Podcast: Taxes and Your Net Proceeds, an Interview with CPA Ryan Turbes
A transaction or M&A CPA is the best person to help you navigate tax law when you are ready to sell your business... if you want to increase your net proceeds.
About the Host
Ryan is an entrepreneur, podcast host of the show Life After Business and the co-owner of Solidity Financial. Having personally experienced the hazards of selling a business, he joined up with his friend Brandon Wood to educate others on the process. Through their business (Solidity Financial), they provide a platform for entrepreneurs called Growth and Exit Planning that helps in exit planning, value building and financial management.
About the Guest
Ryan is a manager at Boulay and is one of the leaders in the firm's transaction advisory services practice. In addition to working with transaction services, he specializes in attest, tax, consulting and accounting services for clients in a wide variety of industries including construction, professional services, manufacturing, and insurance agencies.
Ryan is proactive in helping his clients with their accounting needs and leads attest and transaction engagements. He prides himself on providing cost-efficient and practical solutions to his clients. He presents creative ways to help clients achieve their goals and make the right decisions.
Boulay works with individuals, closely-helps businesses and publicly traded companies who are, or who aspire to be financially successful. Its focus is to protect its clients' businesses, build their wealth and secure their future by partnering with them and integrating its depth of experience in accounting, tax and financial consulting services designed to "help them get there."
If you listen, you will learn:
- Why Ryan chose to be an accountant.
- How the buy-side and sell-side differ.
- Why you need a transitional CPA for a business sale.
- What is EBITDA?
- The steps Ryan and his team follow in the early stages of negotiation.
- What is an add-back?
- When should you make changes to your business?
- How working capital affects the process.
- When not to use a 12-month revenue measurement.
- How to prepare for the net proceeds process.
- The variables that affect the deal structure.
- Why buyers want an asset deal.
- Why sellers want a stock deal.
- When to use a 338-H10.
- What is a waterfall?
- How installment payment agreements work.
- How earn-out agreements work.
- How employment agreements work.
- The importance of a good negotiation team and attorneys.
- The importance of a 1031 exchange.
- How the 2017 tax law changes have changed the sale process.
- Why you need to start planning early.
Ryan Turbes: Getting the company to a spot where it's marketable, that takes time. You can't just flip the switch overnight and like we had talked about earlier, once you sell your business, you're not going to just walk away with everything more often than not.
Announcer: Welcome to Life After Business, the podcast where your host Ryan Tansom brings you all the information you need to exit your company and explore what life can be like on the other side.
Ryan Tansom: Welcome back to the Life After Business podcast, episode 115 here and today's guest name is Ryan Terbus, who is a CPA manager at Boulay Accounting firm here in the twin cities and he has a ridiculously good track record of some very interesting projects where he's done due diligence and financial analysis for private equity funds, search funds. He does a ton of work for strategic buyers that are doing acquisitions and has just a ton of good information to share with us. And Ryan and I's track record and relationship goes back before we were actually talking about M&A and we went to college together and Lo and behold, we can do more than just drink beers together. We can actually talk about some really interesting stuff which is now spreadsheets, but the reality is in all seriousness, Ryan and I had some really good conversation. He's been on the buy-side of a lot of transactions and he has a very unique perspective because he's been getting more into the sell-side and we really want to dive into as the second part of this series in the second episode of this three part series is that we want to know for you the seller, how much will you actually make? Because as we talked about with Brandon Hall, a business valuation is all top line. How the deal is structured, how actually the net proceeds are calculated when and how you get your money is a completely different thing. So what we're going to do with Ryan in this episode, a little bit of a refresher about how to value a company from his perspective on the finance side and the in the tax side. Understanding the multiple of EBITDA. He gives a little bit more of a refresher and explanation of the EBITDA and the multiple and how that's calculated, but then really talking about deal structures, fees, how that works, when and how you get your money.
Ryan Tansom: The tax ramifications of all the different things to consider gives even some of his advice from a buyer's perspective and if he was a CPA on the buyer's team, what are the things that he's going to be looking for? And we really did try and boil down to here are the things that are gonna matter to you, the owner, who's going to eventually sell their business and what you need to think about in order to get the money that you deserve. Because once you have determined which exit option is right for you, whether it's a private equity firm, whether it's an internal sale, whether it's a third party or whether it's an ESOP, then the only thing that matters for you is how much money you put in your bank. All the other stuff is irrelevant until you get your money, so hopefully this gets you where you need to be to level up the playing field, to talk the talk with some of these advisors, potential buyer that's really trying to push the deal structure or the tax structure into something that's more advantageous to them versus you because there's a direct correlation between things that are usually good for the buyer or not as good for the seller. So as I had mentioned in the previous episode, and I will again in the following one, which will be an interview with John warrillow about the eight key drivers of value. There is a link in the episode show notes about how to get your eight key driver survey. Get a score on where you're at on the eight drivers. There's also a link to Biz Equity, which this software system that'll get you a business valuation. It's not a certified one like brandon was talking, but it's something that'll give you a benchmark. Or remember, if you take the business valuation, that's not how much money you will walk away with, which is why you need to listen to this episode with Ryan. So without further ado, here is the episode on tax net proceeds with Ryan Turbes.
Announcer: This episode of Life After Business is sponsored by GEXP Collaborative. Their proven process gives you clarity on all of your exit options and how those options impact your financial success, timing and future happiness. Sell your company on your timeframe to the buyer of your choice at the price you want.
Ryan Tansom: Ryan, what's going on?
Ryan Turbes: Oh, just a living another day in the office ,enoying this lovely fall Minnesota weather that came on us in about 10 hours.
Ryan Tansom: Well, and you and I were just talking where you are, a big hunter as am I, you are definitely above and beyond because you looped in your significant other into the trade as well. So you guys have a lot of, a lot of events coming up that is going to be new to manage with your little one at home.
Ryan Turbes: Yeah, certainly changes things and you get into hunting over 30 years and then your wife gets into it in a manner of one to two years that tends to add up the kid cost in there as you well know is a pretty material.
Ryan Tansom: The blinds with yeah. The car seats are insulated like that. Exactly. [crosstalk] and soundproof. Kinda like, uh. Well I'm looking forward to having you on the show. You and I, you know, for the listeners we've known each other for a long time. Went to college together and we both found out that hey, my gosh, we're both going to do on some of the same stuff and we not only can we drink beers together, but we can also talk about spreadsheets, riveting stuff, riveting stuff. But, so for the listeners that don't know you, Ryan, you might need to just give them a little bit of a background of your specialty and then how you got what you're doing today and what kind of consists of your main activities.
Ryan Turbes: Sure. So I'm currently employed at Boulay, a public accounting firm in Eden Prairie, Minnesota. Uh, we have three offices, one in Naples, Florida, one in downtown Minneapolis and then the prairie office. Um, and really what I enjoy doing most being a public account is just helping people solve their problems, whether it's tax related problems, financial problems, and really over the last four to five years, the transaction side of things which all encompassing, um, there's a lot to consider with the transaction side, um, and that can be a very stressful and yet very important time in a business owner's life. Um, so I, I enjoy that side of it. I like the hard and fast environment that is transaction services and I thoroughly enjoy trying to help, um, whether it's, uh, I'm representing the buyer or seller, uh, kind of walk through that process and uh, try to smooth things over for them so they can ride off into the sunset.
Ryan Tansom: Well, and what was really cool about when you started having these conversations is, you know, understanding your background on audits and really understanding the financials of these companies. It really naturally translates into then valuations and what is this asset worth to someone else and what are the different options. And you guys have a really cool spread of different services that your company, but and what percentage of your time for the listeners, because I think it's a unique perspective to the buy-side versus sell-side. On the tax side,
Ryan Turbes: I will say that it's been changing. So I'll say three years ago it was probably 90 percent buy-side whether we were representing a private equity group, family investment office or search funds. Um, and that, that has started to shift since three years ago. Uh, it's probably more like 80 percent of buy-side 20 percent sell, uh, but I, I going forward, I see that relationship maybe moving closer to 50/50, especially as a lot of our current clients and prospects. Uh, the baby boomer generation reaches that retirement age and there's going to be a lot of turnover in companies as you will know in the next we'll say five years.
Ryan Tansom: It's pretty crazy man. And that's what we're talking about this. So like even since we sold our business in 2014, I mean it's the chatter's going on and you hear a lot of these people going, what, what, what do I do now? Because you're the natural finance people know people probably just it, it's a natural conversation going, okay, so what next? So we're going to be pushed into a lot of that stuff. And so, and I think what the reason I wanted to as I want the listeners to know that because I think your perspective on the buy-side is super treat for the listeners as well because it's a way different. I mean it's the same transaction, but it's a way different thought process because you're trying to understand the risk of the purchase and how to mitigate the risk versus the seller. You want to do the opposite. So I think you're going to build a shed some light that is going to be crucial on like how does this whole thing gets structured and what's the tax ramifications for both sides. And you know, before we do that, Ryan, I think what I'd love you to do is give us the, your perception and opinion of the difference between a normal CPA and an M&A CPA. And the reason I'm asking this question is because I had some major issues in this area when we sold because we left a lot of money on the table from this specific topic that we're going to get into and close to almost a million and a half, couple of a couple million bucks from deal structure, tax ramifications. But I think a lot of the people, like we were just saying they are business owners and there's millions of these business owners up there, right? And they have these relationships with their CPA that they've had for a long time and they naturally just asked the CPA first because of the relationship on the numbers, but there's a humongous difference between an H&R block CPA and well, they're not even CPAs or a versus like what you're doing. So can you maybe just, you know, what's your, what's your opinion and how would you describe it to the. For the listeners?
Ryan Turbes: Yeah, it's really a, it's really an important question to answer. And I will say at first it comes down to trust a solid. Any, a professional advisor, whether it's your bank or your attorney, your CPA, your insurance agent, you have a relationship with that individual and they've been, it's probably been a successful relationship, uh, over the years. So it certainly makes sense for you to go to that individual, whether it's at a, a regional, national or even a sole practitioner from to say, Hey, I'm, I'm kinda going to be going through this transaction and I'd like for you to help me and that, that can be a good conversation to have. But I think one thing to consider in a normal CPA versus an M&A CPA is a normal CPA, a is more of a historical, a CPA, so they're kind of um, producing tax returns and financials and helping you with any maybe historical analysis that there are some very good CPAs that do, anybody can do that historical work, but they try to get you to think ahead a little bit that that's where you can really stand out and add value and gain that trust of, of your clients.
Ryan Turbes: Um, but an M&A or transaction CPA is, is very unique in that there's so many things to consider from a deal structure perspective, um, to normalizing working capital and EBITDA nd we could go on and on to just say, well, there's a lot of unique things that we need to consider before we even go to market before we even consider going to market. What can we do to increase the value of your company so when you get to market, you have this well oiled machine and um, you can reap the benefits?
Ryan Tansom: Well. And I think you hit on a lot of good notes there that we're going to end up peeling apart. But you know, there was a, there was a gentleman that was on my show, Todd Ganos and this guy is like absolutely, like, like an assassin. I think he read both the house and the Senate, a tax books back and forth before it was even approved. Yeah, right. That's not repeatable. But you know what he said at one point, Ryan, was the difference between someone that's doing what you're doing that should be on the team versus like a normal CPA that's just doing tax returns and audits is there's, you know, there's so many things to peel apart and you don't want this person to learn on your dime because if you've done hundreds of these, you know where to look, what tax code to reference and how to structure it in this specific situation versus someone just learning on the fly. Because one specific election like I've brought up before, the 33H10 changes the whole game. You know what I mean? I just don't know that unless you've done it before, so I think there's just a, there's a ton of weight that I want to put onto that.
Ryan Turbes: Yeah, we could talk for hours on a lot of these things and hopefully in the next, uh, half hour, 45 minutes, we can cover a lot of the topics or people can get a good understanding of why you need a transaction CPA.
Ryan Tansom: What we're going to do then for, for the listener series, will, because of our last episode was about valuations. We dove in a lot of that on the certified valuation front, but coming from a, you know, Ryan's perspective and the CPAs and the tax. I want to understand, I think we know, Ryan, you got a unique look on EBITDA and valuations, we'll kind of tee up into that. And then we'll go into kind of how it's structured and literally what matters to is like how much do I walk away with and what do I walk away with it because that's the most important part. And I think a lot of the owners, a lot of business owners think, oh, I've got this $20,000,000 valuation offer, well that doesn't mean anything until you get the money. So Ryan, why don't you leave, let's, let's start with Kinda your explanation on how to get to it, normalize some of the big factors on cleaning this up so you can actually have a realistic understanding where you're at?
Ryan Turbes: Sure. So EBITDA for those, uh, for those of the listeners who are uncertain what is it's earnings before interest, taxes, depreciation, and amortization. So really what it come down to is it's taking our net income for the company and adding back into the non cash items to arrive at EBITDA or EBIT DA, which is kind of our free cash flow for the company. Um, as part of a transaction, kind of a standard practice is to arrive at a normalized EBITDA number for a number of periods. Generally it's one or two years historical and whether you're a fiscal year end or calendar year end and then as well as a trailing 12 months. And I'm gonna use TTM period. Um, or, uh, last 12 months LTM period, um, the, the TTM period is probably the most common that you see and sometimes within some of our LOIs, um, the TTM EBITDA is really what drives the enterprise value in essence, what you're going to get for your company.
Ryan Turbes: So they'll take normalized EBITDA times a multiple of three to ten, anywhere in that range or higher or lower. And that's what drives kind of the value of your company. Now within EBITDA, there's a pretty substantial process to kind of normalize that. So some of the larger things that I'll just briefly touch on that we generally run into as, as the case with most businesses, there's probably quite a few personal expenditures being run through the business. So that's probably first and foremost, uh, when we go into a deal, we try to dig into the weeds and find those add-backs. So the business has been paying for those personal expenditures, whether it's travel, meals and entertainment, cell phones, cars, things like that. We add that back. Shareholder compensation. Are you paying yourself an excessive amount of wages or not enough? Um, do you have the right number of employees in the right positions and are they paid adequately? So we kind of look at the fair market value in essence of the salaries and wages for all those, those current employees. And if you need to bring in another employee like a CFO.
Ryan Tansom: I was going to say, let's give a couple of real examples of that because you know, you and I have so many clients, so many experiences with it. So. Okay. So I used... a Real life example, I used to go, speaking of hunting, we used to go on a fishing trip every single year - a fly fishing trip to Canada and South Dakota, both of which are actually pretty dang expensive if you don't have a business and you know, so what are the, you know, the dialogue that you're having with your clients as it relates to okay, well, you know, how does it impact my current taxes? Right. So I think there's all those gains that they want to reduce your taxes and get all those perch. But then when you say add back, we've talked about it before on the show, but let's say you know, both of those trips because we're bringing customers know that'd be $40,000 and let's explain what you mean by add-backs and how that impacts that value.
Ryan Turbes: So after the business was paying for it and it's reducing our net income. Okay. Um, for example, um, you use a $40,000 for that hunting trip, um, that $40,000 times a multiple of five for example, would be an additional $200,000 of enterprise value for your company. So that's why it's important that we can identify what those are now....
Ryan Tansom: That 40 grand goes on top of that $500 or whatever the EBITDA is. And I think to even expand on that too, because I mean how many people have like a random overpaid family member.
Ryan Turbes: And I think that the easier answer would be how many don't. Yeah, my kids are getting paid and that's fun to do. You certainly have that opportunity as a business owner, but we as independent accountants have to come in and say, well, is that realistic and are all the people getting paid salaries and wages, are those reasonable? And do they have a job description?
Ryan Tansom: Well, and I think what, you know, Ryan, maybe explain how your guys' perspective, their perspective is on it is it doesn't mean that they don't have to do that now, right? It has to just, let's just address it, right? So if you're not the big bad guy that's going to come in and tell them, don't do that immediately, right? I mean, that's what this whole exercise is all about.
Ryan Turbes: Right. And you can continue to do, do that up until deal close, just before you go to market. Let's identify those things. So when I'm, and this is kind of uh, if I'm representing on the sell-side, you want to identify those things before you go to market because then it should allow for a smoother diligence process, which is very substantial. And uh, you can get some deal burnouts with the significant shareholder if they're kind of doing everything. And to get those on the table ahead of time so you know what your company is worth and uh, it will allow for a smoother transaction.
Ryan Tansom: Well, give us your perspective on the, on the buy-side, too, because let's say let's go back to my hunting trip and I say I don't need to do that anymore. What's the dialogue that you have with your clients? And the deal team.
Ryan Turbes: So really when we identify them, if they're not identified when we go into a prospective client, let's say we're representing a private equity group, uh, that private equity group, we'll kinda have some formal discussions with them and what do they think going forward they're going to need to do from an entertainment perspective, um, to kind of keep their current client base. And I'll use an example we were representing this was a search fund on the buy-side. Uh, there was a client who had this annual Chili cookoff and they invited all of their customers to it. It was significant dollars, just shy of a $100,000. Okay. But they were going to continue to do that because it allowed them to get such a wide spread notoriety within that industry for having a fun event and it increased, uh, kinda their retention with their current customers. So it, it can go both ways, but ultimately it depends on what the buyer wants to do going forward. That'll drive what we do from an EBITDA perspective.
Ryan Tansom: Well, and I think what's interesting and we don't have to go down this way long rabbit hole, but you know, so have you ever gone back and forth and we're talking about my company with that Chili Cook off, I would argue that you don't need to do that anymore. And you would say, well we do need to do that and we're, you know, we're going back and forth over potentially a $500,000 on the top end of the enterprise value.
Ryan Turbes: And then you get down to the willing buyer willing seller and you guys ended up settling on a price and everybody moves on.
Ryan Tansom: No, but I think it's a good note. So you know, as to progress the normalized EBITDA, we've, you know, we've had some good conversations about this on the show, but you know, there's a lot of other things that go into that. I'm like the random expenses and stuff like that, but I think you also have some really good perspectives on working capital and that is involved in evaluation.
Ryan Turbes: Yeah. So working capital is probably even as very important, but working capital is as important when we're kind of going in either on the buy or sell side because as a buyer, if I come in, I want to make sure that there's a enough, uh, working capital in the business that I can operate the business through the smooth transaction. Um, so there's where a lot of the work comes in. So we're going to look at accruals. Uh, your revenue recognition policy, is that consistent with gap, um, or their allowances on the books for bad debt, discount allowances, um, accounts payable are you recording things in the proper period? So we'll kind of arrive at a normalized working capital perspective and again, we'll look at that TTM period. Um, but we will also look at, uh, this is an interesting thing to bring up that most people know about, but we do get into instances where people aren't as well versed in it. So if a company is growing, you don't want to use trailing 12 months because a company is growing that trailing 12 months working capital numbers going to be less than let's say a trailing three or a traveling six months. So if you have a company that is growing at an exponential rate, you might want to look at trailing three month or trailing six month average working capital one, one thing to consider, uh, with that said is seasonality. So if your last three months are your busiest time of the year, um, you probably can't use the last three months as, as nice as that would be. Then you probably need to look at trailing 12 months. But it's certainly something to keep an eye on as you work with through the transaction.
Ryan Tansom: It's so crazy around because like we went through, I mean we had some, we hired some pretty intense controllers and CFOs and then had to go through all this. We went through our European implementation day, really know all these dollars are coming, but to your point about, you know, a lot of the accounting terms of their accruals, the payables, not stuff, but when you break it down to kind of just some basic examples. So for example, we had contracts where we had the ability to bill monthly, quarterly and annually and so we build it and you were saying like the revenue recognition, like it's sitting there and deferred revenue grants. It doesn't mean that the money is in the bank account. So I think there's a, you know, for the, for the listeners, you know, I think what you're doing is like I'm, it's like almost like forensic accounting. I know it's technically not because that's more the investigative stuff, but I mean that's pretty much what you're doing because you, okay, we have a new owner, how does this, how does this machine continue to go? Like, you know, for us, we had 26 cars, are they going to continue to get paid because there's so many moving parts to just, you can't just cut the line right then and there. Right? So how does the, uh, how did, how have you seen the working capital impact the value of the company and you know, some of the, the questions behind that is because the new person, whether it's a third party, uh, you know, lifestyle, bar, whatever it is that they're going to have to provide their own financing, protecting me potentially, right? Whether it's a bank or to the self. So how do you determine and what have you seen in how that impacts the overall value for the different types of buyers?
Ryan Turbes: So working capital is kind of a separate calculation. So you have your enterprise value and within that enterprise value, through the diligence process, if, if a buyer comes in and they have a CPA firm that does the buying side due diligence, they'll establish a peg which is a normalized working capital number. Okay. And let's say that's a million dollars now within typically 90 days after the transaction date, um, maybe the same CPA firm or a different independent accounting firm will come in and compare the actual working capital on the transaction date to that average working capital for the TTM period. So a million dollars in that example. So as of close, let's say you're working capital was actually $1.2 million using this is important consistent methodologies with how you determine your trailing 12 month working capital. So you have to compare apples to apples. If you, if you set up an allowance or reserve during the ttm period using one methodology, you have to use that same methodology, uh, when determining the actual working capital like close.
Ryan Turbes: Okay? So back to my example, if it's a million dollar peg and we have a $1.2, million dollars of actual working capital delivered that $200,000, we delivered more working capital than what was required. So that $200,000 is an increase in the purchase price. Okay? Now it can go the other way where we deliver less working capital than the peg, so then that's a reduction in purchase price and generally these amounts are in escrow. So they're, they're held back anyway. Now I did have, and I've seen this more and more where instead of having an actual working capital peg of have a hard number. I've seen a hard number plus or minus a collar of, you know, whether it's $100,000 or x percent, um, because generally what happens is, as we talked about earlier, willing buyer, willing seller, and there's probably going to be some discussions about, well, I don't agree with your number. And the other individual says, well, I know it's a good number. Okay, well let's split the difference. So that collar would kind of help ease those conversations and say, well, if it's within the collar, we're good, there is no additional or reduction in the purchase price.
Ryan Tansom: Got It. And then we don't have to go down this road, but there's also rep and warranty insurance and stuff in here that can be used to help mitigate some of the escrows. And all that kind of stuff, right? [Ryan interjects: Absolutely. Yep. Yep.] So for the listeners, we'll, we'll go into that goal is to have another episode on that, but you know, as we're going, Ryan, like, you know, like, like I was saying is, so let's get this valuation that's coming on. What are the ways, you know, and I think, you know, let's say someone wants to take their company to market or to know whether it's private equity or whatever it might be, ESOP internal, whatever it might be, what are the ways that they could be like preparing and trying to figure out what is this, what am I actually going to make? Because so many people, they figured that out afterwards or at the, at the altar or when that tax bill comes. So what are the different factors that they should start looking at now and how are the different hopefully can transition or lead us into kind of the deal structures.
Ryan Turbes: So this is a very loaded question and generally if I'm advising somebody, this is generally the first conversation we have. So if they say, well, I want to sell my business, uh, we kind of bring in a wealth, a wealth management advisor and say, okay, what do you need to retire? And then we work backwards in essence from the net proceeds to see what that company value needs to be prior to taxes because everybody loves to pay taxes. Paying taxes is a good thing. Okay, it's better than losing money. So once we determine what that value is, then it's, well, is the, is the company actually worth that? So then I would strongly encourage you to go through a valuation, um, as I think you had an interview last week to kind of go over specific evaluation and how those are arrived at. So I'm not going to get into any specifics on that unless, unless, you know, um, so then from there we kind of go through and say, okay, um, how can we structure the transaction to make this work?
Ryan Turbes: Okay? So, um, is it going to be an asset or a stock sale? What makes sense? What does the buyer or seller want? We can get into more specifics on that here in a little bit. Um, but that's where you start to have the fun conversations because if the company isn't worth what it needs to be for you to live your life after you retire, okay, then the, the discussion quickly changes from we want to sell to law, what can we do to get it to that value? What, what can we do to bring synergistic value to this company and increase that enterprise so you can live the life that you want to live post transaction.
Ryan Tansom: Well, and this is what's really cool because you and I've worked on some clients together and as you think about the variables that you were kind of talking about it, and this is what a lot of people don't get is how do you reverse back into that? So Brandon was on the show a few episodes ago to talk and say, let's say we need 250 grand a year for life and that's post taxes. So then we say, okay, well how do we reverse back into that? So you're going to need five plus million dollars liquid in order to get that, but there's a lot of different ways to come up with the cash flow for that. And then there's your when and how you get the money and know there's the other variables of the different buyers will impact the value of the company. There's the enterprise value, but then you know, the timing is a variable. But then also Ryan, you know that a lot of people you probably see it as like I want to sell my company and next year it's like, well there's only so many things that can be done between on that. So what are we, you know, I think when we look at the deal structure, there's the legal deal structure and the tax structure that might allow the customer of yours or the owner to the listener to say, okay, you know what, there's a way that I can actually make my numbers work because of the knowing what the net proceeds are in the deal structure. Because you can squeeze more out of a smaller purchase price you know, figuratively speaking. So let's talk through like what are the big variables in calculating the net proceeds and some of the big things that people need to start thinking about as far as the structure and what's going to be taxed.
Ryan Turbes: Sure. Um, so, so the biggest driver right off the get go is whether it's going to be an asset or a stock deal, most sellers want to stock deal. Um, most buyers want an asset deal, um, because then the liabilities, and you can have indemnification clauses within the purchase agreement to Kinda take care of that issue. Um, but, but an asset, an asset deal, uh, the, the biggest change between that and a stack deal is you're going to have a t two different tax rates. You're going to have your ordinary income tax rates, which is your federal plus state and you're going to have a depreciation recapture on your section 1245 or your fixed assets. Okay? So you're going to have to pay ordinary taxes on the depreciation recapture on those, on those fixed assets based on how the purchase price is allocated. And that's where there's a lot of negotiations between the buyers and sellers because the buyers want to allocate more purchase price to the fixed assets because they get generally a seven year life and they can get the tax savings on it faster than they can over blue sky, which is also goodwill. So goodwill for tax purposes they get to amortize over 15 years. Um, but as a seller I want the opposite because if, if proceeds are allocated to goodwill, well that's at capital gains tax rate, which is about a 16-20 percent difference. Um, so there's, there's a lot of sticking points within that conversation.
Ryan Tansom: It's so crazy, Ryan, because I think about like, and this is where a lot of these sellers and like even what would I, was stuck in with or any of the listeners that are out there thinking, oh, I can just go take this tomorrow. You're literally at a disadvantage off the, off the get go because of the buyer usually is sophisticated as people like you going, we're going to smush everything into fixed assets and we're going to do an asset purchase. And that is both of those are completely the opposite of what the seller wants. Explain, which is interesting. We, you know, maybe dive into the, the depreciation recapture a little bit in the fixed assets because Brandon Hall and I had talked about it on the last show where there's a lot of companies these days where there is a lot of goodwill, which is the people, the culture, the processes, all the stuff that you can't.... Yeah, your brand, your logo, all these different things, which is a really good stuff, which is probably a lot of the reason that you're actually getting bought. And so describe how that, the depreciation recapture works too versus APP because I think it's important for a lot of people. I've, I've even heard deals where they go, everything's fine and then they look at the depreciation recapture and they're like Holy Shit, I can't do this deal because you know, and explain maybe the difference or how, how good depreciation is and what that does on an annual basis versus you know, how that impacts and how that all comes back.
Ryan Turbes: Sure. So for example, if, if a company is using section 179 and they are in essence expensing all of their fixed assets as they're put into service your net book value on those assets. So our, what we paid for it less what we've taken for depreciation on that. If your net book value is zero and when a buyer comes in and says, well, there's still some useful life there and some net book value of those assets. So we think, uh, they may or may not have an appraiser come in and give an actual value to it, but let's say it's $500,000, um, the $500,000 is compared to your net book value, uh, on those specific assets. And in that example of zero, so that $500,000 difference or Delta, um, is then multiplied by your ordinary tax rates, your federal plus your state. Um, so the dollars add up real quick. So you're looking at $500,000 times let's, let's use 45 percent, you have some real dollars going out the door here versus a capital gains tax rate of let's say 27 percent.
Ryan Tansom: And the buyer, the buyer wants it there because they get better tax treatment if it's in the fixed asset versus putting it into the goodwill.
Ryan Turbes: Correct. Because they can write it off twice as fast.
Ryan Tansom: So I think he had just comes back, you, you literally have to know both sides to play the game much better in as far as like the deals that you see because I think there's a lot, there's a lot of interesting things out there where the asset versus stock. So everybody probably says, well why wouldn't everybody do a stock sale? You know? And then can you explain on the tax purposes from a buyer's perspective, the difference and the benefits versus the stock versus the asset.
Ryan Turbes: So on a stock deal. Um, if you don't do a section 338H10 election, the buyer will not get the step up in basis. Okay. So then there is no, there is no tax benefit for the buyer on a stock sale, whereas an asset sale, you get that step up in basis is you're buying assets and assuming liabilities of have a business, I'm a stock sale, we generally see with a C-Corp, um, because the selling shareholder does not want to hit get hit with that double taxation. So a stock sale generally make sense with that regard. Um, those are Kinda the main differences between an asset and stock sale without getting...
Ryan Tansom: You know what one more layer deeper is the buyer gets to depreciate the asset because it's not technically, I mean they're just buying assets and they get to take the right where they can't do that with the stock. [Ryan interjects: Correct.] So therefore, if you think of, and that's, you know, for the listeners who have heard my story, I mean, we didn't know that. And then there's this thing called the 338H10, which is kind of a meeting in the middle of. So can you explain that tax purposes, right?
Ryan Turbes: Yeah. So, uh, 338H10 election. I know enough to be dangerous on, so if it is a stock sale, you can do the section 338H10 election to in sense get that step up and it's treated them more as an asset purchase. Um, so this is where the, the document may say it's, it's a stock sale, but then you get to the tax matters section. Men then they'll, there'll be verbiage within there that says, well they're making this election, so really then it's treated as an asset sale for tax purposes.
Ryan Tansom: So now you've about that. You hit your retina, but this is the ridiculous of. Yeah. Does your, does your normal CPA who's doing your tax returns know that? And that checkbox could save you millions of bucks to guess is this where you know, you're, you're seeing a lot of rep and warranty insurance coming in because in the stock sale you're, you're giving them all of your hidden, you know, unknown. Right? So there's a of more pro. You're promising that there's not a bunch of stuff come up. Is that Kinda how you're seeing the rep and warranty insurance come into play?
Ryan Turbes: Yeah, I mean it's certainly going to be more of a factor on a stock sale versus asset sale, but there are, you know, other ways that you can kind of mitigate that risk, but it's certainly way more prevalent in a stock sale.
Ryan Tansom: So, no, now if we just say, okay, you know, high level, we haven't either an asset or a stock sale, what are other big. So we got depreciation recapture from all the stuff that we've bought and we've taken good tax benefits over the years that are going to come back to us. What are other big things that impact the actual how much money you get and you've got this, a lot of people, if they're, if they have a correct CPA, M&A CPA to do what you call the waterfall? Can you explain that? And not like one of the things that they should be expecting if they're going through this.
Ryan Turbes: Sure. So on a waterfall can be, um, like reading tax law at first it may be pretty straightforward, but you can get into the weeds rather quickly and it can get pretty complex. Uh, so we'll just kind of walk through a pretty basic example, assuming there's no preferred returns on anything. So, uh, enterprise value, something that we touched on earlier, so once the enterprise value or the overall value your company is going to be sold for is arrived at, um, the factors to kind of arrive at net proceeds is kind of as follows. So we add back in the cash, uh, that's within the entity. We subtract out any debt that's going to be paid at closing. We also back then...
Ryan Tansom: Buildings or equipment or any buildings, special equipment loans...
Ryan Turbes: If you have an insurance liability, um, where you're paying your insurance premiums over, let's say 12 months. I'm also a reduction in that enterprise values, your transaction expenses. And that I would say ranges anywhere. It really depends on the deal. Somebody give a range here, it's if it's anywhere from one to four percent of the enterprise value and that would include a investment banking fees, CPAs, attorneys, things like that. And then another thing that is a reduction of the enterprise value is a, any escrow amounts. So what cash is left over that then is distributed to the shareholders or shareholder of the company. So yeah, we get all this cash in our bank account. That's what we have, right? Well, hold on here. We're going to, we're going to have to go through the calculation to say, okay, we got our net proceeds.
Ryan Turbes: Now what is the tax ramification of that? So there's, there's really two components. Um, and I'm gonna walk through an example here, Ryan. A typical deal. Okay. So in a perfect world, um, as a seller, we would get all of our money upfront. [Ryan interjects: That happens 100 percent of the time.] That's why I'm in a walkthrough a difficult on here. We would walk away and ride off into the sunset rule. Thank you very much. See you later. Well that's not the case. Um, you, you will get probably a percentage of it down right away, but then the rest of it's probably going to be either contingent or an installment sale and it will be financed over a period of time. Okay. And as part of that, you may need to stay on in the company for anywhere from six months to two years to kind of help with the transit, the transition of things.
Ryan Turbes: Um, so on the net proceeds side of things, if, if it's an installment sale. So let's say our enterprise value is a million dollars and we're going to get 20 percent of that cash immediately. So we have $200,000 of cash that we got immediately. And $800,000 of it is, uh, an installment. Okay. And installment note, you're going to get paid that over five years at, at the prime rate.
Ryan Tansom: And that's just seller's financing contract for deed. Yup. Exactly. So when you go. Sorry to interrupt, but can you maybe you're going to do this because I think there's, there's the installment which a promissory note installment or however you wanna describe it. And then there's earnouts, employment contracts and stuff like that. And at some point, I just want to make sure that you touched on it because I think there's different ways to structure that, that there's different parts of the contingency rates. So it's not, you're, when you're referring to the summit, you're saying is essentially a guaranteed payment, right?
Ryan Turbes: Yes. Yup. And we'll get into the contingency side of it because that's a, you know, let's, let's just talk about that in a little bit with the installment sale. Um, what we do is we take your annual payments, subtract out your basis in the company. So basis would be, let's say it's a pass-through entity, what have you paid tax on in the past. So that is a reduction of what you're going to have to owe for taxes. Basis is a good thing. We'll arrive at what your total gain is. So let's say you're getting, of that $800,000 note, you're getting $100,000 in the first year and your basis in the company is let's say 100,000 dollars. Well, we would take a portion of that basis and reduce your payment. So let's say you get $80,000 in a gain. So that's $100,000 minus the $20,000 basis. That gain of $80,000 is multiplied by long-term capital gains tax rate. That's the principle portion. The interest portion of that note that is at ordinary income tax rates. Okay. Um, and you just kind of walk through that. So that's how you really arrive at kind of the net cash that I as the selling shareholder am going to end up with in my pocket.
Ryan Tansom: Well, and even think about that Ryan, when you're talking about with it. So this is just a $1,000,000 sale, but if you have, you know, when you're talking about those, when you're hitting the cap gains or the ordinary income, if you've got rental income from other investments or other things that all goes on top of all this stuff. Right?
Ryan Turbes: Right. Yeah. This is just one specific portion of your income.
Ryan Tansom: So keep going. Sorry, I don't know you, let's say. So we got the installment in that. That's a quote unquote just seller financing. But then there's other things that are also calculated at different rates as well. So you've got employment contracts or earnouts or bonus. I mean, describe how those different factors come into it. Yeah.
Ryan Turbes: So if you're going to stay on with the company for an additional, let's say two or three years and you're trying to help grow that company, and if you grow the company at a faster rate than five percent of revenue. Let's say that's one of your target goals. Well that would be a contingency and you would get an additional kickback or additional proceeds once that earnout is met. Okay? And that would then increase what you're getting for net proceeds. So that's. So that's a win-win for everybody. Um, employment agreements, consulting agreements, uh, that's very similar to if I go work for an employer and I'm saying, well, I'm gonna, I'm gonna, stay here for two years and I'm going to make x amount of dollars in salaries and wages, uh, that's going to be your normal withholdings and that'll be ordinary- taxed at your ordinary income tax rates on your individual return.
Ryan Tansom: So then Ryan, I think, which I think is super helpful to note. And so if we think about the buy and the sell side, right? And this is why I think what you and I talked about at the beginning, which is reverse back into what you need. I mean it's really, that's the simplest part because it was 250 grand a year. It's like a jigsaw puzzle with all these sliding funnels that we can put stuff into. So you kind of explain all that stuff on the seller's perspective and how that all is where you want to potentially go into different buckets. But so say so when you look at the buyer and the seller's perspective and the buyer, you know, what can you kind of give the buyer's perspective on where they want to push certain things and how in employment. So if they're, you know, if we're talking about like a million dollar purchase price and that they have got different reasons to push things into different buckets. So we know that you kind of said that, hey, we want to push things into fixed assets, but you know, is there other ways to come up and shore up with the seller wants through employment contracts and all those different things that are. No, it's worth it, you know, and how does that impact the buyer's tax benefits and/or cost of the sale?
Ryan Turbes: Sure. So a buyer is probably going to want to do more things on contingent basis because they don't want to, if this deal goes south, they don't want to be stuck with this huge liability of any benefit out of it. Um, and then on the selling side, obviously we want everything now so we can ride off into the sunset. Um, so really it comes down to negotiation piece and that's where it's important. We haven't really touched base on this, that you have a good transaction attorney representing you as the buyer and the seller. Um, and that's where they can kind of walk through historically what they typically see on things and what makes sense. I'm from you. So typically we'll have the team of, let's say the team of the buyers will have numerous conference calls and talk about the deal structure and, and what, what the sellers want to allocate thing things to from a installment sales, earnouts employment consulting agreements compared to what the other party does. And we talk about those significant impacts and what is the best for our group that we're representing
Ryan Tansomr: Well. And you hit on a good point too, because if you think about, you know, there's another big takeaway for the listeners is you gotta have all these people because you got the tax it, but then how do you mitigate your risk on the legal side? Because I've seen people were like, hey, you know, we throw in the last point like, okay, give me an employment agreement for two years. And the reality is that person's really not going to ever work there. You know what I mean? There's a consulting agreement where it's like, hey, just show up for a call or be available for 20 hours this year. You know what I mean? So there's certain ways to get to the dollar amount that you want without, you know, without having to sacrifice everything or having to just give in because you don't know all the different structures of it.
Ryan Turbes: And that's where it's important. Like we talked about earlier, just real quick is it's important that you have a transaction CPA versus a call it a normal CPA because the transaction CPA knows all the components of the negotiation piece of it and can have that speak the language per se with, with your attorney.
Ryan Tansom: Super Important, right? Versus like, you know, not having a clue what you, all the stuff that you just said and to throw another layer on top of there too, because I think without going too much into this, this episode, but there, you know, if you're backing into how much money you want, there is a lot of these different things. The more you know, if you know the numbers that you're talking about, then you have options because you've got some clarity behind this stuff and you know, one thing that I think a lot of people can can take into consideration and open up options whether they want to try and get it to the internal buyer it, but there's no way to make the numbers work because they needed to cash flow. There's too much risks, et cetera. There's, I think, a good opportunity or interesting opportunity because people have buildings most of the time, a lot, a lot of times the owners have a building in this. So can you explain, because we know where there's the 1031, all this stuff. How do you, when you're looking at the numbers and that tax and backing into this, what are some of the cool things that you've seen people do what their buildings?
Ryan Turbes: Sure. So if, if the, uh, if the buyer is just going to buy the business and not the building, which can happen. I've seen it both way, generally a new agreed upon a rental agreement is signed probably for seven to 10 years so that the buyer knows that my rent is not going to get jacked up by you who just sold me the business because you're using that as your tax shelter. So then you have a, when you're going through that net proceeds calculation that that would probably be something that we would consider when looking at the big picture because that can be a very nice cash flow stream pulse deal. And then maybe after that, seven to 10 years now maybe the buyer wants to buy the building from you. Well now we have another opportunity to kind of take some skin out of the game and uh, additional proceeds.
Ryan Tansom: So if we're, if we're going back to that one, you know, story you're talking about, let's say we've got a building in because now if we're going to be doing a like a triple lease buy-back or something or how are you got a rent and then you know, even if they're buying it. So you've got all these different. I guess what I'm trying to go at with this Ryan is that there's more, there's more variables, rates you get interest if you're wanting to sell it, you've got purchase prices, you got rent and all those things are calculated differently in taxes too that, I'll go drop into the bulk of the 250 grand a year you want.
Ryan Turbes: And then really the fun part is, is we can just briefly touch base on this, is you can enroll a section 1031 and you can roll some of your proceeds into like kind property. So let's say you do sell the building as part of the original transaction price and you want to defer the capital gains on that building because a), either you don't, you don't need the money now or you just kind of want to spread it out until you're, you're done getting the installment note that we talked about earlier because once you're done receiving that installment note, you may or may not be in a lower tax bracket. So let's defer the gain of that building by rolling the funds for that building via section 1031 into a different building. And then maybe 10 to 15 years from now when we're in a lower tax bracket, we don't have any wages. We just have maybe some investment income. Well, now let's, let's consider selling the building because we're going to be at a lower tax bracket,
Ryan Tansom: which I think is so huge because when you said the big picture right in the big picture is income overlap my lifetime, how do I back the, all the different variables and you know, one of the things that we do, which is we didn't do a 1031 exchange. We had a significant uh, equity in our building. And if you think of it, let's say hypothetically that the seller that you said it was a million dollar company, but let's say to get a millionaire and equity and their building, they can roll that into a $5,000,000 building and call it a 10 cap. I mean that's significant income. Yes it is. So have you used that as like a way to help you know when you're looking at that, that net proceed. When we first started out where you and I say, okay, you know what, we're going to back into this, you know, you're, you did this 10:31. You could potentially not need as much for your business and then be able to structure everything backwards into that because they've got different sort of income outside of it.
Ryan Turbes: Right, right. Those are fun conversations to have with clients though because they're really adding value and what they can do with their proceeds and how much they need.
Ryan Tansom: So without having a, you know, even more in depth difference. Going down to specific major tax. Tax Law is code. What, what Ryan, is there anything that you've seen change sensitive reform. I mean, I know there's a lot of still you or get into the second, second wave of this stuff that all the different parts of the conversation we've had that, you know, things that the listeners should know?
Ryan Turbes: I mean, so since, since the change, um, I will say when that change came out almost a year ago now, and at the end of December of '17, that was probably the busiest week and a half of December I've ever experienced because of all the changes. Um, so with that said, I'm not going to get into the detail on any of these or a lot of these because quite frankly it's a whole nother episode or two or three, so I'll just, I'll just touch base on the higher ones that are probably the most talked about, uh, which, which are usually good things. So the first one is individual income tax rates, depending upon what bracket you're in, those decreased by anywhere from four, from zero to four percentage points. Okay. So generally income tax rates went down for most individuals. With that said, there were some limitations placed on a certain deductions.
Ryan Turbes: I'm, I'm not going to get into those because that's a full list of maybe 15 to 20 things that changed, but I will say just consult your local CPA to kind of give you the updates. I'm on what those are. If they haven't communicated a, those two are ready. Uh, certainly send out some articles that kind of summarize it for you. Uh, the changes affecting the business. Probably more importantly, that generally drives the individual's return more so than anything else. Um, you have for C-Corps, this is a big deal. We've had a lot of discussions on this or tax rates were reduced down to a flat 21 percent. Okay. So the first instinct of a lot of pass through entities was, well, I need to, I need to change, I need to change because I'm going to pay taxes at 21 percent versus my individual income tax rate combined between federal and states, like 45 percent.
Ryan Turbes: It's like, okay, yeah, short-term that, that may make sense, but what's the plan for the future? If we're going to sell the business or exit the business in the next, I'll say five to 10 years. A C-corp probably doesn't make sense because you're going to get hit with a double taxation and you're worse off than if you were to just stayed, as a flow through entity.
Ryan Tansom: Even on that note too, aren't, isn't it less appealing as a buyer to buy a C-Corp because you're eventually going to be pushed into a stack even? You might absolutely. That you might not even be as marketable.
Ryan Turbes: Absolutely. It's certainly part of it. Um, some other things that impact kind of the pass through entities, there's the 20 percent qualified business income deduction that's calculated. Uh, some, some, uh, industries were included in that and others were excluded. Um, the ones that were excluded, CPA firms, lawyers, the ones who don't have very good lobbyists - architecture firms were included in that. It's kind of unique in that we're all professional service providers, but architecture figure, [Ryan interjects: well they're building big huge stadiums and they've got big money]. They must have the right lobbyists and attorneys and CPAs, uh, must be a little tight with their wallet. So who knows?
Ryan Turbes: And then just one other kind of big thing as it relates to businesses as bonus, depreciation was doubled to 100 percent and section 179 limit was increased to a million dollars. So those are some big and exciting things for businesses, but there's also the innate, some of the negative things that we really haven't talked about. We could spend a lot of time talking about those as well.
Ryan Tansom: As we're wrapping up here. And I appreciate this has been, this has been a lot of fun because it's a lot of stuff that people need to know what it was dense and you know, people weren't sitting in front of a spreadsheet or a piece of paper with the might have to rewind a couple of times. But if you were to going to highlight something that you talked about or something we haven't said, what would kind of be your big takeaway?
Ryan Turbes: My, I'd say my biggest takeaway with conversations that I've been having with clients is, and you've heard this probably many times, is you can never start planning for succession plan soon enough. So even if you're a 35 year old, you're 45 years, 60 or maybe a 70/75 year old start planning now I'll get some ideas out there because it's going to make that process a lot easier. So whether it's implementing buy-sell agreements, getting the right advisors lined up, getting the company to a spot where it's marketable. Uh, that takes time. You can't just flip a switch overnight. And like we had talked about earlier, once you sell your business, you're not gonna just walk away with everything more often than not, if you do, let me know what industry that's in because, uh, that, that would be pretty fun to just lock away with all the cash and not have to [Ryan interjects: You might just switch away from being a CPA?] But I mean surround yourself with the right advisors.
Ryan Turbes: Uh, there's a lot of people, um, in the area, uh, that may or may not have good expertise. So just find those people that you trust and rely on them to kind of help guide you through the process because it's, it's a, it's a stressful time and we haven't even talked about this. And um, that's a whole nother episode for you is the emotional side of selling a business and being the numbers guy. I can, I can tell you if it makes sense or not from a deal perspective, but getting the seller to kind of overcome the emotional attachment to their business, uh, is probably the most difficult part.
Ryan Tansom: It's awesome to hear you said that and recognize that even though the numbers of the numbers black and white, but knowing that this is a human, the human situation complicates everything.
Ryan Turbes: No, I've, I've appreciated your time.
Ryan Tansom: And what's the best way for our listeners to get in touch with you?
Ryan Turbes: So the best way to get in touch with me is probably my email. That's Ryan Tervis. So my email is our Turbes t u R, B as in boy, e s at Boulay group that com, that's b o u l a y group that Pam. And my direct line is nine five, two eight four. One 31 zero four. That's awesome.
Ryan Tansom: For the listeners, Ryan, I'm going to be putting like a basic net proceeds calculated your, uh, I believe you were going to be doing this, which we very much appreciate that. It's not going to. I mean, you think about all the variables and factors here. That doesn't mean they're going to be able to. You're going to be able to figure out everything, but it'll at least give you some, some fun, fun things to think about.
Ryan Turbes: Yeah, it's kind of fun to play with it a little bit, by all means. It's going to be a very basic model, but you know what, it's a starting point. Um, and, and that's really all that matters for, for the time being. If you want to get to a more complex model, certainly be more than happy to kind of help you put that together.
Ryan Tansom: Ryan, thanks so much man.
Ryan Turbes: Thank you.
Ryan Tansom: So if you were running or driving or doing something while you're listening to this, hopefully there wasn't too much financial and tax lingo and numbers running around, so you were able to actually follow it while you were doing whatever it is that you're doing. And I'm gonna leave this takeaway short and brief and straight to the point one, figure out how much money you need for life. So if you haven't done that, listened to that episode with Brandon, would about calculating how much you need for lifetime cash flow. Reach out to him, understand how much do you need for life back into what do you need this business to be worth net and when you need your proceeds and overtime. So how much do you need up front? How much do you, over time, that'll give you some really good ideas of what do you have for exit options because internal, third party, private equity, ESOP, all of those will net you different dollar amounts up front.
Ryan Tansom: Then you can determine, okay, how long do I need to run this business and what does it need to be worth in order to get me to my goals? Which is the whole point for that is understanding what your company's worth so then go listen to the episode with Brandon Hall was if you have not done that, go take Biz Equity valuation, which is the software valuation that gives you at least a topline benchmark and then hopefully with some conversations here in this episode, you'll have a good idea of how to back into that. We can attach the net proceeds calculator in the show notes so you can run some hypotheticals.
Then the next logical question is how do I increase the value of this company to get me where I want to go and to maximize the value of this company? Therefore, it's the eight key drivers, but John Warrillow, who's on the show. Next what we'll be diving into, how to maximize the value of your business and make transferable revenue, and in the show notes we have the value builder score which will give you a score on all the different eight key drivers and show you where you need to focus on in order to maximize the value of your company. So hope that was straight to the point. If you enjoyed the episode and enjoy what I'm doing, going to Itunes, give me a rating. Otherwise, stay tuned. Next week for my episode with John Warrillow.