Timely, Profitable M&As - Now Might Be a Good Time to Buy — or Sell
Mark E. Battersby
It may sound callous but, because of the current state of the economy, now might be a good time to pick-up or sell a distressed car wash business. After all, handled properly, mergers and acquisitions (M&As) allow the acquiring business to acquire another operation under favorable terms that is a good fit, and that might not otherwise survive.
An M&A transaction can also mean helping a troubled business survive without the owners or shareholders completely losing what they’ve built up over the years. Equally important, an M&A can save jobs.
Although more than one car wash operator has gotten into trouble in an M&A transaction, acquiring smaller businesses usually limits much of the risk. Plus, there is now insurance to further reduce the risk along with potential fraud or misrepresentation.
VIVA LA DIFFERENCE
Mergers and acquisitions are similar but have a few major differences. Mergers combine two separate businesses into a single new entity. True mergers are uncommon because it’s rare for two equal businesses to mutually benefit from combining resources and workers.
Unlike a merger, acquisitions do not result in the formation of a new business. Best compared to buying an existing business or franchise, with an acquisition the purchased business is fully absorbed by the acquiring company. This often means the acquired business is liquidated.
Mergers and acquisitions are an efficient and effective method of growing and expanding a business without investing time and resources. Obviously, there must be a strategic fit between the car wash operation and the business being acquired, but consider a few of the many ways in which acquisitions can be desirable such as: • Expanding the customer base • Trimming and streamlining the operation to help increase profit margins by eliminating inefficiencies. • Acquiring a quality management team and new talent can mean new ideas, thoughts, and mindsets that can challenge the car wash operation’s current workers to start thinking outside the box. • Better customer service. Every business, regardless of size, needs to ensure customers are happy with what the operation is providing. • Beating the competition. A business that chooses to remain stagnant and uninterested will inevitably be overtaken by the competition.
WHY ACQUISITION MAY BE GOOD
When the owners of a business are worried about liquidity, making payroll, or paying the bills, one of the few options to sustain the troubled business or get some benefit and liquidity is via an M&A. Selling to a competitor, another strategic player, or even a financial investor may be the only way of preserving the car wash operation.
Creative deal structures involving earn-outs and other forms of contingent payments may be useful in bridging valuation gaps. A lower asking price with payments spread over a number of years obviously benefits the buyer and mean a smaller tax bite for the seller.
PUTTING A PRICE ON A M&A
A key question in every M&A transaction relates to the value of the business. It is important to understand that offer price and valuation, much like the other terms in an M&A deal, are negotiable.
If the parties to an M&A transaction are unable to agree on an acquisition price, one solution might be a so-called “earn-out” to bridge the different prices. An earn-out is a contractual provision that allows a seller to receive additional consideration later if the business sold achieves certain financial metrics, such as milestones in gross revenues or earnings before interest, taxes and amortization (EBITA).
Although an earn-out can pose significant risk for the owner/shareholders of a selling business, it creates a path for the selling stockholders to ultimately receive the return they seek from the sale of their business.
PAYING FOR IT ALL
Because M&As are expensive, adequate funding is a necessity.
Fortunately, financing an M&A transaction with stock is a relatively safe option for both parties since both share the risk.
In many share-exchange transactions, the buyer will exchange their shares for shares in the business being acquired. Paying with stock is particularly advantageous for a buyer, especially if their shares are overvalued.
In a merger, shareholders on both sides can reap long-term benefits of a stock swap as they will generally receive an equal amount of stock in the newly-formed operation, rather than simply receiving cash for their shares.
Paying with cash is another, potentially expensive from a tax standpoint, alternative. After all, cash transactions are instant and relatively mess-free and usually don’t require the same kind of complicated management as stock would. Unfortunately, smaller car wash businesses, without large cash reserves, usually require alternative, and expensive, financing to fund their cash transaction.
Another popular alternative to paying for an M&A with stock or cash, involves agreeing to take on the debt owed by a seller. After all, for many businesses, debt is a major reason for the sale.
ASSUMING THE BURDEN OF DEBT
Unfortunately, debt can reduce the value of a business, often to the point of worthlessness. From a buyer’s point of view, this strategy can be an inexpensive means of acquiring the assets of another business.
Being in control of an operation’s debt can mean increased control over management in the event of a liquidation since owners of debt have priority over shareholders. This can be another incentive for would-be creditors who may wish to restructure the new business or simply take control of its assets.
Much of the risk in an M&A transaction can be eliminated with an often-overlooked type of insurance. Warranty and Indemnity (W&I) insurance has evolved from its introduction in the 1970s into a popular and sophisticated tool for protecting buyers and sellers from financial losses in M&A transactions.
W&I insurance essentially removes the risk in an M&A transaction. With underwriters offering protection against downside risk, W&I insurance also eliminates the requirement for the use of escrow or personal guarantees while providing certainty and finality to both parties.
EMPLOYEES AND BENEFIT ISSUES
As already mentioned, car wash operators enter into M&A transactions for various strategic reasons usually with the view of creating synergies, enhanced capability, to enter a new market, or gain in economies of scale. But the M&A should not be viewed only from the economic point of view. It should also consider the workforce.
M&A transactions, even smaller deals, typically involve a number of important employee and benefit issues that will need to be addressed. And, many M&As can result in job losses or changes in work culture that impact morale.
Fortunately, much of the confusion during and after the M&A can be reduced with communication — keeping the workforce updated, answering their questions, and attempting to alleviate any doubt they may have.
TAXING THE M&A
When two businesses exchange shares of stock in a merger, rarely does it result in a tax bill unless, of course, so-called “boot” is received. Boot is any consideration received by owners and shareholders in the target entity other than the buyer’s stock.
It is a similar, no-tax, story when a business acquires control of another company by assuming its debts. But, when the acquisition is comparable to a sale, the seller pays capital gains tax on the amount by which the sale price exceeds his or her “basis” in the entity.
Going one step further, the tax bill, even at the current low rate for capital gains, is reduced if the acquisition or sale contract calls for payments spread over a period of time. The spread-out tax bill is often used by the acquiring car wash business to justify a lower overall sale price.
Other provisions of the Tax Cuts and Jobs Act (TCJA), such as full-expensing of asset costs, may cause many to weigh their effects on any transaction. In reality, the ability to do a taxable asset transaction and take advantage of front-loaded deductions may encourage car wash operators to complete a taxable deal instead of a tax-free transaction.
The various coronavirus relief measures make caution advisable. Buyers should have a good understanding if the targeted car wash business took PPP loans or employee retention payroll tax credits.
Both parties should agree on the treatment for the loan or potential forgiveness, along with the impact of new legislation. Plus, the business being acquired should be examined for opportunities with payroll tax deferral, qualified improvement property, or losses that may be carried back for refunds under the CARES Act.
On the downside, M&A deals are often difficult to accomplish. The interests and objectives of sellers and buyers are all-too-often discordant. The owners and shareholders of a business being acquired want the highest price with little or no residual risk or liability. Acquiring car wash operators, the buyers, want the lowest price possible with maximum recovery options.
The Coronavirus pandemic has had a significant impact on business in general and requires everyone to be realistic about how their business will perform in the new normal. The pandemic has also created a tremendous opportunity for M&A transactions where both the acquiring and selling business can benefit. Naturally, expert tax and legal advice are strongly recommended.
Mark E. Battersby is and Ardmore, PA-based freelance writer, specializing in finance and tax issues.