When it comes to due diligence procedures, much attention is focused on those who want to buy a business. But sellers must also conduct due diligence investigations and it’s important to take an organized approach. That way, you’ll stay focused on the most important issues and avoid becoming distracted by less-significant factors. Sticking with a methodical approach also reduces the risk of “falling in love” with the proposed deal and then making a bad decision that causes financial heartache later on. The following analysis briefly summarizes some of the key issues that sellers should keep in mind.

Cash Sale: Taxes are Often the Main Issue

There is obviously no risk of not receiving the expected sales proceeds if you are selling business assets or your ownership interest (corporate stock, partnership or LLC interest) for cash. That’s a good thing. Instead, your biggest risk in this scenario may be failing to fully understand the tax implications and the approximate size of your eventual tax bill. That’s not a good thing! Of course, the tax consequences can vary widely depending on how long you’ve owned the asset or ownership interest and exactly how the deal is structured.

For example, if you simply sell corporate stock for cash, you’ll probably have a long-term capital gain taxed at preferential federal rates. The current maximum federal rate on long-term gains is 20%. However, keep in mind that state and local taxes may be due too and they could be significant.

If your business is a C corporation and you plan to sell the company’s assets and then liquidate the entity, you may face double taxation under the federal income tax rules. In other words, your corporation might owe corporate-level tax on the asset sales. Then you might owe shareholder-level tax upon receiving the liquidation proceeds when your company folds up its tent and goes away. There may be double taxation under applicable state and local tax rules too.

If your business is run as an S corporation, partnership, or LLC, you generally don’t have to worry about double taxation, but the tax consequences can vary depending on the nature of the assets held by your business and how the deal is structured.

Bottom Line: Your tax bill could vary significantly depending on the circumstances surrounding the proposed deal. In many cases, the tax hit can be substantially reduced with proper advance planning. However, if you fail to seek advice before the deal is done, you may find yourself locked into an unfavorable tax outcome that could have been avoided.

What if the Sale Involves Spread-Out Payments?

If all or part of the proceeds from selling your business will be in the form of deferred payments from the buyer, you are making a “seller-financed” deal. In other words, you are providing at least some of the buyer’s financing by taking back a note receivable instead of cash or some other more-tangible and more-liquid asset (or assets). Naturally, this puts you at greater financial risk and makes it a smart idea to take action to protect yourself by investigating potential buyers. Here are some steps to consider in a checklist.

Considerations for a Deferred Payment Sale
What is the potential buyer’s timetable for completing the transaction?
Ensure that you receive as much cash upfront as possible to minimize your financial risk.
Make certain that the sale price is more generous to reflect your increased financial risk.
Ensure that the interest rate you charge on the deferred payments is high enough to reflect the financial risk of late or missed payments.
Assess the creditworthiness of the buyer by obtaining credit reports and financial statements. Also check the buyer’s business reputation and management experience.
Do an Internet search for information about any unethical business practices the buyer might have engaged in.
Understand exactly where the cash flow to make the deferred payments is expected to come from (often, much of the needed cash will come from the business you are selling). Determine whether it is sufficient.
Obtain adequate collateral for the deferred payments in the form of secured promissory notes and guarantees from the buyer and/or other parties. Often the primary collateral consists of the assets or business ownership interest that is being purchased. You may also want to consider buying insurance on the lives of the buyer and guarantor(s).
Check public records to uncover any outstanding liens and judgements against the buyer or related parties, undisclosed litigation against the buyer or related parties, and so forth.
Make sure you fully understand the tax implications of the deferred payments sale. In other words, when will the taxes be due and approximately how much will they be? Depending on what you are selling, you may discover that the tax hit will be more front-loaded than expected. If so, proper advance planning can often improve the tax results.
Evaluate the buyer’s business plan for the business you are selling.
Line up a consulting contract for yourself and other executives. This can provide additional cash flow for you, along with the added advantage of giving you a chance to mitigate your financial risk by helping to run the business you know so well.