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Purchase Price Allocation and Deal Structuring

Purchase Price Allocation and Deal Structuring. presented to MBBI (Midwest Business Brokers & Intermediaries Association) 9-9-03 by Mike Adhikari Business ValueXpress ® / Adhikari International, Inc. 175 Olde Half Day Rd., Suite 100-17, Lincolnshire IL 60069

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Purchase Price Allocation and Deal Structuring

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  1. Purchase Price Allocationand Deal Structuring presented to MBBI (Midwest Business Brokers & Intermediaries Association) 9-9-03 by Mike Adhikari Business ValueXpress® / Adhikari International, Inc. 175 Olde Half Day Rd., Suite 100-17, Lincolnshire IL 60069 Phone: 847-438-1657, Fax: 847-438-1835 web: www.BusinessValueXpress.com email: info@BusinessValueXpress.com © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  2. Mike Adhikari Background Current Illinois Corporate Investments, Inc. - M&A Advisory Firm, $1-100MM BusinessValueXpress® - a Valuation Software and a Deal Tool Education, Experience MBA (U. of Chicago), MSME (IIT, Chicago), MSEE (Cleveland), BSME (India) 17 years, Operating Experience w/Fortune 500 17 years, M&A Experience, owner of Illinois Corporate, M&A firm Other Northwestern’s Kellogg MBA, guest speaker on M&A since 1994 Wall Street Journal & U S Congress: Impact on Business Value due to repeal of Installment Sale tax provision President-2002/03, MBBI (Midwest Business Brokers & Intermediaries Asso.) © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  3. Outline Deal Maker vs. Tax Advisor Factors that impact Taxes A Workshop Example Comments Detail tax calculations © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  4. Today’s presentation Tax impact of Purchase Price Allocation and Deal Structuring in deal making © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  5. Deal Maker vs. Tax Advisor Deal Maker should not be a Tax Advisor Tax Advisor - Does it w/IRS objective - Needs details Deal Maker - Macro what-if tax analysis Understanding Taxes helps the Deal Maker © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  6. Deal Maker Benefits of understanding Transaction Taxes Improved deal screening Avoid unrealistic buyers Manage expectations Reduce deal collapse Improve relations with client & advisors Protect fees © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  7. What does seller want? High Price …No High After-tax Net …Yes (and of course he wants all cash) What impacts after-tax net proceeds? © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  8. Factors that impact after-tax net Premium = Price – Book Value C vs. S Corp. Asset vs. Stock sale Cash vs. Accrual accounting YTD Taxes Existing Debt Allocation of Premium … © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  9. Factors that impact after-tax net (cont’d) Allocation of Premium - Asset write-up (recapture of depreciation) - Consulting - Non-compete - Goodwill - Personal Goodwill - Employment Agreements - Royalties - Patents - Sales Commission … © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  10. Buyer vs. Seller Tax Impact Only Seller’s Tax Impact is considered Buyer’s Tax Impact not considered - More Complex - No tools available, except … © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  11. To understand Transaction TaxesOne must know … Balance Sheet Balance Sheet Balance Sheet © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  12. XYZ Inc. for Sale (1) FMV of M/E is 1000 (2) Financial BV assumed to be same as tax BV (3) Equity includes Common Stock at 40 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  13. XYZ Selling Price Price = 2500 Buyer gets A/R 600 Inventory 900 M/E @ BV 400 FMV is 1000 A/P (300) Net Assets to buyer 1600 @ BV Premium Paid = 2500-1600 = 900 Seller keeps Cash = 100 Debt = -500 Net -400 Liabilities Retained © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  14. Factors considered for Sale C Corp. vs. S Corp. Stock vs. Asset Asset write-up and No Asset write-up Premium allocation - Goodwill - Personal Goodwill - Consulting © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  15. C – Stock (101) Cash Received 2500 Less: Liabilities -400 Cash b4 Taxes 2100 Cost basis of Shares -40 Capital Gain 2060 Taxes @ 20% -410 Cash After-tax Net 2100 Less: Taxes -410 Cash after Taxes 1690 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  16. S – Stock (102) Cash Received 2500 Less: Liabilities -400 Cash b4 Taxes 2100 Cost Basis -1200 Capital Gain 900 Taxes @20% -180 Cash After-tax Net 2100 Less: Taxes -180 Cash after Taxes 1920 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  17. C – Asset (103) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 40% 0 Inventory 900 900 0 OI 40 0 M/E 400 400 0 OI 40 0 A/P (300)(300) 0 OI 40 0 1600 1600 0 GW Corp 0900900 CG 40 -360 1600 2500 900 -360 Corp Tax Step 2 Cash in the Corp. Cash Received 2500 Corp Level taxes -360 Liabilities -400 Cash in Corp. After Corp Taxes 1740 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  18. C - Asset (103 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 1740 Cost Basis of the shares -40 Gain on Distribution 1700 Type of Gain CG Shareholder Level Taxes @ 20% -340 Net Cash to Shareholder Cash from the Corp. 1740 Less: Taxes -340 Net Cash 1400 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  19. S – Asset (104) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 0% 0 Inventory 900 900 0 OI 0 0 M/E 400 400 0 OI 0 0 A/P (300)(300)0 OI 0 0 1600 1600 0 GW Corp 0900900 CG 0 0 1600 2500 900 0 Corp Tax Step 2 Cash in the Corp. Cash Received 2500 Corp Level taxes -0 Liabilities -400 Cash in Corp. After Corp Taxes 2100 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  20. S – Asset (104 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 2100 Cost Basis of the shares -1200 Gain on Distribution 900  900 CG 0 OI Shareholder Taxes @ 20% -180 on CG Shareholder Taxes @ 40% -0 on OI Total Taxes -180 Net Cash to Shareholder Cash from the Corp. 2100 Less: Taxes -180 Net Cash 1920 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  21. Net Cash To Shareholder for XYZ Inc. C Corp.S Corp. 1. Stock Sale 1690 1920(101,102) 2. Asset Sale 1400 1920 (103,104) A) 100% Premium allocated Goodwill B) No Asset Write-up © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  22. Net Cash To Shareholder for XYZ Inc. C Corp.S Corp. 1. Stock Sale 1690 1920(101,102) 2. Asset Sale (no write-up) 1400 1920 (103,104) 3. Asset Sale (w/ write-up) 1400 1800 (105,106) A) 100% Premium allocated Goodwill © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  23. Net Cash To Shareholder for XYZ Inc. C Corp.S Corp. 1. Stock Sale 1690 1920 (101,102) 2. Asset Sale (no write-up) 1400 1920 (103,104) 3. Asset Sale (w/ write-up) 1400 1800 (105,106) 4. Asset Sale(a) (no write-up) 1690 1920 (107,108) 5. Asset Sale(b)(w/ write-up) 1510 1740 (107,108) a)100% of Premium allocated to Personal Goodwill b)100% of Premium allocated to Consulting © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  24. Net Cash To Shareholder for XYZ Inc. C Corp.S Corp. 1. Stock Sale 1690 1920 (101,102) 2. Asset Sale (no write-up) 1400 1920 (103,104) 3. Asset Sale (w/ write-up) 1400 1800 (105,106) 4. Asset Sale(a) (no write-up) 1690 1920 (107,108) 5. Asset Sale(a) (w/ write-up) 1495 1800 (109,110) 6. Asset Sale(b)(no write-up) 1510 1740 (107,108) 7. Asset Sale(b)(w/ write-up) 1435 1740 (109,110) a)100% of Premium allocated to Personal Goodwill b)100% of Premium allocated to Consulting © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  25. Comments (Sell-side consideration) Allocation & Deal Structure has material Impact Estimate Best/Worst scenarios C Corp. Best: Stock sale Worst: Asset sale w/ no allocation outside S Corp. Best: Stock sale or Asset sale w/ no write-up Worst: Asset sale w/ all allocation outside Stock vs. Asset differential is small if Premium over Book Value is low Same after-tax can be achieved with lower price …this can reduce bank borrowing, seller financing or equity © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  26. Comments (Sell-side consideration) Improving on C - Asset sale Minimize fixed assets write-up Minimize goodwill inside C-Corp. Maximize allocation to personal goodwill (PGW) After PGW, allocate to consulting, etc. S Corp. No big difference between Stock and Asset, if no write-up in Asset purchase Minimize fixed assets write-up Avoid allocation to consulting, etc. PGW allocation not needed © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  27. Comments (Sell-side consideration) Non-compete allocation should be avoided …OI to seller and 15 years write-off to buyer Asset write-up better than non-compete … both are OI to seller, but assets can be written-off faster Consulting vs. employment agreement vs. non-compete (all are OI) Consulting has no FICA cost. But no interest and difficult to secure Employment agreement has FICA cost and no interest … but may be needed for health insurance Non-compete has interest cost and can be secured. © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  28. Comments (Sell-side consideration) Personal Goodwill is always good (CG) Requires expert advise to quantify Low down payment and asset write-up will KILL the deal …100% of recapture tax is due at closing © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  29. C - Asset w/ Write-up (105) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 40% 0 Inventory 900 900 0 OI 40 0 M/E 400 1000 600 OI 40 -240 A/P (300)(300) 0 OI 40 0 1600 2200 600 GW Corp 0300300 CG 40 -120 1600 2500 900 -360 Corp Tax Step 2 Cash in the Corp. Cash Received 2500 Corp Level taxes -360 Liabilities -400 Cash in Corp. After Corp Taxes 1740 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  30. C - Asset w/ Write-up (105 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 1740 Cost Basis of the shares -40 Gain on Distribution 1700 Type of Gain CG Shareholder Level Taxes @ 20% -340 Net Cash to Shareholder Cash from the Corp. 1740 Less: Taxes -340 Net Cash 1400 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  31. S – Asset w/ Write-up (106) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 0% 0 Inventory 900 900 0 OI 0 0 M/E 400 1000 600 OI 0 0 A/P (300)(300)0 OI 0 0 1600 2200 600 GW Corp 0300300 CG 0 0 1600 2500 900 0 Corp Tax Step 2 Cash in the Corp. Cash Received 2500 Corp Level taxes -0 Liabilities -400 Cash in Corp. After Corp Taxes 2100 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  32. S - Asset w/ Write-up (106 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 2100 Cost Basis of the shares -1200 Gain on Distribution 900  300 CG 600 OI Shareholder Taxes @ 20% -60 on CG Shareholder Taxes @ 40% -240 on OI Total Taxes -300 Net Cash to Shareholder Cash from the Corp. 2100 Less: Taxes -300 Net Cash 1800 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  33. C – Asset 100% Premium Allocated (107) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 40% 0 Inventory 900 900 0 OI 40 0 M/E 400 400 0 OI 40 0 no write-up A/P (300)(300)0 OI 40 0 1600 1600 0 GW Corp 0 0 0 CG 40 0 1600 1600 0 0 Corp Tax Step 2 Cash in the Corp. Cash Received 1600 Corp Level taxes -0 Liabilities -400 Cash in Corp. After Corp Taxes 1200 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  34. C - Asset 100% Premium Allocated (107 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 1200 Cost Basis of the shares -40 Gain on Distribution 1160 Type of Gain CG Shareholder Level Taxes @ 20% -230 Cash to Shareholder 900 If personal goodwill, Tax @ 20% -180 If Consulting, Tax @ 40% -360 Net Cash to Shareholder PGWConsulting Cash Corp. + Shareholder 2100 2100 Less: Taxes Corp. Dist -230 -230 Less: Taxes Shareholder -180-360 Net Cash 1690 1510 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  35. S – Asset 100% Premium Allocated (108) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 0% 0 Inventory 900 900 0 OI 0 0 M/E 400 400 0 OI 0 0 A/P (300)(300)0 OI 0 0 1600 1600 0 GW Corp 00 0 CG 0 0 1600 1600 0 0 Corp Tax Step 2 Cash in the Corp. Cash Received 1600 Corp Level taxes -0 Liabilities -400 Cash in Corp. After Corp Taxes 1200 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  36. S - Asset 100% Premium Allocated (108 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 1200 Cost Basis of the shares -1200 Gain on Distribution 0 Cash to Shareholder 900 If personal goodwill, Tax @ 20% -180 If Consulting, Tax @ 40% -360 Net Cash to Shareholder PGWConsulting Cash Corp. + Shareholder 2100 2100 Less: Taxes Shareholder -180-360 Net Cash 1920 1740 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  37. C – Asset 100% Premium Allocated & Write-up (109) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 40% 0 Inventory 900 900 0 OI 40 0 M/E 400 1000 600 OI 40 -240 w/ write-up A/P (300)(300)0 OI 40 0 1600 2200 600 GW Corp 0 0 0 CG 40 0 1600 2200 600 -240 Corp Tax Step 2 Cash in the Corp. Cash Received 2200 Corp Level taxes -240 Liabilities -400 Cash in Corp. After Corp Taxes 1560 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  38. C – Asset 100% Premium Allocated & Write-up (109 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 1560 Cost Basis of the shares -40 Gain on Distribution 1520 Type of Gain CG Shareholder Level Taxes @ 20% -305 Cash to Shareholder 300 If personal goodwill, Tax @ 20% -60 If Consulting, Tax @ 40% -120 Net Cash to Shareholder PGWConsulting Cash Corp. + Shareholder 1860 1860 Less: Taxes Corp. Dist -305 -305 Less: Taxes Shareholder -60-120 Net Cash 1495 1435 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  39. S – Asset 100% Premium Allocated & Write-up (110) Step 1 Calculate Corp Level Taxes CostSold forGainTypeTax %Tax A/R 600 600 0 OI 0% 0 Inventory 900 900 0 OI 0 0 M/E 400 1000 600 OI 0 0 A/P (300)(300)0 OI 0 0 1600 2200 600 GW Corp 00 0 CG 0 0 1600 2200 600 0 Corp Tax Step 2 Cash in the Corp. Cash Received 2200 Corp Level taxes -0 Liabilities -400 Cash in Corp. After Corp Taxes 1800 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

  40. S - Asset 100% Premium Allocated & Write-up (110 cont’d) Step 3 Calculate Net Cash to shareholder Cash in Corp. After Corp Taxes 1800 Cost Basis of the shares -1200 Gain on Distribution 600  600 OI Shareholder Taxes @ 40% - 240 on OI Cash to Shareholder 300 If personal goodwill, Tax @ 20% -60 If Consulting, Tax @ 40% -120 Net Cash to Shareholder PGWConsulting Cash Corp. + Shareholder 2100 2100 Less: Taxes Corp. Dist -240 -240 Less: Taxes Shareholder -60-120 Net Cash 1800 1740 © 2001-03, All rights reserved. Patent Pending. www.BusinessValueXpress.com. 847.438.1657

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