October 2016

S-Corporation VS. C-Corporation What is the best legal structure for your business?

S-CORPORATION VS. C-CORPORATION What is the best legal structure for your business? While there is an assortment of different structures (corporation, limited liability company, partnership, etc.), it is first important to understand the difference between an S-corporation (“S-corp”) and C-corporation (“C-corp”).

An S-corp is a corporation that elects to be taxed under Subchapter S of the Internal Revenue Code. The profits (and losses) of an S-corp flow through the entity, and the shareholders are taxed at the personal level. On the contrary, a C-corp is taxed on its profits as a taxpaying entity, and the shareholders are taxed again when dividends are distributed. While this “double taxation” may not seem appealing, there are some advantages for larger corporations. For example, the income of an S-corp may bump the shareholders into a higher tax bracket, resulting in higher tax liability. However, a C-corp can withhold dividend distributions to shareholders to avoid this. This option is not available for an S-corp because the profits automatically flow through to the shareholders.

Despite the differences in taxes, S-corps and C-corps are quite similar. They are both separate entities from the shareholders, subject to federal and state securities laws, protect shareholders from liabilities of the corporation (if managed correctly), require filing documents with the Secretary of State, have a Board of Directors and officers, and must observe corporate formalities. Directors and officers have responsibility for the management of the business, and most decisions must be approved by the Board in a formal meeting or written document. On the contrary, shareholders generally are not entitled to actively participate in management.

S-corps have many restrictions. They cannot have more than 100 shareholders, all shareholders must be U.S. citizens or resident aliens, and certain trusts and tax exempt entities cannot be shareholders. S-corps can also only have one class of stock. However, C-corps provide flexibility through various classes and series of preferred stock (stock that permit preferential voting rights and distributions to the owners). Therefore, C-corps are more appealing to investors and are best if there are plans for an Initial Public Offering (IPO) in the future. Unlike a C-corp, non-taxable fringe benefits (group health insurance, accidental or death benefits, etc.) are generally not excludable from the owner’s income or deductible by an S-corp. Shareholders who work for an S-corp may be treated as self-employed, rather than a W-2 employee (as with C-corps). In this case, they are not entitled to many benefits, such as health and death benefits.

When choosing a legal structure for your business, it is important to consider all aspects and consult with your Certified Public Accountant and attorney. If you have any questions about forming a business entity or any other business law matter, please contact the Law Offices of Tyler Q. Dahl for a free consultation.

Disclaimer: This material was prepared for general informational purposes only, and is not intended to create an attorney-client relationship and does not constitute legal advice. This material should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a qualified attorney regarding any specific legal problem or matter.

Content provided by Law Offices of Tyler Q. Dahl
333 University Avenue, Suite 200
Sacramento, CA 95825
info@tqdlaw.com

Keeping The Sale Of Your Business Confidential

Selling a business is a process that depends upon professionalism and confidentiality.  Selecting a business broker who understands the critical role that confidentiality plays is simply a must.  Unfortunately, countless sellers have in fact dealt with a situation where a breach in confidentiality has caused a deal to fall apart.

A failure to maintain confidentiality can lead to a slew of negative reactions from a range of parties.  Everyone from supplies and vendors to creditors could react in a way that could harm your business, for example, vendors could change their terms and this could in turn negatively impact your cash flow.

A breach of confidentiality could also lead to negative reactions amongst both employees and customers.  The reason is that employees may begin to worry about the security of their jobs and may also become nervous about the change in management.  These fears could prompt employees to find a new job and leave you with a position that needs to be filled.  Potentially more significant is the fact that the loss of key personnel could cause your buyer to have cold feet.

As if all of these factors were not enough of a concern there is also the issue of the competition.  If your competition gets wind that you may be looking to sell they may take advantage of the situation and start attempting to steal your customers.

Finally, a breach in confidentiality could send potential buyers running.  The headaches that are often associated with a breach in confidentiality are such that potential buyers may simply drop the deal.

The best way to protect your confidentiality is to opt for a great business broker.  A business broker is an expert in prompting a business without notifying the competition, your employees, vendors or anyone else.  The process is both an art and a science.

When attempting to sell on your own there are many and diverse pitfalls.  Sellers are much more likely to accidentally reveal who you are; after all, a seller has to provide phone numbers, email addresses, physical addresses and other critical and identifying information.  Even your home phone number could be traced back to your identity and ultimately your business.

A seasoned business broker can help you bypass these potentially damaging issues, by not just shielding your business’s identify but also by ensuring that all interested parties sign confidentiality agreements and are pre-qualified.  In this way you only reveal what is absolutely necessary.  In short, it is best to work with a business broker and maintain your confidentiality at all costs.

Understanding A Buyer’s Key Motivations When Selling Your Business

Negotiations can be tricky affairs.  One wrong move can undo a tremendous amount of work.  In negotiations, it is best to take a moment and think about where the other party is coming from.

What are their needs and how best can you meet them?  Understanding your buyer’s motivation increases the chances of a successful negotiation.

What Appeals to Most Buyers?

When it comes to selling a business, you likely will not know your buyer personally.  This means that you will not know what they value most, how exacting their standards will be, and how easy or challenging they will be during negotiations.  That’s why it is imperative to err on the side of caution and act in such a way that would appeal to most buyers.

Ensuring that your business is in strong financial health means that your business will be appealing to both a corporate executive as well as an individual buyer with a leadership/managerial background.  Keep in mind that individuals who buy businesses will want a strong ROI, and often they will want the responsibilities that accompany that investment to not interfere too greatly with their current lifestyle.

Playing into Emotions

In general, buyers tend to be the most excited at the beginning of the sale process.  It is at this point that you can expect your buyer’s passion to be its strongest.  As a result, the first stages are when you want to keep your presentation and approach the most realistic.  The reason is that once the surge of passion has worn off, your buyer may otherwise feel that you have tried to oversell your business.

Being Forthcoming with Information

It is quite common that you will not at first know if your buyer has previous experience in your market.  As a result, you shouldn’t assume that they understand anything about your business or industry.  In short, it is definitely in your best interest to be very honest about your business and what is involved in running it.  If there are issues that they will invariably discover, then it is best to go ahead and disclose those issues early on as it establishes trust and goodwill.

Understanding Expectations

Another area to consider is what a buyer may expect of you after the sale.  A buyer who already possesses a background in your niche would already be very familiar with the ins and outs of your industry.  Having you around after the sale may not be viewed as necessary or beneficial.

However, with that said, the exact opposite may also be true.  You may be dealing with a buyer who is in dire need of your expertise.  These factors could be of critical importance in what you offer your buyer in terms of your availability.  Again, that’s why it’s best to not make assumptions and make sure your terms would appeal to a wide variety of backgrounds.

An Investment of Value

Invest the time to understanding your buyer’s motivation.  The more you understand what it is that your buyer wants out of the transaction, the greater your chances of focusing on the areas of your business that best match those expectations.

When it comes to the motivations and concerns that prospective buyers may have, a business broker can add a new level of understanding.  The value that your broker adds to the process of selling a business is difficult to overstate.

How Much Goodwill Do You Have In Your Business?

How much goodwill do you have in your business?

The term “goodwill” is often thrown around in conversation as though it is a subjective description of how much your customers like your business.

In fact, when it comes to valuing your business, there is nothing subjective about the definition of goodwill. It is defined as the difference between what someone is willing to pay for your company minus the value of your hard assets.

Let’s imagine you own a HVAC company and the main physical assets in your company are the five vans you own and some tools with a total value of around $100,000. If you sold your HVAC company for $1,000,000, the acquirer would have paid $900,000 in goodwill ($1,000,000 – $100,000).

When a company sells for the value of its fixed assets, it is often a distressed business one step away from closing down. One way to think about your job description as an owner is to maximize the difference between what your business is worth to a buyer and the value of your fixed assets.

Marriott buys more than bricks and mortar

For an example of the difference between valuing a business for its hard assets vs. its goodwill, take a look at the recent acquisition of Starwood Hotels & Resorts Worldwide by Marriott. Neither Starwood nor Marriott own many of the hotels that bear their name. Instead, they license the name to operators, franchisees and the owners of the bricks and mortar.

So why would Marriott cough up $13 billion for Starwood if they don’t even own the hotels they run? In part, Marriott wanted to get its hands on the Starwood Preferred Guest program, a loyalty scheme which has proven more popular than Marriott’s program for frequent travellers.

Similarly, Uber is worth something north of $50 billion because more than one million people per day hail a ride using Uber, not because they own a whole bunch of cars.

Chasing hard assets at the expense of goodwill

Many owners focus on building their stockpile of hard assets, not understanding the concept of goodwill.

Accumulating hard assets like land and machines and equipment is fine, but the savvy owner, looking to maximize her value, focuses less on the tangible assets and more on what those assets allow her to create for customers. There is nothing wrong with owning hard assets unless they take away from capital you could be investing in creating goodwill. Then the opportunity cost may exceed the value of owning the stuff.

Arguably both Uber and Starwood would be a shadow of the companies they are today had they pursued a strategy of accumulating hard assets. Would Uber ever have made it out of San Francisco if they had to buy a Lincoln Town Car every time they wanted to add a driver to their network?

In your case, focus on what creates value for customers and you will maximize the value of your business far beyond the value of your hard assets.

Business Sales And Seller Financing

 The majority of business sales include some form of seller financing. Typically, seller financing is when the seller provides a loan to cover part of the purchase price. The rest of the purchase price is covered by the down payment or often other financing sources are used as well. Summed up another way, the seller is essentially acting as a bank for the buyer.

When sellers offer financing, it often also helps them achieve a higher final sale price. Sellers who are not open to seller financing will likely limit their possibilities.

Performing Due Diligence

When a seller opts for seller financing, it is necessary to do much of the work that a bank would usually perform, for example, checking a potential buyer’s credit report, financial statements and other key financial information. After all, if you opt to offer seller financing, then you’ll want to ensure that your buyer will not default.

Usually contracts allow for the seller to take back a business in 30 to 60 days if financing fails. In this way, the buyer can avoid a potentially serious business problem.

There are often other contractual stipulations as well. A common clause for businesses involving inventory is that new owners need to maintain a certain level of supplies during the payment period.

Providing Benefits for Both Parties

It should also be noted that seller financing is of considerable interest to buyers. Sellers looking to attract as much attention to their business as possible will want to consider this route. Offering this type of financing sends a very clear message. When a business owner is open to seller financing, he or she is stating that he or she has great confidence that the business will generate both short term and long term revenue. That level of confidence speaks volumes to buyers about the health of the business.

What Due Terms Typically Look Like?

In terms of the length of seller financing, 5 to 7 years is typical. The issue of how much a seller is expected to finance is another issue that draws considerable attention. While there are no steadfast rules as to what percentage seller’s typically finance, it is common for sellers to finance up to 60% of the total purchase price.

Finally, seller financing does have a good deal of paperwork and points to consider. Opting to work with an attorney or business broker is absolutely essential to protect all parties involved.

Copyright: Business Brokerage Press, Inc.