A Seller’s Understanding of Net Proceeds
Making a profit during a healthcare M&A transaction is usually the light at the end of the tunnel for sellers in the current healthcare market. Everyone has an idea of what their company is worth and how much they determine that it will sell for to a prospective buyer. However, a seller’s expectations and the reality of what they will receive are often vastly different numbers. The Ambulatory M&A Advisor discusses the process of calculating net proceeds, what is actually included in net proceeds, what is excluded, and how other transaction issues like capital gains and taxes can have an impact on what the overall net proceeds may be at the end of a transaction.
Mark DeBroux, shareholder with Schenck SC explains that in order to calculate net proceeds the seller would take the selling price, subtract from it the cost of the transactions such as a broker fees, PTO staff has coming, any transaction fees such as accountants & attorney fees etc.
“Sometimes you take into account taxes to get to net proceeds and other times it would be cash before taxes depending on the person’s definition. Normally we tried to give our clients the cash flow after-tax consequences so they know what cash they are really receiving,” DeBroux says.
Ken Conner, CPA, shareholder with Elliot Davis Decosimo echoes that net proceeds include cash or stock value after deducting any debt plus the net of any retained assets (AR, Cash) less retained liabilities (accounts payable, liability claims).
“In many deals, an escrow will be set up for unknown or pending liabilities. The net of the escrow funds would typically be released over 1 to 5 years depending the circumstances. In some deals the purchase price includes an earnout or payment based on the future performance and cannot be included in the initial net proceeds but seller will consider as proceeds depending on the likelihood,” Conner says.
On the topic of things not included in net proceeds, Stuart Neiberg, CPA, partner with the valuation firm HealthCare Appraisers says exclusions depend on the transaction structure, but sometimes if there is stock that the seller retains, or other surplus assets/investments, these items may be excluded.
Eric Myers, CPA with Elliot Davis Decosimo says if stock or a partnership interest is purchased from an individual, net proceeds would be cash to the owner and the owner would need to reserve any personal taxes they have to pay.
“Assets and liabilities retained by the seller would likewise have to be accounted for the in value of the transaction and any tax liability,” Myers says.
Conner says that even prior to selecting a buyer, the seller will want to start looking at the price range that they are expecting to sell the business for and thereby gain an understanding of the potential net proceeds.
“During the negotiation, Seller should be tracking all the moving pieces in the sources and uses of funds at closing,” Conner says.
“During the Letter of intent and through closing, the seller should be updating the sources and uses based on interim performance, deal structure, changes during buyer’s due diligence.”
Curtis Bernstein, principal at Pinnacle Healthcare Consulting says that a seller in a healthcare transaction will always have some idea in his or her head about the amount he or she would like to earn upon the sale of the company.
“This amount would be the net proceeds on the sale. From that number, the seller can work backwards to determine the gross process, or the offer amount, that he or she would have to receive to earn the net proceeds. An excel based model can easily be developed that would account for the expenses of the transaction, including the taxes, that will allow a seller to estimate net proceeds as he or she receives offers,” Bernstein says.
Capital Gains Impacting Net Proceeds
Myers explains that capital gains are profits from the sale of property or investment.
“If business property that has been depreciated is sold, the amount of prior depreciation is recapture as ordinary gain while any excess is a capital gain. The gain on the sale of goodwill or other intangibles, such as customer lists, are capital gains. Stock or a partnership interest sold for a gain is also a capital gain. Capital gains are typically taxed at a lower tax rate unless the gain is sold by a C corporation,” Myers says.
DeBroux says that depending on the type and structure of the transaction there can be ordinary tax rates involved and capital gains. This is all dependent on how the assets of the sale are categorized.
“Capital gains can be taxed at two different rates 15% and 20%, depending on income level of the seller. Normally any transaction will move a seller into the higher tax bracket so Usually we are working with 20% for federal tax purposes. State tax treatment of the transaction would be dependent on the state,” DeBroux says.
Bernstein says a capital gain is the difference between the net sales price before taxes (after subtracting non tax expenses) and the cost basis of ownership in the company.
“The cost basis will vary based on a number of different tax strategies employed by the owner including corporate structure (e.g., subchapter S versus subchapter C corporation), distribution policy, depreciation policy, etc. All gains on the sale of a company are taxable. As mentioned earlier, long term capital gains are currently taxed at a lower amount than ordinary income,” Bernstein says.
As far as how capital gains impact net proceeds, Conner says the seller must reserve for personal or corporate taxes which may vary based on basis in the entity, allocation of the purchase price to be agreed upon by the buyer and seller. The seller must also understand that deprecation recapture may apply a capital gain at a higher rate.
“A number of different tax laws affect the net proceeds retained by a seller. The applicable tax las will vary based on the structure of the entity, the classification of the proceeds upon sale, and other tax strategies taken by the seller upon establishment of the entity and prior to sale,” Bernstein says.
“ Long term capital gains rates have historically been lower than ordinary income tax rates. As long as this tax advantage exists, classify as much of the net proceeds into the long term capital gains bucket for tax classification purposes should be beneficial for the seller.”
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.