Insights from the co-founder of a CPA firm
Joe Pease’s passion for helping entrepreneurs fulfill their dreams is rooted in his own career experience as an entrepreneur in the certified public accounting industry. This ability to relate to his clients, combined with 35 years of expertise in handling hundreds of mergers and acquisitions, gives Joe a unique perspective into the needs of buyers and sellers as a co-founder and managing partner of Cleveland-based Pease & Associates CPAs.
He also leads the firm’s M&A group. Joe’s recent experience includes serving as a lead negotiator on the sale of an integrated limestone quarry and aggregate shipping and transportation outfit to a large public company, and working on the sale of a multi-state organization to its employees through the use of an employee stock ownership plan.
Joe works closely with business owners on acquisitions and sales, succession planning, business valuation, corporate tax planning, executive pay plans and other business-related matters. His professional affiliations include serving as a member of the American Institute of CPAs and the Ohio Society of CPAs, and as an advisory member on the board of tax division for CPAmerica International. Joe is the co-author of “Mergers and Acquisitions for Distributors, Expert Advice for Buyers and Sellers.” Crain Content Studio — Cleveland asks Joe to share some key financial and tax insights pertaining to the acquisition or sale of a business.
What procedures are covered by a CPA firm as part of financial due diligence?
Financial due diligence tends to target the quality of the company’s earnings; therefore, it largely depends on the issues of the company, its industry and the type of financial statements prepared by outside accountants. Generally, the services performed for balance sheet accounts will include review and verification of receivables, inventory, fixed assets and prepaids, as well as accounts payable and accrued expenses. For revenue and expenses, we would verify the amounts and timing, as well as look at trends, customer analysis, product and margin history. We usually prepare a report of our findings, which we then review with our client.
What should a client look for in terms of finding a qualified CPA who can help facilitate a merger or acquisition?
It is critical that both the current business owner and acquirer have proper representation. The services can be very different, and much more specialized, than the routine services an accountant provides for their client. The biggest factor should be deal experience, especially relevant to the size and type of deal that is being contemplated. Large deals can provide different challenges than smaller deals. Manufacturing company deals have very different tax, valuation and due diligence approaches than service or IT company deals. Stock deals can benefit a seller, but at a cost to the buyer. Knowing how to navigate through these issues is what should be most important when finding a qualified CPA to assist.
What should one expect as a typical process when buying or selling a business?
If buying a business, the process starts with a plan to locate a business to acquire. This can be done on their own, or with the help of a buy-side adviser. Once an acquisition candidate is identified, there is usually a series of calls and meetings that will lead up to a decision to submit an offer. From there, the buyer performs all due diligence, and then moves into the purchase agreement, financing and closing. If selling a business, the process starts with deciding on whether to shop the business for sale, or handle the sale in more of a private process. Once a buyer is identified, the process is similar to that of the buyer’s.
What are the primary advantages and/or disadvantages between buying or selling a company’s stock versus its assets?
For a seller, the sale of stock may result in lower taxes than in a sale of assets, especially if the entity is a C Corp. The difference can be as much as 30% of the proceeds. The tax rate is generally 20%. The sale of stock can be less complicated and happen more quickly. There are also times when a stock sale may be necessary, such as when the business has contracts that could be terminated in the event of a sale of assets. A buyer of stock will usually forgo certain tax benefits in exchange for the ease of doing a stock deal. This can result in a lower price paid for the business. A purchase of assets causes the selling entity to go away and be replaced by the buying entity. The taxes to a seller can vary between rates of 15% to 39.6% depending on the type of assets sold. The benefit to the buyer is that they can depreciate certain assets acquired, which results in significant tax benefits. This can, and usually does, result in a higher purchase price than if stock is acquired.
What are some of the most common tax considerations that both a business owner and seller face during M&A?
The most common are related to how to maximize the after-tax proceeds to the seller while providing the buyer as many tax benefits on the purchase as possible. It starts with whether the deal will be an asset deal or stock deal, and how that impacts each side. Ideally, you’d like to see a deal that results in a stock-sale type outcome for the seller, with an asset-deal type outcome for the buyer.
What types of tax laws influence the acquisition or sale of a business?
Tax laws related to how a seller is taxed or how a buyer can benefit from write-offs can impact the timing and value of a business. Capital gain tax rates have been relatively low, and the expensing of assets acquired is relatively favorable. These factors can contribute to a strong M&A market. Income tax rates also influence this market. After-tax cash flow available to service debt and meet the needs of the business is lower if tax rates are high. The opposite holds true if rates are low.
What are some of the potential federal or state tax legislation changes on the horizon, and what are their possible impacts?
The proposed Republican tax plan, among other things, plans to significantly reduce the tax rates on business income, which will likely drive up prices of businesses. We have already seen this with the recent run-up in the stock market. By reducing taxes on business income, and increasing the after-tax cash flow of the business, the value of that business should increase. The increased cash flow allows the buyer to have more cash flow available to service acquisition-related debt. While it is too soon to tell how this plays out, it will definitely be of interest to buyers and sellers on any deals anticipated within the next several months.
David Pease is vice president at Pease Acquisition Advisors. Contact him at 216-472-4455 or email@example.com.