Small Business Big World
New episodes every Tuesday discussing the challenges, adventures and fun of being a small business owner. Each week we'll delve into various small business topics, from real-world DEI considerations to selling your business, using video to market your business, unique benefit offerings for your employees and so much more. Curated by the crew at Paper Trails.
Small Business Big World
Buying and Selling a Small Business: Insights and Practical Tips
Get ready to talk small business ownership with Pat Brady, an attorney at Bergen Parkinson and a small business owner in Maine. Have you ever wondered how to find the perfect business to buy or what steps are involved in making it legally yours? We'll guide you through online platforms and dive into the importance of industry relationships and succession planning. Pat shares his firsthand experiences acquiring small businesses, offering invaluable insights and practical tips for aspiring business owners.
Forming a legal entity for your new venture doesn't have to be scary. Learn about the role of a Letter of Intent (LOI) in setting the groundwork for your purchase, and discover why an LLC might be the best choice for your business structure. Pat emphasizes the flexibility and liability protection LLCs offer, especially compared to corporations and sole proprietorships. We also explore the strategic benefits of setting up multiple LLCs, particularly for real estate investments, and the essential elements of an operating agreement to keep your business running smoothly.
This is a great episode for anyone looking into buying and/or selling a small business.
This is Small Business Big World, our weekly podcast prepared by the team at Paper Trails. Owning and running a small business is hard. Each week, we'll dive into the challenges, headaches, trends, fun and excitement of running a small business. After all, small businesses are the heartbeat of America and our team is here to keep them beating. Welcome to Small Business Big World, our weekly podcast, where we talk about everything small business. Today we've got Pat Brady here, bergen Parkinson attorney at law. Welcome. Thank you so much for joining us.
Pat Brady:Thank you.
Chris Cluff:So Pat's also a little bit unique in that he's an attorney, but he's also a small business owner on the side. A little side hustle, right. Yeah, that's right, tell me about that, what you got on the side.
Pat Brady:Yeah, definitely, so we've actually this. This may be news to Chris, it may not be. We actually got two kind of side things going. One is we do own Mail Unlimited, which is kind of an institution around here in Kennebunk, or at least I like to think it is. That's one. My wife and I did buy that a couple of years ago now. It's amazing how fast time flies.
Pat Brady:And the second is as part of trying to grow Mail it, we ended up buying a gift box company. It's called Crateful of Maine, which some people may know it from just kind of being around buying gifts and stuff like that. But we bought it from a gentleman up in Portland almost a year ago now. That is news to me.
Chris Cluff:Congratulations so yeah, well, good, well. So today's topic is buying a small business how to buy a small business. So Pat's going to put his lawyer hat on, is going to put his lawyer hat on, he's going to put his small business owner hat on and we're going to kind of talk through that. But before we do that, don't forget, we've got a little housekeeping, we've got a like, follow, share, rate, review, subscribe. Getting pretty good at that At Small Business Big World. Everywhere you want to see us, we're all over socials, we're all over the podcast places, so check us out If you future episode. So so, pat, let's talk about how to find buying a business right. So for some God awful reason, some of us like to be crazy and be entrepreneurs and start businesses and buy businesses.
Chris Cluff:So what do you think? You know? How are people going about finding those businesses? That's the big thing, right? I mean certainly. I mean we see with our client base, you know, every time a business changes there's a little bit of confidentiality things. Nobody wants to disrupt the apple cart, but then you know, a lot of people may want to get out of their business, right, how are you finding people are finding those businesses to buy?
Pat Brady:Yeah, definitely, and so I'll back up a little bit and just kind of pick up on what Chris said in the intro is that I am, in addition to the mail it and grateful stuff, I am also an attorney Just started at Bergen Parkinson this year. I was at a larger firm up in Portland before that but a big part of my practice is buying, selling businesses, representing people who are buying selling businesses. So I can speak to kind of how we found our opportunities and then what I'm seeing from a lot of my clients and ourselves. We found these opportunities online. There's a lot of my clients and ourselves we found these opportunities online. There's a lot of websites that people are probably familiar with. One of them is called Biz Buy Sell, I think it is, and then there's another one called LoopNet, and these websites are things that really anyone has access to. You can find anything from really sophisticated brokers selling businesses on sellers' behalves on there to kind of DIYers, you know, putting up their business for sale by order on there.
Chris Cluff:And I'm guilty of the Sunday morning scroll on BizBuySell just to see what's out there.
Pat Brady:Yep, absolutely, you know, it's always. It is pretty interesting to just kind of cruise through there and see what's out there, and so that's certainly one way. And we do actually get a fair amount of clients that come to us with businesses that they've found on Biz Buy and Sell and come to us to try and basically get it from the listing to over the finish line. You do see a lot of management succession, so a lot of either, you know employees looking to take it over from the owners that are retiring. That's obviously kind of situational dependent. You've got to be in the right place at the right time to have that. But we also get a lot of people who just develop relationships as part of their current whether they're an employee or a business owner themselves, and they just develop relationships in the industry with other companies and it just so happens they come up in conversation or maybe they approach them and say you know, like what's your plan? You know, is there a deal here?
Pat Brady:Can we put something together. There's a lot of that that happens. I'd say that, by and large, the vast majority of what we see is really just kind of inter-industry people putting deals together because it makes sense for all parties, Sure, and of course there's always just the cold calls. I mean people just like doing deals right. You know, if you see a business you like give them a call.
Chris Cluff:Everything's for sale for a price.
Pat Brady:Everything's for sale for a price. That's right. There's no harm having a conversation, absolutely no-transcript.
Pat Brady:Yeah, and I think the short answer is I think, well, the best piece of advice is just to plan sooner than you think. You can always put these things together at the drop of a hat if you have to, but they usually don't come together very nicely in that case, um and and it's just kind of a rough ride for everybody involved when you're trying to scramble the last minute. So you know, a year, two years, three years out from when you think you may want to start making the transition is always really the best time to start making a transition. You know, making a plan for what that looks like for a lot of different reasons, but in terms of actually structuring it, to say you do have a you know family coming up behind you that you want to get the business to, you know I mean, there's gift.
Pat Brady:There's gifting options where you can just give the company to the next people coming. You know that you want to get it to. That's always an option. There's purchase and sales the people who you want to buy the company just buy it. Lots of financing structures you can come up with and then you can do it piecemeal a little bit at a time. That's a lot. You see that quite often as well. Maybe the you know the current owners, mom and dad, whoever it is aren't quite ready to give up control, but they want to kind of start to get the next generation and give a little equity now and you work it out over time, right?
Pat Brady:yeah, you can sell a little bit now and then sell a little bit next year and a little bit next year and finally kind of things will flip. Or you can give a little bit this year and a little bit next year and that sort of thing, yeah that's good.
Chris Cluff:I mean that's I. I know in our business we see a lot of that right, we see, you know the kids take over, or the nephew or the kids, you know, whatever um, and I think in the management too. I mean we see that a lot here um, a succession plan could be. You know, hey, if your manager's running your business, great, and you get to go to go to Florida for six months, things are good. But eventually you want to step back completely and certainly give that next person the opportunity to own a business.
Pat Brady:And yeah, the other big thing about sort of planning is it gives you if you have a timeline in mind. The objective is to really, if you want to maximize the value of the company for yourself particularly if you're going to be selling it to an outside party and you're really looking to maximize the value of the company, planning ahead and really making operations as efficient as possible.
Pat Brady:Efficient means profitable Getting that profit up as high as you can because, as you know, chris, you know businesses are most often bought and sold as a multiple of profit. So to the extent you can get that profit up, you know it just makes the selling price that much higher.
Chris Cluff:Absolutely so. Once one of these crazy people have decided to buy a business, right? What does it look like from a legal perspective? I think everyone just thinks, hey, I'm going to start an LLC and I'm going to call it XYZ company LLC and we're going to start doing business. But it's a little more complicated than that. Right, Put your attorney hat on. Tell us what that looks like.
Pat Brady:Yep and certainly.
Chris Cluff:we know there's different classifications of entities, there's different considerations for all that stuff especially, and even if it depends on how you might buy your business too, that might matter too.
Pat Brady:Yep, right, yeah, absolutely, and there's just so much that goes into it. But you know, really I view the starting line as really when you get that opportunity kind of in your sights and start approaching the seller, and that's really the first moment in time when you can start to diverge and it's really, you know, choose your own adventure at that point. But I would say most deals start off with a letter of intent, an LOI, and not all of them. Sometimes you can jump right to a purchase and sale agreement. It's kind of the definitive transaction document.
Pat Brady:But an LOI is helpful to really kind of get everybody on the same page. Most LOIs, except for a few provisions in there, are non-binding, so you're not, you know, signing yourself up to anything right out of the gate with an LOI. But it will at least get everybody on the same page in terms of things like purchase price, transaction structure, that sort of thing. And when I say transaction structure I'm talking about things called stock purchases or asset purchases, and I can speak to that a little bit more here in a few minutes. But it's helpful to get everybody on the same page before you start spending money drafting documents, because the documents are going to be drafted off of whatever the party's deal is, whatever that business deal is, and so you don't want to be wasting time and money.
Chris Cluff:And every deal is different. There's no cookie cutter, right? I mean, I'm sure you've done hundreds of deals and there's a hundred different ways to do them right.
Pat Brady:Yep, that's absolutely true, and you hear a lot about like well, can't you just pull the form and use the form, or go online and grab a purchase sale agreement, and the risk there is exactly what you just said is no deal is the same. There's always. I personally have never pulled a document, a form document, and just put names on it and shipped it out. There's always some nuance that's got to be picked up there.
Chris Cluff:So once you get your letter of intent, we're saying listen, this party is going to buy this from this person right. Yep, You've got to set up an entity, a legal entity, right. You've got to figure out now there's a legality there, there's the taxability there, there's different considerations, right? So what does that look like in terms of forming that entity?
Pat Brady:Yep, yeah, so the big two that most people pick from. Well, three, a sole proprietorship, which is just Chris out doing business or Patrick out just doing business by themselves, just their own individual person that's doing business without a corporate entity. Then you've got a corporation or an LLC. Those are the two other big ones. There are others, but they're more or less historical.
Pat Brady:Llcs are really kind of in vogue right now. They're extremely flexible, they're a relatively new creation, but you can have really as many owners as you want. You can really do almost anything with the corporate governance within reason, but the corporate and there's some tax distinctions between the two. But corporations have a lot more uh, they're they're much more rigid when it comes to, like, governance. You gotta have shareholder meetings and uh, that that sort of thing, um, so most people are picking LLCs right now. And then the actual process to form an LLC is actually quite straightforward. You file this thing with the secretary of state all the way up in Augusta. Um, it's called a certificate of formation. It's straightforward. You just basically put the name of the entity.
Chris Cluff:It's basically a one-page document. It's a one-page.
Pat Brady:Yeah, yeah.
Chris Cluff:The second page is a signature page.
Pat Brady:Yeah, exactly, the state of Maine. For the listeners out there is still very much in the Stone Age in terms of they require wedding signatures. They're one of the last states in the country that I'm aware of that you've got to actually get that document up to the state.
Pat Brady:A lot of states do it online now.
Pat Brady:So, yeah, you get your certificate of formation up there and then you adopt something called an LLC agreement or an operating agreement and that is really kind of the rules that you're going to run the company by.
Pat Brady:And it's still where they become incredibly important is when you have multiple owners, because it's that agreement between the owners that's going to speak to like who does what and how much money each person gets, and so on and so forth, and what approvals you need to do certain things, and so on and so forth. It's extremely important for that reason, even with a single owner, you should still have one, even though it sounds a little silly to say. You know, it's an agreement between myself, the owner of the company, and myself as the company. It can be a little silly, but it's still important to do and it's still important to observe all those formalities, because a corporate entity is only going to provide as much protection as you sort of observe of the entity. So what I mean by that is the value of a corporate entity is the liability protection that it provides the owners. So if there's some liability of the LLC that the LLC can't satisfy. It generally protects the owners from having to step up, and that's the big thing, right?
Chris Cluff:If you're a sole prop, you don't have that legal barrier, right? So if someone slips and falls on your property and you own it in your personal name. They're coming after you, coming after your house, your retirement, all that stuff right, exactly Yep. If you have an entity formed, you have an llc formed, essentially. I mean, I'm sure some great attorney out there could pierce this, I'm sure they have but you know, essentially someone slips and falls.
Pat Brady:They can only take what is owned by that entity right and yep, exactly, and that's why you see when people buy, when they have multiple, you know real estate properties and that sort of thing they buy them all in in separate LLCs.
Chris Cluff:That's the Grant Cardone thing on TikTok right, that's what everyone's.
Pat Brady:I have 37 LLCs.
Chris Cluff:Someone to walk.
Pat Brady:my dog is in an LLC, yeah exactly, and the reason for that is you take the property example. If someone slips and falls and there's 10 properties but each one's in a separate LLC, the concept is that if they fall on property A, they're limited to basically property A to satisfy that judgment, whatever it is. They can't go after B, c, d and so on and so forth. But yeah, so that's why you really want to do that entity. But the piercing the veil comment you just made.
Pat Brady:What that means is that if you don't observe the formalities of the entity, some judge could say someday that because you didn't observe the formalities, you don't observe the formalities of the entity. Some judge could say someday that because you didn't observe the formalities, you don't get the benefit of the protection the LLC provides. And when I say formalities I mean things like having that. You know an operating agreement is just going to kind of advance that concept that this LLC is its own box. You know it's its own living, breathing thing. Things like commingling bank accounts, using the LLC's bank account as your own, paying your own mortgage out of the LLC account and going grocery shopping out of the LLC account, all that stuff's going to get you into a lot of trouble.
Chris Cluff:Those are bad things. Those are bad things yeah, from a legal, from a bookkeeping, from an accounting perspective.
Pat Brady:Yeah, yeah, just keep them separate, please, right, yeah, yeah.
Chris Cluff:So one of the things you talked about, you know piercing the veil, going through keeping things separate, of course you know we've had, I know I have clients that have literally filed that certificate of formation. They've gone to the IRS website, they got the REIN and they're in business right.
Chris Cluff:I mean, legally speaking, they're in business right. But I think the value of having someone like yourself draft that operating agreement and all the documentation and so forth yeah, okay, we're going to pay a thousand bucks or whatever it is this week to do that, but it really is that last step that you have to have to protect yourself and your entity right.
Pat Brady:Yep, and what I tell clients a lot of times is when you're setting up the business, it's just so important to sort of set yourself up with a strong foundation, because it really sets the tone for kind of how you're going to do business the rest of the time. And if you just kind of haphazardly pull it together, the paper foundation isn't really there. One it's just. It makes life difficult in a whole number of different reasons. But the second is if you have in your mind that you're going to one day sell the company a buyer, you know, if you think of yourself as a buyer, if you go in and you see, if you're looking at this opportunity, that's just in disarray there. They have no foundation, they're just kind of haphazardly running it.
Pat Brady:No, it may not kill the deal, but it's a paper. You know it could be one of those death by a thousand paper cuts, things where it could be this issue and that issue. Maybe those aren't so bad. But then the house is a mess and maybe you know you kind of pull all this stuff together.
Chris Cluff:I bought one of those businesses and I can tell you I got 999 paper cuts I probably should have gotten that thousand.
Pat Brady:Yeah, so, yeah. So you know it is important to kind of get that house in order out of the gate and do that. You know, set up those entities correctly.
Chris Cluff:So I think you know you mentioned something really important. When you're buying a business, you know, in most terms, right Someone is exiting this business, even when you're buying it, even though if your exit plan isn't for 20, 30, 40, 50 years, it's important to start thinking about that at the beginning right. And that comes from okay. You know I've got my business, businesses of businesses and assets, valuable right. A lot of particularly my clients, I'm sure yours too say gosh, my business is my retirement right Yep.
Chris Cluff:And so don't run it into the ground, right? Don't Make sure you have it organized. Make sure, just like if you were putting money into any other investment, keep it organized right, right, yeah, and do it right and have the advisors most importantly, like yourself and an accountant and so forth to be guiding you through that right, yeah and so forth, to be guiding you through that right?
Pat Brady:Yeah, one of the most painful examples I can think of just illustrate, you know, like, do it right is we had a company with three owners out of the gate and the two owners bought the third one out. They thought they did, but they didn't really do any paperwork. It was just kind of a handshake We'll give you some amount of money and yeah, like, we'll just sign this little thing that says you're an owner anymore. And off they went. Well, 10 years later, you know the two guys that were selling it I mean selling it for a significant sum of money and the buyer, you know, opens up the hood and says, well, what's this third owner? And you know the response is well, he's not an owner anymore. Well, yeah, he actually is. Whatever you guys did back then was not enough. He's still an owner. You've got to go find that guy and you've got to get him to sign the release and, of course, at that time the value of the business is huge.
Chris Cluff:Well, significantly more than it was way back and of course that guy is not going to just sign a release at this point.
Pat Brady:So that was kind of a tough one to work through. So it's stuff like that. There's lots of horror stories like that, but keep yourself organized right.
Chris Cluff:I am one of these trusted advisors, I consider myself that, but don't be afraid to call your trusted advisor. And yeah, it may cost you a couple hundred bucks to have that conversation but could save you tens or hundreds of thousands of dollars down the road, potentially right, depending on the scenario. So I know, you know, I, you know just to shit on you for a minute. You know everyone's afraid to call a lawyer, right, god, they bill me by the minute, right, but sometimes most of the time that's really warranted.
Chris Cluff:And don't be afraid to do that.
Pat Brady:Yeah, we like to think we can add value once in a while.
Chris Cluff:Not just add to the bill, right, yeah, exactly.
Pat Brady:But yeah. So I guess to jump back to the buying, the business entity sort of thing and actually what type of how you're structuring the transaction is also going to play into how you set up the entity. To go back to what I mentioned initially, there's really kind of two types of transactions what they call asset transactions, and then stock transactions stock deals, equity deals, whatever you want to call them and the distinction between the two is in an asset deal, think of it as the seller has their LLC or corporation, whatever that's. That box that's, the seller owns that company. There are assets within that cars, trucks, desks, goodwill contracts, all that good stuff.
Pat Brady:In an asset deal, what you're going to do is you're going to set up your own entity, your own LLC, a new box, a box that you own. You're going to pick up those assets from the seller's box and put them into your box. That's an asset deal. In a stock deal, you're going to just buy. You're going to buy the whole box. You're going to buy the stock, the ownership, whatever represents the ownership of that box. That's what you're buying in a stock deal. There's good things and bad things about both transactions. Most, I would say, are asset deals.
Chris Cluff:Well, with a stock deal like that, you're also buying the liabilities, the potential future liabilities, right, exactly. So who knows, the previous owner may have screwed up a year ago and you don't know about it. And if you buy that box, that's your problem now.
Pat Brady:Exactly, yep, exactly. So most people do prefer asset deals because of that liability. You can generally get all those skeletons in the closet that may not, you know, come out of the woodwork yet. But my point, what I was going to say, is that if you do do the stock deal, you actually don't need an entity.
Chris Cluff:You just because it's just You're just taking the old one over.
Pat Brady:You're just taking the old one over. You're just really kind of stepping in the shoes of the seller.
Chris Cluff:So you know we've talked about creating the LLC and running through that. You know. Again, I'm going to go back to the TikTok world. Everyone says make sure your LLC is in Nevada or Delaware, right. Why should I form it in Maine instead of one of those quote unquote more friendly states, right? What are the implications? Does it really matter if you're a small business?
Pat Brady:Yeah. So Delaware has this sort of like lore in corporate world like as being super fit. You know the place you want to form your entity right and that has some truth to it, but usually because it has a very friendly and well-developed body of law. So if you have a Delaware entity and there's going to be some issue down the road, you know with some certainty how it's going to be resolved, because there's just so many cases that go through the courts down there with business entities. I mean, there's a lot of cases in Maine that go through the courts but not in Maine.
Chris Cluff:But does that matter for mom and pop restaurant?
Pat Brady:as much as it matters for General Electric.
Pat Brady:Yep, so exactly. So what I tell most people is you don't need to form a Delaware entity. If you're generally a kind of a small Main Street business and even maybe not necessarily a Main Street business, but I mean a big player, even just for Maine, you don't need to be down in Delaware. For one almost primary reason is it's going to cost you just a lot more administratively. You've got to maintain two registrations. You've got to maintain your Delaware registration and then you've also got to because you are in the state of Maine doing business, you've also got to register in the state of Maine. So why not just form in Maine and get rid of that separate filing? And if you do, if you are going to grow into some very large company that's going to start taking on investors and that sort of thing, yeah, those investors probably will want to see a Delaware entity. But you can always change.
Chris Cluff:So that's a great segue. Investors, right. How do people I mean gosh, people are buying and selling businesses all day long. It feels like we're trading candy in the playground, right, but how are people accumulating that candy?
Pat Brady:right. How are people finding the money?
Chris Cluff:other than just their life savings, right? I mean, what types of financing methods are most common that you're seeing?
Pat Brady:Yeah, yeah, where I see it is a lot of bank financing, just really traditional bank financing.
Chris Cluff:Put your 20% down, we'll give you the rest.
Pat Brady:Exactly that sort of thing and in that scenario what happens is buyer seller negotiate a deal, they paper it and you get to the closing table and the bank comes in. So buyer gives their 20% to the seller, the bank comes in, gives the 80% and you know the buyer is just borrowing that money from the bank. That's a really sort of conventional way to do it. The challenge with a lot of main business in particular, but probably nationwide, is that banks don't like quote goodwill, they like hard assets, right.
Chris Cluff:They want a building, they want vehicles, they want equipment. They don't want your client list. They don't care about that, right.
Pat Brady:Exactly so you end up in this tough space where, if a business is $500,000, but maybe there's only like $100,000 worth of hard stuff, well, that's $400,000 that the bank is not going to lend on. So if you either got to come up with $400,000 yourself or you got to find some other way to kind of crack that nut, and how you do that in most cases is either seller financing, and what that means is the seller says you know, the seller acts as a bank in that scenario and they just basically say, yeah, pay me out over time. That's one way to do it, and there's all the sorts of push and pull and negotiation of what that looks like. How long are you going to pay them out over?
Chris Cluff:And you can stack some of those things sometimes right, maybe you'll do bank. Maybe you'll do seller financing. You may be able to bring an investor in. You can do multiple things right.
Pat Brady:Yep, exactly. And then another really powerful one that I like is an SBA loan and how the SBA loans work generally and I am no banker by any stretch of the imagination but the SBA will come in and guarantee a traditional bank loan and what that allows a traditional bank, a local bank, is to lend on that goodwill, knowing that the federal government is going to stand behind it. So if things go catastrophically wrong and the bank's not really stuck holding in that $500,000 example, $500,000 of you know, $100,000 of trucks and $400,000 of, like you know just goodwill Right.
Chris Cluff:the government's going to come in and secure that.
Pat Brady:The government's going to come in and just give the bank that. You know that money, they're out of pocket and they're happy. You know, obviously, cave, give the bank that money, they're out of pocket and they're happy. Obviously, caveats with all that. But that is a pretty attractive way to kind of get that out.
Chris Cluff:It's sometimes not the cheapest way to do it, though SBA has their own fees that you, as the borrower, are going to pay, right Exactly, but certainly it's a tool. It's a tool in Zoolbox.
Pat Brady:Yep, absolutely. And with that, like you just said, you can stack that traditional bank SBA debt, you know, seller finance, all that sort of stuff.
Chris Cluff:So it's. You know I don't think we see this a lot in our market, you know, particularly with smaller businesses. But you know, people are people bringing in investors Like, hey, I'm going to, this is the business I'm going to make, I'm going to pitch it to you. I need a half a million dollars and I'll turn it into $20 million or whatever right Over 10 years or whatever.
Pat Brady:Do you see a lot of that in the small business space? Yes and no. It's that once you do start bringing in, I mean, if it's just kind of two friends pooling their resources and going in, that's one thing and you do see that quite a bit.
Chris Cluff:But you're not seeing Shark Tank.
Pat Brady:But well, there is actually quite a bit of that in Maine, a lot less so than you know, like San Francisco, for example, but that does exist and there's it. Just it becomes harder, right? Because the federal government, the SEC, regulates who can invest in these sorts of startup companies. You have to be what's called an accredited investor, and an accredited investor is a defined term. There's financial thresholds that you have to meet. You know annual income or assets to be a quote accredited investor and when you're going out soliciting investments you can generally, generally, only take it from accredited investors. So you kind of got to know a lot of wealthy people or people that are accredited investors or know people that know people. So it's certainly possible and it certainly happens in Maine. But I would say that a lot of those companies in Maine that are raising that money it's not necessarily from even just Maine individuals, it's people who have People from outside.
Pat Brady:Yeah, exactly. But it certainly does happen in Maine Interesting and ESOPs are a really interesting tool as well that are very popular right now.
Chris Cluff:Which is an employee stock ownership plan, yep.
Pat Brady:And that creates that kind of takes on a whole different level of complexity, but it can be an attractive way for people to exit.
Chris Cluff:So we actually have a podcast episode scheduled to talk about.
Pat Brady:ESOPs oh perfect, so that'll be the next thing.
Chris Cluff:But that is definitely something that is particularly in our market has become really business friendly and really what happens is the owner essentially transfers the assets of the business to the employees and they become owners legally right, and certainly every one of these operates a little bit differently. You talk about those operating agreements, but it's a really interesting model that a lot of folks are doing nowadays and what people really like about them.
Pat Brady:sellers at least, it's sort of almost an opportunity to kind of create your own buyer, because you just create as you guys get into it. You create a trust and the trust buys the stock from you. Pretty into it you create a trust and the trust buys the stock from you. Pretty interesting stuff, Very interesting.
Chris Cluff:So let's wrap up with the thing that always is the last thing to be talked about before a deal closes and will be the last thing we talk about today. It's something about asset allocation. So I've seen many, many deals go through. You probably have as well where, the day before the closing, everyone's like, oh, what's the asset allocation? You probably have as well where, the day before the closing, everyone's like, oh, what's the asset allocation? And you're negotiating literally at the 11th hour about what the asset allocation is. You can tell us what. That is how it works all that stuff.
Pat Brady:Yeah, so when you in asset deals or really in any deal, particularly in asset deals, you're going to buy a whole bunch of stuff, right, You're going to buy cars, trucks.
Chris Cluff:Inventory.
Pat Brady:Inventory, tables, chairs, accounts, receivable, maybe contracts. Goodwill is the big one. The IRS says that buyers and sellers both, when they engage in one of these transactions, has to have to file something with the IRS that actually says that they give you these. I think it's like six or seven classes of assets and you have to put down a dollar amount in those.
Chris Cluff:So you buy your half a million dollar business? Yep, it's not just I bought a half a million dollars, it's I bought $100,000 worth of inventory, $50,000 worth of furniture and fixtures and so forth. Right, Yep.
Pat Brady:So the IRS makes each party submit one of those to the IRS and in our experience they need to be consistent with one another. The IRS is going to take a big issue if one of them says they've, if they're wildly disproportionate from one another, and the reason is that these different classes of assets have different ways to depreciate them.
Chris Cluff:The taxability could be different. The taxability exactly so.
Pat Brady:the easiest example is goodwill and fixtures, shelves and tables and stuff like that. Typically as a buyer you want all of your allocation into that stuff like fixtures and the hard assets, because you can write that off as soon as you leave the closing table. Goodwill if you put a lot of it into goodwill you have to amortize that over 10 or 15 years.
Chris Cluff:Or longer sometimes Depends on what you're buying, right, Right?
Pat Brady:So you can only get a little bit of a tax deduction each year for that. But on the seller side you want all of that into goodwill. You want to push as much of that into those sorts of buckets because it's capital gain for you versus these.
Chris Cluff:Other than ordinary income.
Pat Brady:Right. These hard assets are often going to be ordinary income, which means a higher tax rate and an immediate tax hit and I still never understand why.
Chris Cluff:Maybe the realtors don't understand this, but you'd think when they're drafting the purchase and sale and you're having these conversations, you start at the beginning with these kind of things it should be in that letter of intent. I would think, yeah, uh, but for whatever reason, it always seems like it's the thing that is right holds things up at the closing table right yeah, and I and I like to, I, I do.
Pat Brady:We use these things called disclosure schedules quite often in our purchase and sales agreements, and what they are are are a really healthy, robust purchase and sale agreement is going to say basically what the deal is and then it's going to go through and it's going to have all these disclosures, these reps and warranties is what they're called. They're statements that the seller is going to make about the business that they're selling. There's no litigation, the company's in good standing, there's no outstanding tax audits, I mean no employee fair labor violations, all that good stuff and it's going to reference schedules. If there's any exceptions to that, it goes on a schedule. Just, the asset allocation is another schedule.
Chris Cluff:Put it in the beginning, put it at the beginning. So one thing we really didn't talk about is you talked about, you know, the due diligence. Yep, right, we didn't talk about due diligence. But when you're buying a business, you should do some due diligence and making sure there are no legal pitfalls, there's no issues, there's no lawsuits, those kind of things. Make sure the books are as they are presented Yep, making sure what you're buying is real.
Pat Brady:Yep, and the thing to always keep in mind is that when you're buying a business, when you get past the finish line, really the only recourse you have against a seller is what's in the purchase and sale agreement. So it becomes so important to whatever you care about, whatever you're making your decision on to buy that business, it's got to be in the purchase and sale agreement. Make sure whatever financial statements you're using to base your decision off of, you've got to reference those in your purchase and sale agreement. Make sure whatever financial statements you're using to base your decision off of, you've got to reference those in your purchase and sale agreement. Because if you just sign a purchase and sale agreement that says I'll buy your business for $200,000, and then post-close, you find out that the financial statements they gave you are full of garbage and they're meaningless and, lo and behold, the company doesn't make 200 grand, it makes 10 grand a year. And and there's this lawsuit they didn't tell you about and all this stuff.
Chris Cluff:You know you're in a there's not much you can go back for pretty tough spot there, okay, yeah well, good, well, that's. That was a quick summary of there's. I certainly there's a lots of ins and outs and I would encourage everybody uh, if you were thinking about doing that, find a good attorney to represent you. Don't be afraid of the bill. It will be well worth it because certainly, as we know, there's lots of folks out there that may not be doing things on the up and up and we don't want anybody to come under there.
Chris Cluff:So just really quick, I got a plug for my friends at Strategic Talent Management. So we know that people are the most important ingredient in our business's success and our friends over at Strategic Talent Management believe the way to take your organization to the next level begins with knowing your people and yourself. When leaders and managers are spending fewer hours addressing the fallout of a disengagement, mediocre performance and unclear communication, they have the time and energy to achieve the organization's goals. Tune into our friend STM's People Solutions podcast. So they also have a podcast on your favorite platform every other Thursday and they dive into all sorts of people challenges and offer practical solutions for that. So that's a very people-focused podcast. Strategic Talent Management is a client of ours, but they're also great friends and we use their services in our hiring assessments and so forth. They're really great folks.
Chris Cluff:But, Pat, thank you so much for joining us today. It's been really good. And uh, anybody certainly remember like follow, share, surprise rate review on your podcast platform for small business, big world. And again, if you have any questions for us, uh, feel free to email us at podcast at paper trailscom. How do folks get in touch with you? We have any good way you want to get through us? Yeah, Nope, Through Chris is fine. P Brady at Bergen, Parkinsoncom Perfect. There's a good email, Perfect. So again, feel free to get in touch with us and uh, or with Pat, if you have questions, and and I wish everyone the best of luck. That wants to buy a business? It's a rollercoaster.
Pat Brady:Go get them.
Chris Cluff:Good Thanks. So much to everybody. We'll see you next week. Thanks, chris. Small business, big world. This podcast is a production of paper trails. We are a payroll and hr company based in kennybunk, maine, and we serve small and mid-sized businesses across new england and the country. If you found this podcast helpful, don't forget to follow us at at paper trails payroll across all social media platforms and check us out at paper trailscom for more information. As a reminder, the views, opinions and thoughts expressed by the hosts and guests alone. The material presented in this podcast is for general information purposes only and should not be considered legal or financial advice. By inviting this guest to our podcast, paper Girls does not imply endorsement of or opposition to any specific individual organization, product or service.
