Today we sit down with Clayton & McKervey Tax Manager Ruben Ramirez to share some considerations and tax implications for buying or selling a business. There’s a large transition of wealth on the horizon as baby boomers are looking to sell their businesses. The pandemic has also jumpstarted some transaction plans on both the buy and sell-side. Listen in and learn why it’s never too early to start preparing for a transaction.
Podcast Transcript
Announcer:
Welcome to The Sound of Automation brought to you by Clayton & McKervey, CPAs for growth-driven businesses.
Denise Asker, Director of Mkt. & Practice Growth:
Great. Hey Bryan!
Bryan Powrozek, Senior Mgr. Industrial Automation:
Denise, welcome back.
Denise Asker, Director of Mkt. & Practice Growth:
Did I see Rubin Ramirez in the waiting room?
Bryan Powrozek, Senior Mgr. Industrial Automation:
You did see. Rubin will be joining us here shortly to kind of share some of his insights on businesses that might be considering a transaction.
Denise Asker, Director of Mkt. & Practice Growth:
Great. Well, that’s got to be exciting for him and for you.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Well, let’s save the great until after it’s recorded. We’ll see.
Denise Asker, Director of Mkt. & Practice Growth:
Yeah. He’s got a lot of passion for what he does.
Bryan Powrozek, Senior Mgr. Industrial Automation:
A little bit.
Denise Asker, Director of Mkt. & Practice Growth:
Yeah?
Bryan Powrozek, Senior Mgr. Industrial Automation:
Rubin’s a little intense.
Denise Asker, Director of Mkt. & Practice Growth:
So, I feel like we’re hearing about transactions quite a bit. I mean, even before COVID we were hearing about it and certainly in 2020 it made the news and certainly our conversation a lot. Are you attributing most of that to COVID or is there some other dynamic going on?
Bryan Powrozek, Senior Mgr. Industrial Automation:
In industrial automation, for a while now, there has been just a lot of transactional activity, right? You’ve got the bigger players in the market acquiring a lot of the smaller players and things like that. But I think where a lot of the chatter is coming from now is, there was already a lot of talk about baby boomers, right? The baby boomer generation is moving out. So, now you’ve got this … the largest transition of wealth that has ever been seen kind of on the horizon. So, we’re starting to see that as the boomers are looking to get out of their businesses and sell them.
Bryan Powrozek, Senior Mgr. Industrial Automation:
You’ve got that, but now it’s almost like the … like a lot of things, the pandemic jump-started a lot of digital transformation, got a lot more people to adopt these technologies. We’re expecting a similar thing on the backend, that it’s going to jump-start a lot of those plans to maybe get out of the industry once everything is stabilized again, just you don’t have to ride that business cycle again in. And on the buying side, there’s people sitting out there looking, saying, “Okay, we’re going to have some good opportunities here so let’s keep our eyes open and see what’s out there and be ready to move when something comes up.”
Denise Asker, Director of Mkt. & Practice Growth:
Well, that makes sense. So, you must work with our transaction service team a bit then, on behalf of our industrial automation clients?
Bryan Powrozek, Senior Mgr. Industrial Automation:
Yeah. Yeah. We’re involved with them obviously on the transaction side, but even just kind of helping consult. And I think what we’ll see today through Rubin’s conversation is, it’s never too early to start planning for it. And so there are things … whether it’s the way that you keep your books or the way you manage certain transactions and things like that. And I’m not talking about the sale transaction, but just day-to-day transactions within your accounting system can all factor in and have an impact on what the final selling price of your business turns out to be. So it doesn’t hurt to have the conversation now, even if you don’t have plans to do anything for two, five, 10, because you can start doing things. If you’re thinking about selling, if you’re looking at the exit strategy side of it, there’s things you can do to kind of get yourself ready for that.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Alternatively, if you’re thinking about the buy-side kind of as I mentioned, maybe this opportunity comes up and you’re ready to jump on it. Well, that’s not the time to start figuring out what you can afford, how you would bring it in, etc. So, you really want to start thinking about these things as soon as possible.
Denise Asker, Director of Mkt. & Practice Growth:
Yeah, well, that lines up with a lot of the content that’s on our website. So if our listeners go to claytonmckervey.com, shameless promotion here, but we do have quite a bit of information about you’re not for sale but, or considerations for transaction services. So that can supplement what Rubin talks about today.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Exactly.
Denise Asker, Director of Mkt. & Practice Growth:
Great. Well, I will listen and learn from you both momentarily.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Fantastic. Thanks, Denise.
Denise Asker, Director of Mkt. & Practice Growth:
Thank you.
Bryan Powrozek, Senior Mgr. Industrial Automation:
All right. So today I have my colleague Rubin Ramirez with me. Rubin’s here to talk a little bit about some of the considerations you should have if you’re thinking about buying or selling a business. Rubin’s part of our … he’s a manager in our tax department, and he also specializes in doing some transaction services work. So Rubin, I guess, tell me a little bit about what you do here at Clayton and McKervey. Because I really don’t know exactly what you do.
Rubin Ramirez, Tax Manager:
Well, Brian, I guess first off, thank you very much for having me on this podcast. It’s very exciting.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Well, thank you for being he third option, once two other people backed out.
Rubin Ramirez, Tax Manager:
Awesome. Awesome. So yeah, no, I’ve been with the firm for going on … for seven years now. And as Brian mentioned, I am a member of the transaction service group. And specifically I deal with more of the sell side, tax matters, whether it’s pre-structuring the entities prior to the transaction, basically identifying the potential considerations that should be thought of on the front end, whether it’s in attempts to have a roll over interest, or if there is a needed [inaudible] organization. Basically I’m the tax guy. I’m the guy that you ask, “How much money am I going to walk away with from the transaction?” Which is also a pretty important, I would say, question to ask up front.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Exactly. So I guess, yeah, to kind of put that into some plain English for folks. So you’re … when a business is looking at selling … or, I mean, there’s tax implications on the buy side as well. But if you’re looking at selling, consulting someone like yourself to really understand what’s going to happen, because it’s not as simple as, okay, I bought it for a million, I sold it for 10 million and so my profit is 9 million. So you’re really helping them kind of understand the best way to structure the deal, try and minimize that tax burden, if you will, to the extent you can, right? There’s no way to get away from the taxes at some point, but that’s really what you guys get involved in.
And I guess is that … if I’m a business owner, so that’s my hope through this podcast, that if we’ve got any business owners out there who are listening, who are thinking about transactions and that’s … as we were preparing for this, that’s kind of the interesting thing to me about working with the type of business owners that we work with. If you’re a automation company of some sort, and you’ve built the company from the ground up, chances are you’re an engineer or some other technical position, right? And so you’ve, you’ve grown this thing because you had a really good knowledge of the product or service that you’re providing. And now you’ve grown this thing into a business and so you need to understand marketing and you need to understand accounting and all these other things. Now you add that extra layer of a transaction, which is something that doesn’t happen every day. So really hoping to kind of share some insights for folks on just what should they be thinking about? What are some of the initial hurdles they run into?
So you kind of went through a lot of things there at the outset, but if you were to kind of take those more technical topics of a restructuring or some of the things, what is your … the team’s goal, when we’re engaged by a client to work on their transaction? What are some of the high level things that you’re looking to do?
Rubin Ramirez, Tax Manager:
Yeah, absolutely. I think first and foremost, we want you to be comfortable in every aspect of a transaction. And I mean, there’s a likelihood this will be the largest financial transaction that you’re going to deal with and be faced with. And for you as a business owner, goal is to make you as comfortable as possible, dumb down some of these technical, transaction related topics and really identify what are your true objectives. And first, I mean … I guess, secondly, what you want to do is really reach out to your advisors as soon as you’re thinking about selling. I mean, pick up the phone and call your CPA, call your attorney.
A transaction takes a lot of forethought and really, you don’t typically just wake up one day ready to sell. This is something that you’re thinking about two, three, five years down the road. And there’s a lot of work that could be done on the front end to help make that transaction smooth or make you more marketable in the next two or three years. So, if a client is talking to me and they’re thinking about selling their business, we’ll talk to them and we want to make sure all their ducks are in order, make sure they have clean financials on a month to month basis.
When a buyer comes in, they’re going to want to see all the transparency and they want to see clean and orderly documentation. So there’s a lot of items that could … and a lot of work that could be done on the front end that just helps you facilitate the transaction much easier. I mean, you want to be confident when you’re going through the due diligence process and the same thing from an attorney perspective. You tell an attorney that you’re going through a transaction two years down the road, they’re going to work right now to clean up any skeletons in the closet and obviously put you in a good position to sell. So that’s probably one of the things that I really stress, is really get your professionals involved.
And a caveat to that is not … the professionals that you’re working with now, might not be the professionals that you’ll need during a transaction. But I suspect they might have someone in their office that specializes in [inaudible] like myself or the transaction service group, so they can bring those professionals in.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Right. Well, and I think that that’s … that might be the assumption is, “Well, I’ve got my attorney. I’ve got my accountant.” And depending on the level of provider you’re working with, right? Like we work with a lot of companies who, as they’ve gone through that growth, they maybe started out with somebody local that they were referred to, and that provider at the time was able to do everything they needed. I can get your books closed at the end of the year. I can get your returns filed and make sure that you’re protected, you don’t have any penalties, interest, other things like that. But really it’s harder for those smaller firms to necessarily provide that full suite of services that they might need. So I guess I want to go back to something you touched on. Because you mentioned if I’m thinking about a transaction in two to four years, is it ever really too early to start thinking about this? Obviously I don’t want to open my business today and then reach out to you and say, “I want to start talking about my exit strategy.” But I guess, is there a problem with starting to think about this earlier rather than later?
Rubin Ramirez, Tax Manager:
Absolutely not. Opportunity knocks on the door sometimes at the most outrageous timing. You have no idea if someone’s looking and possibly acquiring you and what your intentions will be two years down the road or if you might have some health issues. So no, get your ducks in order as soon as possible. And I’m not saying there’s a ton of work that needs to be done on the front end. But if you have two or three years to prepare, you could start chipping away at some of these items that we suggest and really putting yourself in a position where if someone did make you an offer, you’re ready to go right then and there.
So again, bring in your CPA, bring in your attorney. One professional that often gets overlooked is your financial advisor on the front end. A lot of times we don’t pull in the financial advisors until we’ve identified potentially how much they’re going to walk away with on a deal. But I mean, that should be one of your number one thoughts that you have is, “What’s my dollar?” What am I willing to walk away with from a transaction? How much cash do I need a sustain the amount of lifestyle that I want to sustain and the type of lifestyle?” And we could back into that number. And if that means you have to sell your business for 70 million, when realistically it might only sell for 30 million, well, now we know on the front end. We know what’s realistic. We can help you set your expectations on the front end, which again, I mean, that’s a huge point right there, is really understanding what are you willing to pursue in a transaction? I mean, obviously everyone wants the highest value possible, the highest multiple. I’ve never had a client tell me I want the lowest number possible.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Exactly.
Rubin Ramirez, Tax Manager:
But there’s a lot of other considerations that could come into play. Are you willing to put your money where your mouth is basically? And if someone’s offering you $50 million for your business, but only 30 million guaranteed and 20 is on contingency based upon you hitting metrics the year after sale, are you willing to do that? What’s your expected level of involvement post-sale? Do you want to stay on for a couple years and help the buyer during a transition period, which is oftentimes required in a deal? So it’s really knowing what you’re willing to do and what you’re willing not to do before even any transaction even drops on your plate basically.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Sure, sure. So something you’d mentioned here previously, you’re obviously very obsessed with ducks and having them in a straight line, but I mean, what does that really mean? Because if I’m a business owner, I’m focused on the next payroll, I’m focused on my bank covenants, I’m focused on just trying to grow this business. And I rely on folks like you to make sure that my taxes are filed and things like that. What are a couple of the things, when you use that phrase ducks in a row where you kind of make sure … what are the few of the things that fall into that, that business owners should be thinking about in terms of, hey, this thing that I’m doing over here can really impact what the business ends up looking like when I go to sell it? So what are some examples of that?
Rubin Ramirez, Tax Manager:
Yeah, so I think I touched on one of those examples, which is having clean financial statements month over month. I guess when it comes to IA clients specifically, a lot of them work on long-term contracts and might be required to do percentage at completion. Well, we know as professional accountants and CPAs, and a lot of times those adjustments aren’t posted until year end or on a quarterly basis. You want that information, or you’ll likely want that information, on a month to month basis because that’s what a, buyer’s a demand during the due diligence process. So having clean cutoffs, making sure your financials are in order, making sure that you’ve identified all your potential state filing issues and relaying that over to your professionals just so they’re a little bit more diligent when they’re performing their year-end work. A lot of the work doesn’t necessarily need to be done by the business owner, but could be handled by their outside professionals. Making sure your organization is registered where it needs to be registered, that you have all your tax filings accounted for that need to be accounted for. So again, a lot of the work could be addressed or handled in incremental periods over the course of two or three years.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Yeah. And so, as you kind of alluded to there, when a transaction starts to happen and you got the buy sell side, everyone’s trying to agree on that final selling price, that what’s this business going to be worth? And so from the buyer side, you’re trying to find every reason why the price needs to be lower. And that can come back to some of the things you talked about. “We looked at your books and we’re seeing this fluctuation in your revenues or your profits and we can’t really understand that so it’s not so much that we don’t believe it, as that we think there might be underlying issues that we need to dig more into.” Or, “We looked at your tax return and saw you only filed in one state, but based on your business, we know you probably should have been filing elsewhere.”
So those are the kinds of things you’re trying to talk about, making sure you’ve got your arms around addressing. And from my perspective, with really focusing in on research and development tax credits, we often talk to clients that we’re working with of, “Hey, don’t let the R&D credit tail wag the dog.” You’re not going to change the way you’re doing everything just to make it easier to file for your credit at the end of the year. However, a lot of the things you’re talking about are just kind of good business practice. That if you want to understand how your business is operating, it’s good to have those financials in order so you’ve got good, accurate, comparable information that you can use month over month to assess your performance. And so it’s not like you’re asking them to do anything above and beyond what they’re already doing. It’s just helping them get to that point where they’ve got it in order before they need it.
Rubin Ramirez, Tax Manager:
Yeah. Crossing your Ts, dotting your Is, just spending a little bit more time wrapping up on a month to month basis, what needs to be done. But, no, I absolutely agree. You’re absolutely correct.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Excellent. You’re like the human cliche machine, just spitting them all out there. So I guess the … to go back to something else you said, which is really interesting, especially given the environment that we’re operating in today, people have been projecting some sort of a worldwide pandemic for years, saying it was a big risk. But now it’s actually here and people are trying to live through it and go through it. And a lot of … if you look at a lot of the economists and things they’re projecting for businesses operating in industrial automation is that, hey, we’re expecting transaction activity coming out of this. And that there’s going to be some people who’ve maybe been in the business for a longer time and say, “I made it through this one. I don’t want to try and survive another one. I’m ready to get out. Like once things stabilize, I want to move on.”
Similarly, you could be a newer company that says, “Hey, if I can make a few key acquisitions here of people that are either having to leave the business because they’re retiring or maybe they just … they’ve ready to move on.” That’s a great way to jumpstart some growth. So that kind of underscores what you said about, yeah, you may not plan on doing anything for 10 years, but if this opportunity pops up, you want to make sure you’re ready and available and you’ve got all this stuff put together. So it’s kind of dual purpose. You want to make sure you’ve got your plan for the long run, but also be ready so that if you think you could have one of those opportunities that pops up, you’re ready to jump on it.
Rubin Ramirez, Tax Manager:
Absolutely. Absolutely. I mean, the market’s been great the past few years. There’s no question about that. And even with COVID, if you’re one of those businesses that were able to weather the storm, I mean, in my opinion, you’d be more marketable. If you’re able to operate on a cloud base basis and have your employees work remotely and still generate the … relatively the same type of operating income and cash flows that you have in the past, I mean, that’s icing on the cake. So yeah, just being well-prepared and it’s not all about just the compliance aspect and having your financials in order and having your tax filings all addressed. But it’s really just cutting the fat of the company. Try to grow your revenue and try to grow your bottom line.
We work with a ton of small businesses and everyone knows, their financial statements that are prepared at the end of the year might not be the most reflective of their true operations. Bonuses are paid out to owners and I guess family of owners that are on payroll and people run their private club dues through the income statements. So it’s really identifying those items and just knowing what those are, just to help a buyer during the due diligence process.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Yeah. How about the … especially when you’re talking about a privately held business, and you mentioned, it’s most likely the largest transaction that any of these individuals will be engaged in the rest of their life. And there’s also that personal aspect of, “I built this business myself. I’ve seen it grow. I’ve seen it develop. So now I have this personal connection with it beyond the professional aspect of it’s where I work and things like that.” How do you guys go about managing those expectations? Because you mentioned that example, an owner who wants to get 70 million for the business but it’s only worth 30. That’s a little bit of a blow to the ego. “You’re telling me my business is less than half of what I thought.” But how does the transaction team kind of approach that with clients to help them understand where their expectations should be?
Rubin Ramirez, Tax Manager:
Yeah. That’s a great question. I mean, every business owner expects more from the sale than what they’re going to be offered, in most cases I would say. And that goes back to the whole presale process and talking to your advisors well in advance, because a lot of those items could be quantified. We know what multiples are across the industry. We have a pretty good insight. And and that’s why it’s so important to, on the front end, really get a good understanding and really set your expectations up of what’s actually possible.
A lot of times, business owners are surprised to see maybe the letters of intent that are sent to them. And to be totally blunt, a transaction is an expensive process. You’re paying attorneys, CPAs, investment bankers, but not even just from an expense perspective, you’re having your management team really dedicate their resources and time during this entire process. So really setting up your expectation and knowing what’s available and out there could really help you avoid some costs that you might not have to incur.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Exactly. As you talk about engaging these third parties, is there … have you seen any … is it best to start with, as you said, your attorney, your accountant, have those conversations? Because I think that’s the challenge, is … take your home, right? There’s people that still try to sell their home and say, “Oh, I don’t want to pay those commissions, those fees. I can do this all myself.” But in reality, you’re paying … the value you’re paying there is to make sure the transaction goes smoothly, that you get the most value you could. Because you might look at it and say, “Well, I’m comfortable just selling my house for … whatever, $250,000,” when the market’s going for three, and it gets snatched up like that. So this really should be something where they’re talking to their accountants and their attorneys kind of on an annual basis. It should be more than just, “Here’s the information you need for my tax return. Go ahead and prepare it.” You should be having those conversations almost every year, right?
Rubin Ramirez, Tax Manager:
Yeah, absolutely. And it’s … Your CPA that you work with, that files your taxes or your financials or your attorney that is your corporate attorney, going back to the point that they likely aren’t the ones that are going to be working on the transaction or shouldn’t be. That’s not their experience and that’s totally acceptable and totally fine. We work with a lot of businesses where we just come in and do the consulting aspect of the transaction and leave all the compliance aspect with who they’ve already built relationships with, their current professionals. But again, yeah, these are discussions that should be brought up on an annual basis. And if they can’t address your considerations, your questions, they should be able to direct you to someone that can, whether it’s someone within their organization or an outside consultant.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Excellent. So, I guess the … we focused kind of a lot of the conversation intentionally, unintentionally on the sell side. If I’m a business owner out there right now listening and think about saying, “Okay, well, that’s probably something I should start putting into my strategic plan, starting to think about that exit strategy or succession planning, things like that,” what are one or two things they should really start thinking about now if they don’t have that plan in place? Beyond like … we’ve already kind of established, getting the expectations down, getting your financial house in order, some of those things. Any things they should start thinking about to help them in the process, to start looking at potential … whether it’s meeting with their … and when I say preparing for, preparing for a meeting with their CPA or their attorney to start broaching the subject of a sale?
Rubin Ramirez, Tax Manager:
Yeah. I would say that the first one which you briefly mentioned is just your succession plan in general. What are your options? A lot of times people are … think that they’re forced to sell to an outside party but consider your key employees. You might have someone on board that you have a lot of trust in and confidence in that might be able to take this company to the next level, or potentially selling your business to an [ESOP], where your businesses basically could generate enough cashflow to sustain the payoff to you as a business owner over time. And sometimes selling your business might not be the best option. If you’re concerned about your … I guess you’re too concentrated and your value is entirely derived from your business, possibly consider a recapitalization. Take out a bank loan and that loan could be distributed to shareholders, and go invest in the S&P 500, diversify yourself. So really consider what other options are out there.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Yeah. So just for folks that might not be familiar with ESOP, what’s … can you give them that?
Rubin Ramirez, Tax Manager:
Oh, employee stock option plan.
Bryan Powrozek, Senior Mgr. Industrial Automation:
And what does that basically do?
Rubin Ramirez, Tax Manager:
In essence, you are selling your business to the employees of your organization. So it gives them a vested interest to grow the company and with the intention of that payout structure occurring over time.
Bryan Powrozek, Senior Mgr. Industrial Automation:
I mean, I knew what it was. I don’t want to make it look like I didn’t know what it was. Just for the people who are listening.
Rubin Ramirez, Tax Manager:
Right, right.
Bryan Powrozek, Senior Mgr. Industrial Automation:
Well, Rubin, I think this has been really informative. And actually looking at our outline, we could probably go for another 40 minutes, but we’re kind of capped here. So if anybody wants to reach out to any member of the transaction services team, or even just get some input, how’s the best way for them to get ahold of us?
Rubin Ramirez, Tax Manager:
Yeah. So I suggest reaching out to whoever is currently assigned to you as an individual, whether that’s a Mr. Bryan Prozac or someone else in the organization. And then they’ll coordinate a time for us to come out or talk virtually, I guess. And again, we don’t even need to talk specifics, but just give us an idea of where you’re at right now. What are your intentions two, three, four, five years ago?
Bryan Powrozek, Senior Mgr. Industrial Automation:
And Denise is probably staring daggers at you over here for not saying they could go to Clayton & McKervey’s website and find the transaction services section.
Rubin Ramirez, Tax Manager:
Right, right, right. Absolutely. Reach out to Denise, ask her please.
Bryan Powrozek, Senior Mgr. Industrial Automation:
This was your first and probably last podcast based on forums, but no, I really appreciate you coming in and sharing some of your insights. I think that, just in my experience recently here talking with a lot of different business owners, this is definitely something that’s top of mind. So I think this is a good kind of intro for them to think about some of the things that they should be considering. And we’d be always happy to entertain a call to give them a little more input. So thanks, Rubin.
Rubin Ramirez, Tax Manager:
Yeah. Thank you, Bryan.
Announcer:
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