Photo by Wesley Tingey on Unsplash
Over the years, here at Apex, we have been approached by sellers who have, for various reasons, created a company that is split out across different legal entities. Although there may be compelling reasons for building multiple entities to operate your business, this necessarily complicates a sale, and sellers instinctively sense it. In this article, we will spell out the reasons why a business operating across multiple legal entities should be recharacterized before going to market.
Diligence Becomes Lengthier and More Expensive
Instead of a single entity with one set of books and tax returns, you and your team of advisors will now have to delve into multiple sets of financials and try to connect the dots between various entities, e.g. does one entity lease real estate or IP to another?
It’s also possible that there will be inconsistencies and undocumented arrangements, which can be red flags not just for buyers but for banks.
Diligence will take longer and cost more, pushing out a deal, and as we say here all the time, time kills deals.
Valuation Becomes More Complex
What is the true value of a business if one entity bears all the marketing costs, or another entity holds the real estate, and yet another holds the IP? It can be difficult for professionals who do valuations for a living to get a true value of a business, much less advisors or buyers.
Because of a lack of control in multi-tiered structures, valuators may apply discounts to the price of a business.
Transfer and Closing Becomes More Cumbersome
You will probably be unable to execute a simple “stock sale” of one company. Instead, you may have to create:
- Separate bills of sale
- Assignments of contracts and leases per entity
- Multiple membership interest transfers
Furthermore, some contracts may have change-of-control clauses, triggering renegotiations or terminations. What if governance documents are misaligned or outdated? This could hold up a sale as it might not be clear who can approve a sale.
Tax Complications Increase
Different entities (and classes of entities) may trigger separate tax events (e.g. an asset sale at ordinary income rates vs. capital gains on membership interests).
Intercompany arrangements can create unexpected recapture or basis issues.
Structures that are not themselves primed for a sale will have to restructure before the sale, which itself will cause delays and perhaps, more taxes.
Buyer Pool Shrinks
All kinds of buyers, not just individuals, but strategic buyers and PE, prefer simple structures.
Post-Sale Integration Headaches Loom
Shared employees, payroll, and systems across entities have to be unraveled or transferred cleanly. Real estate or IP held by a different entity may require a separate sale or a leaseback.
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So, knowing all this, when sellers come to us with businesses that are spread out across multiple entities, we advise putting in the work to simplify now, which will not only increase the value of their business but will improve the curb appeal with buyers. Here are four steps you can take if you are in such a situation as we have outlined above:
- Consolidate into a holding company structure (if there isn’t one already)
- Clean up intercompany balances
- Maintain separate books and bank accounts
- Align operating agreements, buy-sell provisions, and estate plans
This will take some time, but taking these steps before your business goes to market ensures the best possible outcome for all stakeholders, before, during, and after the sale.
Do you have a business split across multiple entities? We’d love to help you get it ready for sale to get you maximum value. Reach out today.