What Happens to Cash in a Business Sale: Is Cash an Asset?
When selling a small business, there are a few things to consider regarding cash. Companies have different types of cash, and it's important to understand what type of cash you have before selling. There are various categories of cash, ranging from company cash to earnouts, all of which impact the sale of the business differently. It's also important to consider taxes when extracting cash from the business prior to sale. Some strategies can be used to minimize taxes, which should be considered in the negotiation process.
In this guide, we will provide a comprehensive overview of everything you need to know as a business owner about how cash is treated during the sale of your business. We will cover topics such as negotiation strategies for dealing with cash, the impact of cash on the purchase price, the role of cash in earnouts and seller financing, and the tax implications of cash during the sale.
Types of Cash Involved in a Business Sale
Before understanding how cash is treated during the sale, it’s critical to define the different types of cash on the balance sheet that may be involved.
- Company cash: This refers to cash held in the company's bank accounts at the time of the sale. This includes the cash on hand and any cash equivalents, such as money market accounts, CDs, and short-term investments.
- Petty cash: This refers to the small amount of cash that is kept on hand for day-to-day expenses, such as buying office supplies or paying for small expenses. This is typically not a meaningful amount of cash and is rarely a major subject in the negotiation of a sale.
- Accounts receivable: This refers to the money owed to the company by its customers, which can include outstanding invoices, payments due on installment plans, and other forms of credit extended by the company.
Cash situations can be slightly more complicated depending on how the company is sold. Although it's common for the buyer to make an upfront payment to the seller to secure the sale, there can be cases where the buyer agrees to make additional payments.
These payments are typically performance-based and known as "earnouts." Earnouts are often tied to specific financial metrics, such as revenue or profitability, and depend on negotiated terms.
In other cases, the seller may agree to finance part of the sale themselves, essentially acting as a lender to the new owner. In this scenario, the seller would receive payments from the buyer over time, typically with interest.
Who Gets Accounts Receivables/Accounts Payable in a Business Sale?
When a business is sold, the transfer of accounts receivable and accounts payable can significantly impact both the seller and the buyer. Accounts receivable refers to any money owed to the company by its customers, while accounts payable refers to any debts or liabilities owed to its vendors or suppliers.
For the buyer, assuming responsibility for accounts receivable can be a significant benefit, as it provides an immediate source of cash flow for the business. These funds can be used to cover ongoing operating expenses, make investments in the business, or pay off any debt incurred during the acquisition process. Additionally, assuming control of accounts receivable can provide the buyer with valuable insights into the business’s financial health, as it can help them understand customers' payment behavior and identify potential areas of risk.
On the other hand, assuming responsibility for accounts payable can be challenging for the new owner, as it means taking on any outstanding debts or liabilities the company owes to its vendors or suppliers. This can include unpaid invoices, loans, or leases, significantly impacting the business's overall financial health. Therefore, buyers must carefully review the accounts payable of any business they are considering purchasing to ensure that they are not taking on more debt than they can handle.
Buyers will often adjust the purchase price based on the number of outstanding accounts receivable or accounts payable, as these can change the business’s overall value. For the seller, the transfer of accounts receivable and accounts payable can affect the final purchase price of the business.
Overall, the transfer of accounts receivable and accounts payable can significantly impact the sale of a business, and it's essential to understand the implications of these assets and liabilities for both the buyer and the seller. Working with a team of professionals, including a business broker and an attorney, can help ensure that the transfer of accounts receivable and accounts payable is handled appropriately and that both parties are protected throughout the sale process.
Is Cash an Asset in a Business Sale?
Cash is considered an asset in a business sale, and it can significantly increase the overall valuation of the business. Any cash or cash equivalents held by the company at the time of the sale will be included in the sale price and transferred to the buyer.
However, it's essential to keep in mind that cash is just one of many assets that may be included in the sale, such as equipment, inventory, intellectual property, and customer lists.
It's crucial to work with professionals to ensure that all of the company’s assets are appropriately valued and accounted for and that the sale process proceeds smoothly and efficiently for both the buyer and the seller.
Strategies to Minimize Taxes When Extracting Cash Prior to a Sale
Extracting cash from a business before a sale can be a complex process that requires careful consideration of several factors. One common strategy is to distribute excess cash to the owner as a dividend or distribution, which can be taxed at a lower rate than ordinary income. However, the amount and timing of these distributions can impact the sale price of the business. They may trigger certain tax consequences, such as the potential loss of tax deferral benefits.
Another strategy is to sell certain assets of the business prior to the sale, such as real estate or equipment, to generate cash and reduce the overall tax liability of the sale transaction. However, this approach requires careful planning to ensure that the sale of assets does not trigger unintended tax consequences and that the sale process remains compliant with all applicable regulations.
Ultimately, the best approach to extracting cash from a business prior to a sale will depend on the unique circumstances of the transaction, and it's essential to work with a qualified tax professional to develop a customized strategy that maximizes value and minimizes risk.
Negotiation Strategies for Dealing with Cash During the Sale of a Business
During the sale of a business, it's crucial to consider the treatment of cash and develop a plan to manage this aspect of the sale. One strategy for negotiating the sale of your business is to opt for a cash-free/debt-free sale. In this scenario, the buyer takes on all the company’s liabilities, including accounts payable, while the seller retains all cash and cash equivalents.
Another option is an all-cash sale, where the buyer pays the entire purchase price in cash. This strategy may be beneficial if the seller wants to exit the business quickly and avoid ongoing involvement or earnouts.
Alternatively, a partial payment at closing can be negotiated, with the remaining balance paid out over time through earnouts or seller financing. This approach allows the seller to receive a portion of the purchase price upfront, while still retaining an interest in the success of the business over the long term.
It's important to remember that the negotiation strategies you choose will depend on various factors, including the value of the business, the financial position of the buyer, and the specific terms of the sale agreement. Again, working with an experienced business broker or attorney can help you navigate these negotiations and protect your interests throughout the process.
Conclusion
Selling a business can be a complex process, and it's important to carefully consider all aspects of the sale, including how cash will be treated. By understanding the types of cash involved, who gets accounts receivable/accounts payable, the tax implications, and negotiation strategies for dealing with cash, you can better position yourself to negotiate a successful sale that maximizes your return on investment.
Working with a team of professionals, including a business broker, attorney, and tax professional, can also help ensure that your sale is handled correctly and that you receive the best possible outcome.