Published: New Hampshire Society of CPAs Connection Newsletter
January 23, 2023
In the relatively small-dollar sale of a closely-held business (for these purposes, a sale with total consideration between $2 million and $10 million), a relationship that is often not fully exploited for the client's benefit is the relationship between the seller's accountant and attorney. Too often, accountants and attorneys operate in their separate silos (with all due respect to my brethren in my profession, my experience is that attorneys are more guilty of this than are accountants). The purposes of this article are to provide an overview of the sale process and to discuss areas where accountants and attorneys can work together during that process to deliver value to the client.
Often, the first formal step in the sales process is the drafting by the seller's attorney of a Non-Disclosure Agreement (NDA) for presentation to a prospective purchaser. The attorney will draft the NDA broadly in order to prohibit the purchaser from making unauthorized disclosures of any information it receives from the seller. Because NDAs address the seller's confidential and proprietary information in general terms rather than on a specific, item-by-item basis, the attorney will in many cases not confer with the seller's accountant at the NDA stage. This can be a missed opportunity. First and foremost, the attorney needs to have a general understanding of the types of accounting and financial information that are likely to be provided, and whether there might be particular problem areas. The accountant likely has more experience with the client in those areas, and therefore can contribute to that understanding. Second, at the NDA stage negotiations are less intense, and the parties' positions less entrenched, than they will become later. This period of relative calm provides an excellent opportunity for the accountant and the attorney to discuss their overall understanding of the transaction, as well as their goals and expectations of outcomes for the client.
In addition to exchanging general information about the sale, the accountant and the attorney should treat the early stages of a transaction as an opportunity to become acquainted (or better acquainted, for those who have worked together before), to understand areas in which each other's familiarity or experience with the client might be limited, and to develop a level of trust and personal camaraderie. I recommend that these discussions take place by phone or video meeting rather than by email, which is inherently less personal and more prone to errors and misinterpretations. First-time sellers- who in my experience comprise the majority of sellers in this price range – are at just the beginning of a sometimes bewildering, and often frustrating and anxiety-provoking, journey. The typical successful business owner has grown accustomed to having a command of facts, and is confident in his or her ability to make appropriate decisions based on those facts. A sale will often take him or her outside the scope of his or her knowledge and experience, which is unsettling. It also places a premium on having an accountant and an attorney who work well together to provide consistent guidance and perspective through the process.
After the parties sign an NDA, the next step is usually the negotiation of a Letter of Intent (LOI), most often drafted by the purchaser's attorney. The main substantive provisions of an LOI, such as whether the sale will be of equity interests or assets, purchase price, payment terms, and restrictions on the seller's post-sale competitive activities are generally non-binding. Often, secondary provisions, such as identifying a period of exclusive negotiations, agreeing to keep the terms of the LOI confidential, and which state's law will govern the LOI, are binding. Although its most important provisions will be non-binding, the LOI is valuable in that it provides the parties with a useful roadmap for them to follow. It also provides the accountant and attorney with a useful guide to negotiating on the client's behalf.
The execution of an LOI is usually followed by a due diligence request, whereby the purchaser's attorney asks the seller's attorney for a full range of soul-baring information, including accounting, tax, and financial information, about the seller and its business. In some transactions, that request will come in the form of a due diligence checklist or other formal document identifying an exhaustive list of information to be compiled and provided by the seller. The attorney, working with the accountant in relevant instances, will then create detailed disclosure schedules. Those schedules are then appended to the sales agreement, with the seller certifying as to their accuracy and completeness. In other transactions, the purchaser's attorney will initially deliver a sales agreement that includes seller's representations and warranties that identify information to be included in disclosure schedules. In either case, the attorney should inform the accountant about what tax and financial information is to be provided and the representations the seller will be required to make. The attorney and the accountant should work together to ensure that the information to be provided is accurate and comprehensive, thus minimizing the risk of the client making an unintentionally inaccurate representation that results in potential liability.
Many sales agreements will include a post-closing purchase price adjustment, often referred to as a working capital adjustment, to calculate the closing day value of items on the seller's balance sheet that regularly change in the ordinary course of business (e.g., cash, inventory, receivables, payables, etc.). A working capital adjustment accounts for the fact that the initial purchase price was based on financial information that becomes outdated during the period leading up to the closing date. Using closing date numbers, shortly post-closing the purchase price is recalculated as of the closing date, and payment is then made by one party to the other based on interim-period changes. It is essential that the accountant and the attorney discuss which balance sheet items should be included in the calculation of working capital, and how that calculation will affect the sales proceeds ultimately payable to the client.
Early on in the course of a transaction, the accountant and the attorney should discuss whether any tax elections advantageous to the seller are available, as well as their potential effect on the purchaser. They should then provide the seller with the information he or she will need to make the most informed decision possible about whether to make elections and how to respond to any resistance from the purchaser. With respect to tax elections, as in virtually all aspects of the sale, the seller should be encouraged to take a walk in the purchaser's shoes. Playing a zero sum game is likely to result in higher transaction costs for the seller with little or no corresponding benefit.
While some sales involve the initial signing of a sales agreement followed by due diligence and the satisfaction of various contingencies, at the conclusion of which the transaction is closed, in my experience sales are more often of the "sign and close" variety. In a sign and close, nothing is signed after the NDA and LOI are in place until the closing, at which time all sales and other agreements are signed and various supporting documents are exchanged. The sign and close model might come as a surprise to a first-time seller, especially one with experience in real estate transactions, which more often follow the two-step model. It is therefore incumbent on the accountant and the attorney to prepare the seller for a quick exit shortly after agreement to the terms of all transaction documents has been reached.
An area in which a seller's accountant will play a vital role is the allocation of the purchase price in an asset sale or a stock sale in which the purchaser wishes to make an election to step up its basis in acquired assets. A purchaser generally will (to the extent permitted under the Internal Revenue Code) want to allocate as much of the purchase price as possible to those assets that can be depreciated most quickly. Based on the seller's specific tax situation, which the accountant is likely to know far better than the attorney, that allocation might be disadvantageous to the seller. Therefore, the accountant, attorney, and client should collectively determine the allocation most beneficial to the client and discuss how hard the attorney should negotiate the issue with the purchaser's attorney.
The sale of a closely-held business is frequently a confusing and stressful experience for the seller. Working together, the seller's accountant and attorney can ease that stress and provide guidance to bring about a successful outcome. The accountant and the attorney who work collaboratively will bring about the best results for their clients, and might even enjoy themselves more in the process.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.