Post-Sale Risk Management
Fundamental tax approaches will help you ensure a safe, seamless sale.
Let’s dream. You’ve sold your business and cashed out. Worries, gone. Cares, gone. The next day, flush with cash you head south to live your own Jimmy Buffet lifestyle, song-filled, with little umbrella cocktails, flip flops and sunsets… Right?
Unfortunately, this is far from post-sale reality with the majority of business transactions. After selling your business, your risk of ownership has only been minimized by the amount you received at closing. Any earn-out or note payable is still at risk and linked to the success of your former business. In addition, many buyers require former owners to stay on for a period of employment after the transaction to ensure the transition goes smoothly.
At Burke & Schindler, we’re skilled at identifying and minimizing these post-sale risks so even if you aren’t living on sponge cake, the shrimp are at least beginning to boil in your retirement. The best way to minimize the post-sale risks of earn-outs, note payables, and employment agreements, like most situations, is on the front end.
Minimizing Risk & Earn-Outs
An earn-out is a contractual obligation of the buyer to pay the seller additional consideration based upon the business achieving certain financial goals. As a business owner looking to sell, the best way to minimize your risk of not receiving your earn-out is to base a majority of the earn-out on top line sales or gross margin. If the earn-out is instead based on the net income or EBITDA of the business, then your earn-out will be at the mercy of the buyer’s SG&A costs, which are more easily manipulated than top line sales. Top line sales are easy to track and are hard to manipulate, so you can easily determine if you’re entitled to your earn-out payment.
How to Minimize Risk Post-Sale
The portion of the purchase price not paid at closing generally takes the form of a note from the buyer. The buyer is expected to pay off this note from income generated by your former business, again linking your payment to the success of your former business. At Burke & Schindler, we recommend minimizing this risk by suggesting the note be secured by shares of the business. If the buyer defaults on the note, you can regain ownership in the business. Although it’s not the ideal scenario when you’re looking toward sandy beaches and flip flops, but re-entering the business puts you in control rather than being stuck in the back of the creditor line if your buyer defaults.
Another way we at Burke & Schindler seek to minimize the risk of your buyer defaulting on the note is by advising our clients to obtain a personal financial statement from potential buyers to ensure they are stable enough financially to buy the company and personally guarantee the note. This is no different than a bank asking for a personal financial statement when you borrow money. As simple as it sounds, this risk management tactic can be one of the best ways to secure a successful transition.
Minimizing Personal Risk
The amount of the risk associated with the employment contract is dependent upon the level of salary you are to receive post sale. If a material part of the purchase price is comprised of the salary you are to receive after the transaction, then you need to ensure you have protection in the form of a “For Cause” clause. A For Cause provision ensures you cannot be fired from your employment unless the buyer has cause for doing so. This simply prevents the buyer from terminating your employment because he or she no longer wishes to pay you.
Selling your business and transitioning to your next stage can be an exciting time. At Burke & Schindler, we’ll help manage your post-sale risk so you can keep dreaming about the beach. Contact one of our skilled advisors today.