The number one question I get asked by business owners is "How will things change after closing this deal?" Hadley Capital buys businesses with really successful operating histories - businesses in which we feel really good about the people involved (owners, managers, etc.), the company's strategy and it's ability to continue to do what it has done really effectively. Our goal at acquisition is first to not mess that up, so our approach to change after closing can be quite a bit different than other private equity firms. Many other firms come at a business after closing with a 100 Day Plan, which is a plan to accomplish a list of things in the first 100 days. That requires, in most cases, a significant amount of change during this short time period. This approach is different from ours, but both work. It's just important for business owners to understand what to expect after closing.
But, in any transaction, there are some things that change. Some of the changes can be time consuming and, in certain situations, there are existing relationships that a business owner might have that will change and it's important to know what to expect after closing.
Changes Associated with an Asset Versus Stock Sale
The vast majority of small companies in America are S Corporations or LLCs. They are flow-through entities, so, from a tax perspective, the seller of the business is typically neutral to an asset versus a stock sale. There are a variety of benefits to the buyer for completing an asset transaction; therefore, more than 75 percent of the transactions we complete are asset transactions and many of the changes that are identified here are a result of completing an asset transaction versus a stock transaction. Some of the changes described here (contract assignments, for example) may be eliminated in a stock transaction. But, if you were to look at the transactions in totality in the small business marketplace, the vast majority are going to be an asset transaction.
Changes from S Corporation to C Corporation
When we buy the assets of a target company, we form a new company as a C Corporation. This new company buys the assets and business of the target company. As a new company, let's call it Newco, it receives a new EIN. So, from a tax perspective and for other purposes, it’s a brand new operating entity. It also has a new legal name. In most cases, we use a form of the target company’s name. If the target company was ABC Distribution, Inc., Newco would be named ABC Distribution Holdings, Inc. or something similar. From an operating perspective, we would use the old company's name so the outward-facing name to the market doesn’t change.
The change from an S Corp to a C Corp also involves some tax changes. Flow-through corporations, like S Corps, typically distribute money to their shareholders because the individual shareholder pays taxes on their individual return. As a C Corporation, the entity pays the tax, not the shareholders. As such, any distributions that were taking place for taxes in the S Corporation go away. Similarly, if there were profit distributions in the flow-through S Corporation, those would also go away in the C Corporation for two reasons: one, there’s double taxation that is associated with taking dividends, which is tax inefficient; and, second, the excess cash or profits that are generated by the business are used to pay off the debt that was used to acquire the business and to continue to grow the business.
Changes in Banking Relationships
In every case, when we buy a business, we're borrowing money from a bank to help us finance the transaction. The bank that lends us the money requires that Newco's primary deposit relationship exists with them. So, in all cases, the companies that we acquire change their primary banking relationships. Along with changing your banking relationship and legal entity name, comes a number of other practical changes like new checks, new ACH payment and wire instructions, replacing or introducing remote capture or check scanning capabilities, and, in some cases, credit cards need to be changed from an existing credit card provider to a new credit card provider or new cards issued for the new company. In cases where Newco requires a local bank relationship for employees to cash paychecks, our lenders allow our companies to develop a separate, local banking relationship.
Time Frame for These Changes
Usually, in the final week or two of closing a transaction, we get all of this set up and ready to go so that, at closing, Newco is functioning just like the old company. Our bank partners are very adept at assisting our companies in making these changes. That's because our banking partners' primary business relationships are with small and middle market companies, so they are very familiar with the challenges and realities of operating a small business. Our goal is to make the transition as seamless as possible and to avoid any added stress to all parties involved.
Be sure to continue reading part two of this three-part article series, where I'll discuss more changes to expect after closing a private equity deal. You can also listen to our webinar on the subject here.