Sell-Side Tax Considerations for Mergers and Acquisitions – Part 1: Performing Sell-Side Tax Due Diligence
REDW | May 20, 2019
This article is the first in a series that focuses on best practices that can help sellers to prepare for a merger or acquisition.
2018 proved to be a strong year for the domestic M&A market, and the outlook for domestic M&A activity in 2019 remains positive despite investor concerns regarding U.S. trade policy and economic uncertainty. Abundant cash, unprecedented equity valuations, and low interest rates are expected to continue to fuel a robust deal market for both corporate buyers and private equity groups. These market indicators appear to signal that 2019 may remain an optimal time to sell.
No one understands how a business operates quite like the seller; it is a deep understanding coupled with an ability to anticipate how a buyer may react to a transaction that provides the seller with an “upper-hand” when selling their business. These same principles are true from a tax perspective—sellers with a thorough understanding of their tax profile and who anticipate a buyer’s view on taxes are better positioned to have a leg-up on a buyer.
Now more than ever, sellers and their advisors are beginning to appreciate the value of having a thorough understanding of a company’s tax profile, areas of potential tax risk, tax attributes, and desired structure of a transaction before undertaking a deal process. Amid these changes in the dynamics of how sellers approach taxes in sale transactions, employing best practices can have a dramatic impact on outcomes.
In this article and two more to follow, we outline three best practices that are some of the most critical for sellers to consider in order to maximize deal value and ensure a smooth process when disposing of a business or business line.
Best Practice #1 – Performing Sell-Side Tax Due Diligence Before Conducting a Sale Process
It’s all too often that a material tax issue is identified during the course of a buyer’s tax due diligence which delays the deal process, results in a change to the terms of the transaction to the seller’s detriment, or causes a buyer to walk away from a deal. With taxes having a major impact on post-transaction cash flow as well as being one of the most significant items of potential exposure on many deals, not having a thorough understanding of a company’s tax position and potential areas of tax risk or benefits before conducting a sale process often puts sellers at a disadvantage during the deal negotiation process.
Tax exposures identified by a buyer during tax due diligence provide a buyer with negotiating items to use during the ’horse-trading’ that typically occurs as the parties move toward closing. To avoid surprises and to streamline the buy-side tax due diligence process, sellers more frequently choose to perform sell-side tax due diligence.
So, what is sell-side tax due diligence? Although an appropriate work plan is one that has been well-tailored to the specific situation, sell-side tax due diligence is typically a process whereby a seller engages an independent third-party service provider to undertake a tax due-diligence analysis with respect to its business with a buyer’s perspective in mind. The goal is primarily to gain a sophisticated understanding of the tax profile of the business in the context of an M&A transaction, identify potential areas of tax risk or liabilities that could be inherited by a buyer in a transaction, and to gain an understanding of the value of any tax attributes that could provide a future benefit to a buyer (e.g., net operating loss carryforwards, tax credit carryforwards, tax basis in assets, etc.).
Sell-side tax due diligence is typically documented in a report that summarizes the company’s tax profile, potential areas of tax risk, and tax attributes of the business which can be shared with prospective buyers. There are several key benefits for a seller in undertaking sell-side tax due diligence before commencing a sale process.
Opportunity to Remediate Exposures Before Being Identified by a Prospective Buyer
To the extent a material tax issue is identified during the sell-side tax due diligence process, sellers have the opportunity to take steps to remediate the exposure before launching a formal sale process. Sellers can pursue voluntary disclosure agreements with the taxing authorities that typically provide for a limited lookback period in exchange for voluntary payment of a reduced tax liability. They can also cure past tax missteps, such as filing additional elections, amending previously filed tax returns, and/or seeking relief from the taxing authorities through a formal ruling process.
By proactively identifying potential areas of tax risk and taking steps to reduce or eliminate this risk, sellers put themselves in a position to unilaterally choose how best to deal with identified issues (as opposed to buyer exerting influence or control). Sellers can be forthcoming with prospective buyers on the tax issues which exist within the business, thereby, reducing a buyer’s ability to seek price discounts during the sale negotiation process and reducing the risk of a ’dead’ deal.
Expedite the Deal Process
The time and resources incurred by prospective buyers and their advisors are often minimized to the extent a seller has engaged a third-party advisor to perform sell-side tax due diligence. A sell-side tax due diligence report allows buyers to quickly gain an understanding of a company’s tax profile and potential risk areas, thereby permitting buyers to focus their buy-side tax due diligence on certain key areas.
While buyers will want to conduct an independent review of a target company’s historic tax positions, the buy-side tax due diligence process becomes confirmatory in nature rather than having to start the process from scratch. Having just undertaken this process on the sell-side, management is often better prepared to address buyer inquiries with respect to taxes and the information is readily available to respond to buyer information requests. As a result, the buy-side tax due diligence process is expedited, thereby reducing the strain on the organization and ensuring that tax does not hold up the deal.
Identification of Tax Attributes
Not only will buyers inherit historic tax risks of the business in a transaction, but they may also inherit tax attributes of the business that could provide a buyer with a future tax benefit. Through a sell-side tax due diligence process, sellers can identify and value tax attributes within the business (or be created by the transaction itself) and market those tax attributes to prospective buyers during the sale process. Sellers, therefore, may be able to negotiate a higher sales price for the potential value that such attributes may provide to a buyer post-transaction. At a minimum, identification of valuable tax attributes will increase the certainty of close.
This article originally appeared in BDO USA, LLP’s “Insights” newsletter (March 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. Content by Alexander Mayberry and B. Nathaniel Collins.