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?
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.
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.
This shows how comfortably your business can pay short-term debt from assets readily converted to cash within the next year.
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.
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.
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.
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.
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.
When you are selling your business as a going concern, these are the major steps.
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.
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.
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.
