Who cares what you sell your business for? How much of it do you get to keep? This is the second in a three-part series explaining the math behind selling your company.
Part 1 – Enterprise Value
Part 2 – Equity Value
Part 3 – Net Proceeds – Asset Sale vs. Share Sale
In Part 1, we discussed calculating Enterprise Value and then adjusting for owned real estate, cash and other redundant assets to arrive at total Business Value as the first steps in determining what you get to keep once you sell your business.
This part explores the next important step of determining Equity Value from Business Value. This is the frequently confusing world of determining how interest bearing debt, working capital adjustments, owner bonuses payable, related party loans, preferred shares and common shares determine net proceeds and what amounts are taxable.
Interest bearing debt – includes operating loans, term loans and capital leases.
Recall that Enterprise Value is estimated using a Net Present Value approach which incorporates a Weighted Average Cost of Capital. Your business’ capital structure (debt vs. equity) does not impact Enterprise Value and Business Value, but it is fundamental to determining your Equity Value.
Working capital adjustment – A buyer expects a business to have an adequate level of working capital to sustain operations; typically no less than has historically been required, and perhaps a higher level if the business has excessively relied on trade payables. The minimum level of working capital required is usually specified by the buyer in the purchase offer or Letter of Intent. Upon closing of the transaction, the vendor will be required to fund any shortfall, typically via a downward adjustment in the Purchase Price.
Equity Value = Business Value – interest bearing debt – any working capital adjustment
If your Business Value is $3.1 Million and you have $1 Million in interest bearing debt, the net of that is $2.1 Million in Equity Value if there is no working capital adjustment. Alternatively, if the business is debt free, Equity Value would be $3.1 Million assuming no working capital adjustment.
Equity Value is inclusive of all related party obligations – owner bonuses payable, related party loans, shareholder loans, preferred shares and common shares.
Owner bonuses payable is money owing to you that the corporation has paid tax on and will be taxable in your hands upon receipt in the normal manner.
Shareholder or related party loans payable represent money loaned to the company that can be repaid without tax consequences in your business. Shareholder loans owed to you personally are tax paid money and can be repaid without personal tax consequences.
Preferred and common share capital represent actual funds invested and is, again, tax paid money that is not taxable, but the amounts involved are typically nominal in a small or medium sized owner operated business.
Retained earnings, recapture of depreciation, capital gains and goodwill represent the balance of the sale proceeds after deduction of the above items. Detailed tax estimates by your professional advisor based on the specifics of both your situation and the structure of the sale transaction will be required to estimate the taxes payable on this portion of the proceeds.
|Equity Value =||+ Business Value
– Interest bearing debt
– Working capital adjustment
In Part 3 we will examine the tax, transaction and value implications of an Asset Sale vs. a Share Sale; the final piece in the puzzle of what you get to keep.
Our Corporate Finance team can help you figure out this math and present it to you in a language you can understand. We promise. Why? Because we are business owners, too.