptions to the fee tail. For example, the investment banker may agree that the fee tail applies only to buyers that the investment banker contacted about the deal during the engagement.

Investment bankers customarily require payment of an up-front retainer fee when the engagement begins. The retainer fee is generally non-refundable, but should be credited against the success fee due at closing. In our experience, the typical retainer fee ranges from $50,000-100,000 in middle-market transactions. You will also be required to reimburse the investment banker for out-of-pocket expenses.

While the success fee, the retainer fee, the fee tail period, and the expense reimbursement are common elements in almost every engagement letter, you should remember that the dollar amounts, percentage amounts, break points and many other terms in the engagement letter can and should be negotiated. If properly structured, the engagement letter terms will motivate the investment banker to help you achieve your goals in the sale of your family-owned business.