Timely, Ethical and Profitable Mergers and Acquisitions

It may sound callous, but because of the current state of the economy, now might be a good time to pick up or sell a distressed commercial tree care business. After all, handled properly, mergers and acquisitions (M&As) allow the acquiring business to acquire another operation under favorable terms that is a good fit, and that might not otherwise survive.

An M&A transaction also can mean helping a troubled business survive without the owners or shareholders completely losing what they’ve built up over the years. Equally important, an M&A can save the jobs of workers.

Although more than one tree care professional has gotten into trouble in an M&A transaction, acquiring a smaller business usually limits much of the risk. Plus, there is now insurance to further reduce the potential of risk, fraud or misrepresentation.

Vive la différence

Mergers and acquisitions are similar but have a few major differences. Mergers combine two separate businesses into a single new entity. True mergers are uncommon, because it’s rare for two equal businesses to mutually benefit from combining resources and workers.

Unlike a merger, acquisitions do not result in the formation of a new business. Best compared to buying an existing business or franchise, with an acquisition, the purchased business is fully absorbed by the acquiring company. This often means the acquired business is liquidated.

Why acquire?

Mergers and acquisitions are an efficient and effective method of growing and expanding a business with a lesser investment of time and resources. Obviously, there must be a strategic fit between the tree care business and the operation being acquired, but think of the many ways in which acquisitions are desirable, such as:

• expanding the customer base;

• trimming and streamlining the combined operation, which will increase profit margins by eliminating inefficiencies;

• acquiring a quality management team and new talent – this means new ideas, thoughts and mindsets that can challenge the tree care operation’s current workers to start thinking outside the box;

• better customer service – every business, regardless of size, needs to ensure customers are happy with what the operation is providing; and

• beating the competition – a business that chooses to remain stagnant and uninterested will inevitably be overtaken by the competition.

Why a merger or acquisition may be good

When the owners of a business are worried about liquidity, about making payroll or paying the bills, one of the few options to sustain the troubled business or get some benefit and liquidity for it is via a merger or acquisition. Selling to a competitor, another strategic player or even a financial investor may be the only way of preserving the tree care operation.

Creative deal structures involving
earnouts and other forms of contingent consideration may be useful in bridging valuation gaps. A lower asking price with payments spread over a number of years obviously benefits the buyer and means a smaller tax bite for the seller.

Value and pricing

A key question in every M&A transaction relates to the value of the business. It is important to understand that offer price and valuation, much like the other terms in an M&A deal, are negotiable.

If the parties to an M&A transaction are unable to agree on an acquisition price, one solution might be a so-called “earnout” to bridge the different prices. An
earnout is a contractual provision that allows a seller to receive additional consideration later if the business sold achieves certain financial metrics, such as milestones in gross revenues or earnings before interest, taxes and amortization (EBITA).

Although an earnout can pose significant risk for the owner/shareholders of a selling business, it creates a path for the selling stockholders to ultimately receive the return they seek from the sale of their business.

Paying for it all

Because M&As are expensive, adequate funding is a necessity. Fortunately, financing an M&A transaction with stock is a relatively safe option for both parties, since both share the risk.

In many share-exchange transactions, the buyer will exchange their shares for shares in the business being acquired. Paying with stock is especially advantageous for a buyer, especially if their shares are overvalued.

In a merger, shareholders on both sides can reap long-term benefits from a stock swap, as they will generally receive an equal amount of stock in the newly formed operation, rather than simply receiving cash for their shares.

Paying with cash is another alternative, though potentially expensive from a tax standpoint. After all, cash transactions are instant and relatively mess free, and usually don’t require the same kind of complicated management as stock would. Unfortunately, smaller tree care businesses without large cash reserves must usually require alternative, and expensive, financing to fund their cash transaction.

Another popular alternative to paying for an M&A with stock or cash involves agreeing to take on the debt owed by a seller. After all, for many businesses, debt is the reason for the sale.

Assuming the burden of debt

Unfortunately, debt can reduce a business’ value, often to the point of worthlessness. From a buyer’s point of view, this strategy is often a cheap means of acquiring assets.

Being in control of an operation’s debt can mean increased control over management in the event of a liquidation, since owners of debt have priority over shareholders. This can be another incentive for would-be creditors who may wish to restructure the new business or simply take control of its assets.

Insurance

Much of the risk in an M&A transaction can be eliminated with an often-
overlooked type of insurance. Warranty and Indemnity (W&I) insurance has evolved from its introduction in the 1970s into a popular and sophisticated tool for protecting buyers and sellers from the financial losses in M&A transactions.

W&I insurance essentially removes the risk in an M&A transaction. With underwriters offering protection against downside risk, W&I insurance also eliminates the required use of escrow or personal guarantees, while providing certainty and finality to both parties.

Employees and benefit issues

As already mentioned, tree care professionals’ businesses enter into M&A transactions for various strategic reasons, usually with the view to create synergies, enhance capability, enter a new market or gain in economies of scale. But the M&A should not be viewed only from an economic point of view. It also should consider the workforce.

M&A transactions, even smaller deals, typically involve a number of important employee and benefit issues that will need to be addressed. Naturally, any M&A may result in job losses or changes in work culture that impact employee morale.

Fortunately, much of the confusion during and after the M&A can be reduced with regular communication, keeping the workforce updated, answering their questions and attempting to alleviate any doubts they may have.

Taxing the M&A

When two businesses exchange shares of stock in a merger, rarely does it result in a tax bill, unless, of course, so-called “boot” is received. Boot is any consideration received by owners and shareholders in the target entity other than the buyer’s stock.

It is a similar, no-tax story when a business acquires control of another company by assuming its debts. But, when the acquisition is comparable to a sale, the seller pays capital gains tax on the amount by which the sale price exceeds his or her “basis” in the entity.

Going one step further, the tax bill, even at the current low rate for capital gains, is reduced if the acquisition or sale contract calls for payments spread over a period of time. The spread-out tax bill often is used by the acquiring tree care business to justify a lower overall sale price.

Other provisions of the Tax Cuts and Jobs Act (TCJA), such as the full expensing of asset costs, may cause many to weigh their effects on any transaction. In reality, the ability to do a
taxable-asset transaction and take advantage of front-loaded deductions may encourage tree care businesses to complete a taxable deal instead of a tax-free transaction.

Caveats

The various coronavirus-relief measures make caution advisable. Buyers should have a good understanding of the situation if the targeted tree care business took PPP loans or employee-retention payroll-tax credits.

Both parties should agree on the treatment for the loan or potential forgiveness, given the impact of new legislation. Plus, the business being acquired should be examined for opportunities with payroll-tax deferral and/or qualified-improvement property or losses that may be carried back for refunds under the CARES Act.

On the downside, M&A deals are often difficult to accomplish. The interests and objectives of sellers and buyers are all too often discordant. The owners and shareholders of a business being acquired want the highest price with little or no residual risk or liability. Acquiring tree care businesses, the buyers, want the lowest price possible with maximum recovery options.

Conclusion

The coronavirus pandemic has had a significant impact on business in general and requires everyone to be realistic about how their business will perform in the new normal. The pandemic also has created a tremendous opportunity for M&A transactions where both acquiring and selling businesses can benefit. Naturally, expert tax and legal advice is strongly recommended.

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