Small business being acquired. What to look out for?

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CFM300
Posts: 1574
Joined: Sat Oct 27, 2007 5:13 am

Small business being acquired. What to look out for?

Post by CFM300 » Tue Aug 06, 2019 12:48 am

Background:

My friend developed a solution to a problem and has built a consistent base of clients who want the service he provides. Other individuals and companies have tried to solve the same problem without success. Now a large company wants to acquire his business and hire him to help them build the same sort of solution/system on a much larger scale. His business is a sole-prop, one-man operation. He's excited about the prospect of seeing his solution implemented on a grand scale.

He's already been offered a fair salary, the multiple of current earnings and earnout that he requested, and has reached an agreement regarding his precise responsibilities. But he's not business savvy.

Questions:

What should he look out for?

Should he have the agreements/contract reviewed by an attorney? If so, how would he find such an attorney?

What else might he be overlooking?

Thanks.

ivk5
Posts: 820
Joined: Thu Sep 22, 2016 9:05 am

Re: Small business being acquired. What to look out for?

Post by ivk5 » Tue Aug 06, 2019 4:42 am

Friend absolutely needs an attorney with relevant experience. Best referral source would be other small business owners who have been through similar transactions in his geographic area. Could also check with other professionals eg his tax preparer, but main thing is someone who regularly does transactions of similar type (pro services, IP) and size.

One consideration is to try to maximize the amount of the proceeds that are eligible for LTCG treatment rather than being taxed as ordinary income (or, worse, self-employment income). A proper asset purchase agreement for the IP may do this. Stock purchase presumably not possible for a sole-prop. IANAL.

For the same reason, one-time payments tied to his employment relationship may be disadvantageous. Retention bonuses may be important to the buyer, but consider how timing of these will interact with earnouts in future tax years.

Pay attention to restrictive covenants and potential impact on any future business endeavors he may want to pursue independent of the future buyer/employer.

Does he live in a high-tax state? If he would otherwise be contemplating a move to a lower tax state in the future, doing so before the deal is consummated could be highly advantageous timing. If this is in the cards, the lawyer’s help may be needed here too to make sure he breaks residency effectively.

CarpeDiem22
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Joined: Tue May 22, 2018 11:20 pm

Re: Small business being acquired. What to look out for?

Post by CarpeDiem22 » Tue Aug 06, 2019 5:01 am

1. Details of earn-out. For example, if it is based on Net Revenues, be sure to include in the agreement what "Net" means.
2. Earnings of your friend's company may be revised downwards post due diligence (if there is one), so be mindful of that.
3. Financial strength of the acquiring company.

Term sheet/agreement should surely be reviewed by an attorney, although I'm not sure where you can find one.

RubyTuesday
Posts: 102
Joined: Fri Oct 19, 2012 11:24 am

Re: Small business being acquired. What to look out for?

Post by RubyTuesday » Tue Aug 06, 2019 7:00 am

Be careful of non-competes and retention agreements. They are likely unavoidable, but could be mitigated with exceptions for constructive termination or reductions in compensation/ benefits, etc.

RubyTuesday
Posts: 102
Joined: Fri Oct 19, 2012 11:24 am

Re: Small business being acquired. What to look out for?

Post by RubyTuesday » Tue Aug 06, 2019 7:08 am

Consult tax advisor and atty for sure. Depending on how his business is structured, there could be large tax consequences of the sale, which could vary depending on structure (e.g. “hot assets” taxed as ordinary income in LLC taxed as partnership). Make sure he understands likely after tax proceeds. It’s possible buyer could be engaged to help minimize the taxes for the seller.

RT

smitcat
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Joined: Mon Nov 07, 2016 10:51 am

Re: Small business being acquired. What to look out for?

Post by smitcat » Tue Aug 06, 2019 8:15 am

CFM300 wrote:
Tue Aug 06, 2019 12:48 am
Background:

My friend developed a solution to a problem and has built a consistent base of clients who want the service he provides. Other individuals and companies have tried to solve the same problem without success. Now a large company wants to acquire his business and hire him to help them build the same sort of solution/system on a much larger scale. His business is a sole-prop, one-man operation. He's excited about the prospect of seeing his solution implemented on a grand scale.

He's already been offered a fair salary, the multiple of current earnings and earnout that he requested, and has reached an agreement regarding his precise responsibilities. But he's not business savvy.

Questions:

What should he look out for?

Should he have the agreements/contract reviewed by an attorney? If so, how would he find such an attorney?

What else might he be overlooking?

Thanks.
He actually needed an attorney before he divulged specific information about his proprietary solution.
Waste no time in consulting one now before he goes any further. Once he understands the results from the Atty consult he may or may not wish to seek out an accountant for further detail.
Question - how and who determined the calculation and multiple of current earnings was fair?

bluebolt
Posts: 921
Joined: Sat Jan 14, 2017 9:01 am

Re: Small business being acquired. What to look out for?

Post by bluebolt » Tue Aug 06, 2019 8:24 am

He should speak to an attorney.

He should protect himself against changes the acquiring company makes to his position, responsibilities or salary. If he leaves for any of these reasons, he should still be eligible for some/all of the earn out.

He should protect himself against decisions the company makes to prevent him from hitting the earn out (e.g. they decide to exit the business he's in).

He should make he is compensated for the duration of any non-compete. He should also try to be exempt from some/all of the non-compete if he is terminated not for cause or if he leaves because his responsibilities or compensation are decreased..
Last edited by bluebolt on Wed Aug 07, 2019 4:39 am, edited 1 time in total.

Topic Author
CFM300
Posts: 1574
Joined: Sat Oct 27, 2007 5:13 am

Re: Small business being acquired. What to look out for?

Post by CFM300 » Wed Aug 07, 2019 12:24 am

Thanks for all of the advice. Lots of helpful suggestions.

My friend and I will continue to check this thread, and definitely welcome further contributions. :beer

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