by Michael Whitacre, tax partner at BDO USA, LLP
Startups are great—to start—but most should have a vision of moving to the next stage of their business life-cycles. Such a change typically spurs the startup founders or management team to undertake one of three business scenarios: getting acquired, scaling up and staying closely held or scaling up and going public.
Each scenario comes with its own set of tax and accounting considerations. However, for the purposes of this article, we are going to focus on the third option: what startups need to know from a tax and accounting perspective when looking to be acquired.
Manage your state and local tax (SALT) exposure:
SALT risk management is an important pre-acquisition activity. Evaluating your state and local income tax exposure can help you identify ways to mitigate your overall tax liability, create efficiency, minimize penalties and possibly increase profits and cash flow, which in turn can make you a more attractive acquisition target and avoid having some of your acquisition proceeds “clawed back” by unrecorded tax liabilities and penalties.
Because of complex rules and aggressive state tax authorities, multi-jurisdictional startups may be subject not just to state income tax, but also sales-and-use tax. Even if your company may not be generating taxable income yet, you should still be aware of sales tax liability which can be applied against your company’s sales regardless of your level of profitability.
Between founders’ stock, investors and equity issuances to employees, startups may have numerous stock issuances that are not properly tracked and documented which can cause some practical issues when you are in the process of being acquired. Startups should ensure that an accurate capitalization table, with a detailed listing of vesting events, is maintained and that stock certificates are properly issued and maintained.
Revenue recognition matters:
Revenue recognition rules under financial reporting guidelines can be extremely complicated for many companies and often result in startup companies misstating their revenues. This can be an unwelcome surprise and result in a negative adjustment to your anticipated proceeds if this is discovered during due diligence related to the sale of your company. By looking at a finance department structure, you’ll see how dealing with finances has changed over time. In terms of your business, if you are not sure about how to deal with the finances, you’ll definitely be able to find a specialist that can assist you within this finance structure.
To add to the complexity, the accounting standards for revenue recognition will be changing over the next few years and technology companies are expected to be impacted by these changes. The company should have its revenue recognition policies reviewed by a qualified professional in order to ensure that they are in accordance with the accepted accounting guidelines.
What’s your transaction sale structure?
Understanding the different issues and outcomes of stock sales vs. asset sales is important because it’s not always a net sum zero game—it has tax and risk liability implications for both seller and buyer.
Buyers may prefer asset sales, where they purchase individual assets and liabilities, because they assume less risk and could realize additional tax benefits. In a stock sale, the purchaser buys the owner’s shares of the company, assuming all associated risks, and may be unable to obtain a stepped-up basis tax treatment for the acquired assets.
Additionally, you may consider the benefits of structuring the deal as a tax-free reorganization—i.e., accepting stock rather than cash and avoiding or minimizing the tax impact.
While some founders actively pursue becoming an acquisition target, others may find themselves being pursued. Regardless of how you get there, the sheer complexity of these deals often requires an expert level of tax and accounting financial acumen. Therefore, taking steps to understand the basics of these transactions and leveraging trusted advisors accordingly can mean the difference between success and failure.
Material discussed is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs.