Written by Tandy Jouret, Attorney at Shields Legal
Can hidden costs arise prior to, or post-closing, that could have a substantial contrary economic influence on a transaction? The answer is most definitely yes. When selling a business, there will always be certain expenses that need to be paid at the closing table. Getting an estimate of these numbers is critical to find out what your net sale proceeds will be. Many business owners don’t consider this and end up disappointed with the check they receive at the closing table. The exact amount of expenses involved in the sale of your business will be based on a number of factors, but there are some hidden costs that almost always emerge. You should be aware of these costs beforehand. The following list was prepared mostly from the Seller’s perspective; however, buyers should carefully consider these points as well.
One needs to be fully aware of the hidden costs so you can plan ahead. For instance, corporate or business restructuring can be required by the buyer for closing. In this case, a buyer may require that the seller reorganize its business, entity structure, personnel, or make other operational changes prior to closing the transaction. These costs can be very expensive.
Another main hidden cost is post-closing adjustments - such as working capital adjustments, inventory adjustments, or indemnification holdbacks. These are usually handled in the transaction as an escrow or hold back, to be determined and paid or deducted post-closing. The buyer “holds back” the release of a portion of the cash purchase price in an escrow account, to be calculated after closing (usually 90 days). You must pay careful attention to these calculations and time periods for these efficiencies to be most beneficial to Seller. Be aware of the taxes, in particular. Hidden taxes, such as sales tax can pop up after a transaction. You must hire a competent CPA or tax counsel to evaluate all potential tax implications of a proposed sale transaction. Hidden liabilities can also contribute to hidden costs. Employee potential claims, infringement claims, or post-closing liabilities can also arise. A Seller should attempt to discover all possible claims or causes of action or liabilities that could be looming, and the payor resolves them prior to entering into negotiations with a potential buyer. Debts and liens not resolved prior to closing will have to be resolved by the Seller or will negatively impact the total sales amount. If part of the consideration for the sale is continuing equity to the Seller, pay careful attention to the operating agreement and terms for the equity participation granted to sellers.
Earnouts are another factor contributing to hidden costs – Earnouts sound great upfront, as the seller is paid cash plus the ability to participate in profits post-closing. The problem arises when those post-closing earnout thresholds are impossible to obtain, or measured in such a way that they are unobtainable. Meticulous attention to accounting functions and definitions of revenue and measurements of such revenue must be negotiated and specifically detailed in the transaction documents so that there is no unreasonable or unknown future hindrance to Seller’s ability to collect the post-closing portion of a purchase price.
Pre-closing litigation must also be taken into consideration. Are there any potential or actual claims that could lead to litigation or are inactive litigation? Those claims need to be identified and resolved/paid prior to entering into a sales transaction, or they will negatively impact the sale price or post-closing payments. One last item to consider is Post-closing Insurance costs. The buyer may require certain post-closing insurance coverage including officer and director tail policies, or reps and warranty insurance policies that can be expensive.
Careful analysis and pre-transaction planning and strategy can mitigate much of these costs and can add millions of dollars to a transaction. If you are concerned about what hidden costs are lurking out there, explore all the possibilities that you can face and be prepared before it’s too late. Rule out all the financial fears, and don’t let those hidden costs lurk in the shadows.