Third Party Transfer Scenario
What are Third-Party Transactions?
Third-party transactions are formal sales where a business (an LLC or corporation) is bought by an individual or other business entity which is unaffiliated with the seller’s business. These types of transactions are commonly referred to as “Mergers and Acquisitions”. However, there are three primary forms of third-party transactions: “Acquisitions”, “Private Re-Capitalizations” and “Mergers or Re-Organizations”. Each form of transaction results in the sale and transfer of some form of “ownership interest” or “tangible and intangible assets”. Each is different in terms of their purpose, structure, timetable, investment and outcomes. The goal is to select and design the “best” type of third-party transaction to accomplish your intended Universal Goals and Objectives (UGOs).
Sales and Acquisitions
These types of transactions typically consist of an individual buyer or organization acquiring some or all the ownership interests from an another organization’s owner (a “stock or equity” sale), or an organization’s tangible and intangible assets (an “asset sale”). The consideration is some amount of money (equal to the value of the seller organization), which is paid to the seller’s owner (in an equity sale) or the seller entity (in an asset sale) at closing or over a specific period after the closing. The outcome is that the seller’s owner completely transitions out of the business 1-3 years from the closing date.
Private Re-Capitalizations
These transactions are more like “investments” than sales since they consist of private investor groups (generally private equity firms) or larger organizations which purchase either a “minority interest” (minority re-cap) or a “majority interest” (majority re-cap) in the seller’s company. These sales provide needed financial and intellectual capital to help finance the company’s growth. These transactions are great for companies which need cash and or resources for growth and with owners who want to stay in the business for at least 3-5 years, then sell their remaining interests to the investor group or sell the whole business to another outside buyer.
Mergers and Re-Organizations
These are the most formal and time-consuming transactions and consist of one entity “merging” or “consolidating” into another entity (usually larger) with the acquiring entity being the sole surviving business. Given the potential liabilities and post-closing risks to the acquiring entity, these transactions generally apply to companies which are familiar with each other or have a long-standing working relationship. These transactions are generally “tax free” or “tax deferred” to the merging entity’s owners since most of the consideration paid to them is in the form of the acquiring entity’s stock. These work great when there is strong synergy between the companies and the seller owners don’t need much cash from the sale.
Major Pitfalls and What Can go Wrong?
There are many potential pitfalls with any third-party transaction. The primary concerns consist of (1) the seller’s “enterprise value” won’t yield the money (or payment terms) to allow them to live the life they desire, or provide the terms and conditions to enable them to completely “dis-engage” from the business after the sale, (2) that the buyer’s won’t acquire a business which can operate profitably without the owner’s on-going involvement, (3) that the parties don’t conduct enough (or adequate) due diligence to truly understand the strengths and weaknesses of each other, (4) that the buyer doesn’t have the financial resources (or future wherewithal) to pay-off the seller or (5) the parties are not represented by qualified and experienced advisors (legal, tax and organizational).
As a result, it’s crucial to have a well, designed and documented “pre-sale, transaction and post-sale plan” to address each of these and other key considerations which are sure to arise before the deal is over.
How to Ensure Success as a Seller or Buyer?
To ensure a successful third-party transaction, the seller/owners need to make sure that their business is a “well-oiled” cash flow machine which can run without them and be easily transitioned to the ideal buyer. As discussed, in “Building Value”, sellers can and must build future Transferable Value by implementing various “Value Drivers” to enhance the profitability and transferability of their business.
As for buyers, they need to be well educated and informed on how to pursue, investigate, review and acquire the right business for them. Evaluating all potential liability, tax consequences, employee retention and integration issues and the “post-closing” roles of the seller/owner are all important in determining if a business is a good deal.