Key Business Liabilities to Address When Selling a Business
Business liabilities, such as debts, legal obligations, and pending lawsuits, can potentially affect a company's financial health and perceived value. During due diligence, prospective buyers will thoroughly examine all liabilities. If they discover undisclosed current liabilities, it can lead to a lower offer, extended negotiations, or deal cancellation. A business owner must be transparent about total assets and liabilities to support a smoother sale process, instill buyer confidence, and increase the value of the business.
There are several important categories of liabilities that most businesses must navigate, including tax liabilities, employee liabilities, and environmental issues.
Tax Liabilities
When selling a business, there are different types of liabilities that may arise.
- Capital Gains Tax: A tax imposed on the profit from the sale of business assets. If the business has appreciated in value, the payable tax can be substantial.
- Income Tax: Earnings and revenues generated before the sale are subject to income tax. This includes any final profits made up to the sale date.
- Sales Tax: Depending on the jurisdiction, you may need to collect sales tax on certain balance sheet transactions. You will need to settle any outstanding sales tax obligations and not pass them on to the new owner.
- Payroll Tax: Businesses must pay all payroll taxes related to employee wages and compensation.
Managing and mitigating tax liabilities involves several steps. First, you should consult with tax professionals early in the sale process so they can review your bookkeeping as well as the financial statements and current assets. Their advice can help you pinpoint potential tax implications and create strategies to minimize long-term liabilities. From there, you should focus on income tax planning, paying short-term liabilities and bank debts, or consider new short-term loans, if needed.
Depending on your financial position, your plan can impact tax outcomes or trigger consequences. Exploring tax deferral options, like installment sales or 1031 exchanges, are also worth consideration. Some advisors will recommend that you spread out tax payments or defer capital gains taxes, which provides more flexibility and efficiency in managing tax responsibilities.
Employee Liabilities
Employee-related liabilities can have a significant impact on the sale of a business. Types of business liabilities include:
- Unpaid Wages. A business owner must pay all salaries and wages to avoid legal disputes and maintain goodwill.
- Benefits. Any owed benefits, such as health insurance and vacation pay, must be addressed. These financial obligations need to be clear and settled before the sale.
- Severance Pay. If employees are terminated as part of the sale, the business owner should consider and plan for potential severance.
- Pensions. Obligations related to employee retirement plans must be clearly understood and managed to ensure compliance with legal requirements.
Addressing employee liabilities involves clear communication, legal consultation, settling outstanding obligations, and documenting agreements. Moreover, it's important to keep employees informed throughout the sale process for morale and to reduce uncertainty. Labor lawyers can help ensure compliance with employment laws, navigate payroll tax, avoid disputes, and document agreements about transitions or terminations to prevent misunderstandings.
Environmental Issues
Environmental liabilities can present significant challenges in some industries. The most common examples of contingent liabilities include:
- Contamination. Potential buyers will be wary of environmental hazards and subsequent costs and time delays. Even if the financial liability falls on the current business owner, a buyer may develop an unshakable negative connotation about the site or associated risks.
- Regulatory Compliance. Ensuring compliance with environmental regulations and permits is critical. Non-compliance can result in fines, legal action, and significant remediation costs that risk spiraling a business owner into long-term debt.
Mitigating environmental issues involves site assessments and thoughtful consultation to develop remediation plans. As a business owner, you and your advisors must form a partnership to regularly audit operations and demonstrate responsible management to buyers. Environmental consultants and legal advisors will best be able to provide ongoing guidance on complex regulations and liabilities with an eye to enhancing the business’s appeal to potential buyers.
Other Common Liabilities to Consider When Selling a Business
There are a variety of other common liabilities that are essential to address for a seamless business sale.
- Pending Litigation and Legal Liabilities. Unresolved legal issues can deter buyers. Address these by settling disputes or negotiating resolutions before the sale. If there is any ongoing litigation, it's important to fully disclose it in the sale documents.
- Intellectual Property Disputes. Make sure that all intellectual property rights are clear and uncontested. Resolve any disputes or potential infringements to avoid complications during the sale.
- Outstanding Debts. Reduce any outstanding bad debts, including business loans and credit cards. A favorable long-term debt ratio makes the business more attractive.
- Contractual Obligations and Ongoing Commitments. Review and resolve any long-term contracts or obligations with business partners. Any remaining commitments should be clearly documented and transferable to the new owner, if necessary.
- Lease and Real Estate Liabilities. Address any lease agreements or real estate obligations and be prepared to outline any liabilities that may carry over to a new owner. As part of this, make sure leases are transferable or renegotiated, and resolve any property-related issues before the sale.
- Warranties and Customer Guarantees. Honor existing warranties or guarantees provided to customers. Ensure these obligations are clearly outlined and managed to prevent disputes post-sale.
Impact of Liabilities on Business Valuation and Sale Price
Liabilities significantly impact business valuation and sale price, which ultimately influences the bottom line during a sale. High-risk or unresolved liabilities can decrease a business's value by increasing perceived risk and potential costs for buyers. Even lenders and business loan officers will measure risk and deny a small business owner a business loan due to related business liabilities. If a business owner cannot properly justify or resolve liabilities, a potential buyer is certain to adjust their offer to account for additional risks or future expenses.
Not all liabilities result in loss during a business sale, though. Well-managed and disclosed liabilities can enhance a business’s attractiveness. How? By demonstrating operational transparency and financial stability. A business owner who discloses liabilities effectively before the sale can improve the business's valuation and potentially lead to a higher sale price, making it a critical aspect of the preparation process.
Find a Broker to Help Navigate Liabilities
Identifying and managing contingent liabilities early in the sale process can maximize your business’s value and facilitate a favorable sale. Proper handling of liabilities not only enhances your business’s attractiveness but also helps secure a better sale price. Consider working with a broker to navigate this complex process. Visit the BuyBizSell Broker Directory to connect with an experienced professional who can help you achieve a successful business sale.