Chapter 6
Selling to a third party

As we discussed earlier, the traditional path for a family-owned business is a family succession. But there are numerous reasons why that approach isn’t always appropriate. Most often, no one in the family is interested or qualified. Or rocky family relationships may make a fresh start for your company desirable. So rather than force a family succession, you might look to another trucking company or to an individual who is looking to enter the industry or move from a management position at another carrier.

Special considerations
Recognize that selling to a third party likely will be a highly emotional decision. When selling to a family member, the transition somehow seems less final because the business is staying in the family. But when a third party takes over, the business you and perhaps your ancestors have built over decades is gone – at least in terms of control. In some cases, such as when the new owner plans to absorb your company into an existing operation, the company may not even exist any longer, which may be especially traumatic.

In cases where the new owner really wants your capacity, drivers and real estate, he may no longer want your services in any capacity. Often, however, the new owner may ask – or sometimes insist as part of the transaction – that you remain in the business for some time. Those usually are situations when the buyer is very interested in your book of business and desires your presence as comfort to customers that there will be continuity.

A typical period for retaining a seller in the business is six months to two years. But there are many exceptions. One large southeastern trucking company was purchased by a New England company, and the seller stayed on as CEO. The seller had no reason to keep ownership because he had no family, and the buyer recognized the seller’s genius in running a trucking company. Immediately, the buyer put in place some irresistible golden handcuffs and named a successor-to-be.

Another important way a transfer to a third party usually differs from transfers to insiders is negotiating strategy. When you transfer the business to family or even employees, you certainly want to provide for your retirement and be rewarded for your years of efforts. But you also have an emotional attachment to the successors and want them to succeed.

When you sell to a third party, however, your goal typically will be to maximize your financial return – period. That involves considerable attention in selling and promotion that isn’t required when transferring the business to insiders. And while the bankers who will finance internal deals will certainly demand a great deal of documentation and commitments, it’s nothing like what you will endure in a third-party transaction. Expect the prospective buyer to scrutinize your company – fleet age and condition, driver quality, customers, lanes and financial stability – to a degree that will at times be uncomfortable.

Assets or stock?
When you sell your business, the transaction will be structured as either an asset sale or a stock sale. An asset sale involves your tractors, trailers, equipment, accounts receivable, and any other amount above your hard assets called “blue sky” or goodwill. In a stock sale, you sell the business itself rather than its discrete parts. The difference may not sound that important, but it most definitely is from a legal, tax and accounting perspective.

Sellers prefer stock sales. In a stock sale, you transfer not only all assets but also all liabilities, known and unknown. In an asset sale, however, you could still be liable for actions taken by your managers and employees before the transaction was completed. All things being equal, you surely would sleep better knowing that you no longer bear any liability for a trucking company that you no longer own. In addition, the seller usually fares better on taxes in a stock sale because he will be paying capital gains tax rates instead of ordinary income tax rates.

Meanwhile, most buyers will insist on an asset sale for precisely the same reasons – liability and tax treatment. The buyer can take what he paid for your assets and depreciate them starting from the purchase price. In a stock sale, however, the buyer must keep the same depreciation as you had. The buyer most likely would lose a lot of depreciation expense if he isn’t able to start at his purchase price. Any extra depreciation that the buyer can take through an asset sale is that much more of a tax deduction.

Most deals ultimately are structured as asset sales, but the outcome depends on a number of factors that often are highly specific to your case. One major consideration is whether the buyer or the seller is more motivated to complete the transaction. If you are anxious to exit the business, you cede some leverage to insist on a stock sale. But if the buyer is chomping at the bit to get your business, you might get your way.

Thinking ahead
Prepare to consider a full range of financial, operational and tax-related issues. Pretend that you are the buyer and ask the questions you would ask. You are kidding yourself if you think the buyer is going to overlook a significant impediment to a deal. It’s better to anticipate those hurdles and figure out a solution before you get to that point.

Draft credible projections of future performance. Don’t assume, for example, that you can add $1 to your revenue per mile. You will wreck your credibility and kill any chances at a deal. Don’t try to hide the age of your equipment or the timing of your fleet replacement. You might find a buyer who won’t insist on verifying these facts, but it’s highly unlikely. To the buyer, you will appear to be either dishonest or incompetent. Either way, you have blown the deal. If you have unusual one-time costs, explain them. Don’t leave a buyer to guess what might have gone wrong.

Remember that appearances are everything. As you near the time that you will be inviting prospective buyers to visit, watch for and address situations that can erode the value of your trucking company. What is the condition of your trucks and trailers? Are they clean? Is there a large amount of deferred maintenance? Do you need to clear junk from your yard? Is your compliance up to date? Even in an asset sale, buyers these days are interested in your drivers despite the fact that many of them will leave during the transition. Buyers will want to look at log books, drug tests, safety records and the history of safety meetings.

Sellers must also devote sufficient effort to demonstrating the strength of the business’ management team and its coherent business plan. Invest in a business plan before you put your company on the market.

Your preparation horizon isn’t just weeks or months. Selling a business requires upfront planning ranging from possible pre-transaction restructuring to identifying the strategic alternatives. As in any succession planning option, it may take five to 10 years to prepare. If selling is your best option, you will need to have an attractive company to sell. Restructuring may also be required. Discuss the following steps with your CPA:

• Conversion of legal entity. You may need to address what type of legal entity your company is, and you may be in for a long waiting period, perhaps up to 10 years, so the tax man won’t hit you.
• Transfer of assets. Consider separating your business into several entities. You might want to retain some assets, for example. Or you might get a better return or tax treatment if you sell your assets piecemeal. There may other reasons for combining assets in different ways.
• Re-capitalization. This is a big word for changing the structure of your stock. If you are an LLC, you may want to issue non-voting units. If you are a C corp, you may want to issue preferred stock. There are estate planning, tax and control reasons to re-capitalize.
• Movement of money. You may want to change the way the company is funded. If you are sitting on cash, you may desire to take the cash out and borrow. There may be tax reasons to make this move to get your cash out of the business.
• Preparation for seller financing. You may need to consider helping the buyer fund the transaction – assuming you are up to the sizable risk. You would need other sources of income in case things sour. But more important, you will need to watch ongoing developments in the business closely. You will need legally binding covenants that govern the buyer’s management so that the company retains its value in the event of a default. Plus, you will need an ironclad contract defining precisely when the buyer is in default and what your rights are when he is.

Again, these are very complex steps that go beyond the scope of this book. Discuss your options with a CPA.

The process of selling
If you have been successful in trucking, you know that the effectiveness of your sales effort can be as important as the value of the service you are selling. The same is true for selling your company. You wouldn’t blast out an e-mail to a bunch of trucking company owners offering to sell the company to the highest bidder. That approach would fail and, worse, would damage your company’s reputation in the eyes of potential serious buyers and, especially, customers. The timing and approach of your sales strategy should take into account these key steps to a successful transaction:

• Identifying potential deal-breakers and avoiding costly surprises
• Maintaining control and credibility of the selling process
• Preparing a package in anticipation of the buyer’s due diligence
• Optimizing tax benefits with the best deal structure

Let’s assume that your fishing for buyers has attracted a nibble. After the formalities of clarifying who represents whom, and the signing of nondisclosure or confidentiality agreements, you’ll likely be meeting with the buyer and his agents. So where do you go from here?

Qualify your buyer. Your prospective buyer should already have arranged for financing. At the very least, he should have discussed the purchase with his banker or other funding sources. Also, you should be confident that the buyer can run the company or has a plan in place for running it. This is absolutely essential in the case of seller-financed deals, of course.
Insist on a down payment. Obtain personal financial statements, and do what bankers would do – look for three sources of repayment: (1) the cash flow of the deal; (2) the assets of the guarantors and (3) collateral. Lenders will examine debt-to-equity ratios on a before-and-after basis, so it can pay to do some “what if” scenarios to determine what the prospective buyer can afford. If you can’t make the numbers work, neither will your buyer.

This may sound like a lot of work at this stage, but you don’t want to endure the hassle of due diligence and negotiation just to have the deal fall apart over financing.

Brace for due diligence. If you are uncomfortable with being second-guessed, get ready for some trying times. The financial side of due diligence is fairly straightforward and number-driven. The prospective buyer will ask for monthly financial and operational statistics and compile them in a way that facilitates a good understanding of the seasonal trends, the customer base, the weekly averages per truck, etc. He also will compare your numbers for reasonableness against his own numbers.

More unsettling is the subjective part of due diligence. The buyer will examine operations and culture – aspects of the company that go right to the heart of your performance as chief executive. The buyer is looking at whether your drivers and managers will “fit” with his present team.

Closing the deal
If the buyer likes what he sees and there is mutual agreement on at least a ballpark price, the parties will sign a letter of intent (LOI). While not usually structured as an enforceable legal contract, the LOI really sets the stage for the entire transaction, so don’t sign it lightly. Have your CPA and attorney review it, and don’t rush. Many items in an LOI, if not changed at some point in the process, can have huge tax and legal consequences down the road. This is really the point where you should be committing to a deal or killing it. Ideally, later steps in the process are about putting the LOI into a binding agreement.

Next comes another round of due diligence, often far more intense than the first. Assuming the deal survives this far, you move to the document stage. The agreement drafts arrive, and your attorney and CPA carefully verify that your understanding of the agreement is reflected in the final purchase agreement.

You aren’t done yet. You now have two closings to endure – the purchase transaction and the bank financing. These are tedious, detail-oriented affairs that usually end without a major problem. But deals occasionally do fall apart at this stage.

That’s a very basic look at selling to a third party. Next we address the final commonly used method for transferring a business: selling to employees or management.