Apr 15, 2022
Considerations When Selling a Business as a Going Concern
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The sale of a business is a complex process where each party looks to extract maximum value from the transaction. There are a myriad of legal factors that encompass everything from employment law and property law, to value-added tax (VAT) and capital gains tax. The laws that apply and the pros and cons of the transaction will depend on the type of sale of the business.
As a seller, the best-case scenario for you is to sell your business as a going concern. But what does that mean?
What is a Business that is a “Going Concern”?
Though “going concern” sounds negative, it’s actually a positive term used to designate companies that play crucial roles in their communities. From an accounting and financial reporting standpoint, a business is termed as a “going concern” when it has the attributes of an operating or ‘live’ entity that could, in theory, operate indefinitely - or at least for the foreseeable future. This is in contrast to the business being an inert collection of distinct assets.
“Going concern” implies that the company is unlikely to face bankruptcy or foreclosure in the coming 12 months. The company portrays the ability to satisfy its financial obligations without the need for debt restructure or the disposal of assets outside the normal running of business. Once control moves to the buyer, operations continue to run smoothly with hardly any noticeable changes from the customer perspective.
Other than the tax and continuity benefits covered further down in this article, selling a business as a going concern has other merits. First, it protects employee contracts. This is in contrast to what would happen if the business were to enter administration - a process during which jobs may be lost.
Second, it steers clear of the negative publicity that would otherwise dampen the future prospects of a business sold as not a going concern.
Determining if a Business is a Going Concern
So how do you determine whether a business is a going concern? Remember that “going concern” is an accounting and financial reporting term. Financial statements are the primary source of data that would show whether a business is a going concern or not. Work with your accountant to identify and calculate the financial ratios that demonstrate your business’ financial health. Let’s review three of the more important ratios under consideration.
Current Ratio (current assets divided by current liabilities)
This shows how comfortably your business can pay short-term debt from assets readily converted to cash within the next year.
Debt Ratio (total liabilities divided by total assets)
With this, you can see if your debt exceeds your assets. If that’s the case, your company is deemed insolvent and unlikely to be considered a going concern.
Net Profitability Ratio (net profit divided by net sales)
This ratio shows financial performance in the context of costs incurred in product distribution and production. It illustrates the company’s financial value and whether it is making enough money to be sustainable.
Red Flags to Look Out For
Even though your business may tick all or most of the right financial ratio boxes, certain events or conditions may indicate it may lose its status as a going concern in the near future.
Negative trends and signs of financial difficulty – Persistent operating losses, working capital shortfalls, negative cash flow, loan defaults, debt restructuring, dividend arrears, denial of credit lines by suppliers, failure to comply with statutory requirements, disposal of significant business assets, declining market share, search for fresh sources of financing, and scaling down of operations.
Internal risks – Labor difficulties, work stoppages, loss of key employees, overdependence on a particular project’s success, expensive long term contractual commitments.
External risks – Lawsuits, new legislation and regulations that could jeopardize operations, loss of a franchise, loss of a key patent or other intellectual property, loss of a critical customer or supplier, underinsured or uninsured catastrophe like flood, earthquake or drought.
Selling a business is, in many respects, the sale of multiple distinct company assets as one entity. Ordinarily, a VAT/goods and services tax (GST) would be levied on the transfer of the individual assets with rates and exemptions applied depending on the asset type.
When you sell a business as a going concern, however, it is not classified as a supply of goods or services, and therefore may not be subject to that tax. To fall outside the scope of VAT/GST, the transaction will need to meet specific conditions depending on your jurisdiction. These may include the following.
A payment for the sale has been executed.
Transaction includes all necessary assets under the control of the business such as fixtures, machinery, premises, contracts, and goodwill. “Necessary assets” means not every single asset, but those without which the company cannot function as usual.
The buyer is registered for VAT/GST.
The buyer intends to continue running the business, not necessarily in identical fashion, but within the same industry.
Both seller and buyer agree the company is a going concern.
Seller has provided all that is needed for the business’ continued operation.
Seller continues to possess and operate the company until the sale is settled and effective control is passed to the buyer.
Work with your accountant and/or a tax professional to ensure the sale meets all the relevant requirements for the sale as a going concern.
Steps for Selling a Business as a Going Concern
When you are selling your business as a going concern, these are the major steps.
1. Due Diligence
Due diligence is checking what is offered for sale, and if there are restrictions blocking the buyer from acquiring the business or that may reduce the value of the business or asset.
The buyer carries out and pays for the due diligence process. However, this process will require the seller to provide information via active participation. The ensuing sale of business agreement will usually include a section stating that the buyer can cancel the transaction or seek damages later if the seller did not fully disclose pertinent information.
2. Sale of Business Agreement
To sell a business as a going concern, there must be a sale of business written agreement agreed to by both parties. The agreement for the sale of the business should state that the transaction is for a company as a going concern.
For the transaction to be VAT GST exempt, this agreement must be entered into on or before the day of transfer of possession and effective control to the buyer. Note that the transfer of effective control doesn't necessarily have to be tied to the settlement date. You can pass on control to the buyer before the financial transaction is executed.
The timing and content of the agreement are important because it is possible for a seller and buyer to conclude a business sale and transfer without this agreement. If that happens, the transaction will not be eligible for a VAT/GST exemption, even if the business otherwise met all the criteria of a going concern.
3. Business Continuity
As a legal precondition for selling your business as a going concern, you must continue to operate the business until the sale is settled and control handed to the new owner. This should be included in the sale of business agreement so that failure to do so would constitute a breach of contract.
The continuity is vital since it gives the buyer the opportunity to access assets associated with business operations; push through the transfer of contracts, leases, and equipment; and to assess all accounts for goods, materials, and supply chains.
Eventual transfer of ownership should include everything that the buyer will need to continue running the business.
Selling your business as a going concern is the best-case scenario. By allowing prospective buyers to acquire a company that continues functioning from the first day of transfer, you will get a better purchase price than you would if you were selling it as an unstable, unviable entity. It saves buyers time and resources. Get started selling your business with a free valuation from Beacon.
The rules for transferring a business as a going concern may seem a little ambiguous sometimes. There may be tax exemptions for selling the business as a going concern. Work with your account or tax professional to ensure compliance with all relevant laws and regulations.
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Will is responsible for helping sellers market their businesses to prospective buyers and providing hands-on support from offer to close. Using his background in mergers and acquisitions at Wells Fargo, he drives value and provides clients with the necessary resources, best practices and advice for a successful sale of their business.
Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.