Tax Implications of Selling an Online Business

It shouldn’t shock you to learn that when you sell a business, you will have to pay taxes on the sale. However, the amount of taxes you will pay can vary depending upon the expertise and advice of a knowledgeable accountant and business broker. While there are many nuances to each sale, here is a brief summary to help sellers understand the general tax implications of selling an online business.

There are two types of business sales; asset sales and stock sales. Most transactions are structured as asset sales.

Asset Sale: With an asset sale, the buyer acquires the business’ assets, rather than the corporation or entity. This is the preferred route for buyers as they are only acquiring the assets but no prior or potential future liabilities.

Stock Sale: With a stock sale, the buyer will purchase the legal entity of the business, which includes all its assets and liabilities. While the purchase agreement signed by both parties will typically indemnify the buyer from any known or unknown legal or tax liabilities which occurred prior to the sale, the buyer is still liable for such damages and must then litigate against the seller.

Obviously, an asset sale is a much cleaner process and usually the only time that our transactions are structured as stock sales are when there are licensing agreements tied into the entity which are not transferable or assignable.

When the asset purchase agreement is finalized, there is an accompanying asset allocation which will list all the assets of the transaction, with monetary amounts assigned to each category.

For instance, in an online business sale, the allocation might be divided into the following categories: fixed assets, intangible assets, goodwill, and non-compete agreement. The intangible assets and goodwill are taxed as capital gains, which can be anywhere from 15-20%. The other categories would be taxed as ordinary income, which clearly would be at higher rates than capital gains.

The majority of our sales are negotiated to be nearly entirely all intangible/goodwill asset allocated and thus taxed at a significantly lower rate. However, not every website broker is experienced in such matters and understands the complexity of these tax issues. They will likely push this job on your CPA. Our advisors have advanced finance degrees and are properly educated in these matters. Therefore, we are able to favorably negotiate this significant phase of the process for our clients.

As we are only briefly touching on this subject, there are additional extremely beneficial strategies which we discuss with our clients when we list their online business.

If you are considering selling your website business and would like some proper guidance, feel free to give us a call, email or complete an inquiry on our website. We’ll be happy to work with you!

Common Mistakes Sellers Make When Selling Their Online Businesses

Each year, hundreds of online businesses that are listed on the market are not sold. Sometimes external conditions such as the economy, an industry or access to capital are factors but most of the time the reason is that the seller is simply not properly prepared by his or her advisor. When a seller is not properly prepared by his broker, fatal errors can occur, which can easily destroy the transaction process.  Some of the most common mistakes are listed below, in no particular order.

  • The owner either has or is given unrealistic expectations in terms of the valuation of their internet business. Some online business owners believe that their business is worth more than it truly is and find a rookie business broker that is eager for a listing and will therefore agree to list it at an unreasonable multiple. A more seasoned broker will provide a rough valuation upfront and advise the potential client that their expectations are unreasonable and unachievable, and that it would simply be a waste of everybody’s valuable time to proceed with the listing at an unobtainable price.
  • When an internet business owner does not have a proper website broker advising them in the process, they will likely not be properly educated about the different sort of buyers that are out there. For instance, private equity buyers might just be looking for a strong ROI and might be seeking to improve margins by eliminating employees. A strategic buyer or competitor would be a great suitor but sometimes they do not offer an attractive enough multiple to entice a seller. Other buyers may only be looking to put down 20% and finance the acquisition with an SBA loan. There are intangibles with each type of buyer and it is important that the seller is properly educated on such. Some sellers believe that they are saving themselves money by not hiring an online business broker to begin with. Unfortunately, they have no idea of how time-consuming and intensive the process is and the inevitable mistakes that will be made and the subsequent fallout either. An online business sale is extremely nuanced and complex. Additionally, an educated and experienced website business advisory service such as W3 Business Brokers will ensure that you’re reaching the right buyers and receiving the highest possible price for your business along with the best terms. We would provide you with the proper guidance during each step of the process and protect you and your business while making it as stress free as possible for you.
  • Owners sometimes believe that the best buyer for their business is a local competitor, customer, supplier, friend, or family member. However, those buyers may not be interested or financially qualified to consummate the deal. In today’s global environment, the buyer of your online business does not need to be local. The majority of our website sales are to buyers in other states. It is a fairly simple process to transfer the business with its tangible and intangible assets to another state or country. The ideal internet business broker will have a database and Rolodex of institutional and individual buyers who are actively seeking profitable private website businesses. It is crucial for a broker to identify the ideal buyer pool to market the business to. For that reason, when interviewing a prospective broker, it would be prudent to inquire about their buyer data base. We know the types of online businesses and price-points that our buyers are looking for and the types that our competitors’ buyers are as well. There are some website brokers that mainly represent businesses with cash flows of $50,000-$100,000, while our listings begin at the $100,000 level. We simply know that our buyers are looking for higher priced businesses and would therefore refer a potential seller of a smaller business to one of our competitors if we did not believe that we could properly serve them.
  • It is also important to present the business in the best possible light. Some brokers spend very little time on their presentations, while we spend dozens of hours on our prospectuses, highlighting the key aspects and highlights of the business, such as growth opportunities, reputation, industry position and overall analysis, supplier relationships, valuable intangible assets and other factors which buyers will certainly need to be made aware of. We make it appoint to be as transparent as possible, knowing from being one of the oldest website brokerages in the country, what questions prospective buyers might have and certainly what they should know. Unfortunately, not all online brokers understand this, nor do they put in the ample time necessary to prepare a professional and inducing CIM.
  • An experienced and financially educated internet broker also knows what financials, documents and data will be requested and necessary during the due diligence process. Based on the 100+ deals that we have closed, we can easily advise you in advance so you can prepare and organize all the necessary documents ahead of time, which will make the due diligence process more seamless and quicker, leading to a smooth and prompt close. We can assure you that not all brokers will do this, and this very well might hamper the due diligence phase, which many times may kill a deal.

The bottom line is that if you’re considering selling your profitable online business, you want to work with an experienced internet business broker, who will educate you and prepare you for the transaction as it will eliminate key errors during this important process.

Deal Optimism in 2019

Just about a month into the new year, small-to-middle market M&A confidence appears to be gaining. A few recent surveys questioned M&A participants and business owners about their expectations in 2019. Most responded that they believed M&A activity would increase due to a strong economy, baby boomers exiting their businesses, GDP growth, and a favorable business environment.

Both strategic buyers and Private Equity firms are sitting on a lot of cash, eagerly looking for solid deals. The majority of the respondents also stated that they expect the average size per transaction to increase this year as well.

On the sell-side, we are noticing the same as there are many family businesses and baby boomers contacting us as they are exploring their exit options. Some are looking for outright exits, while others are open to taking most of their money off the table while sticking around for a prolonged transition.

On the buy-side, deal particulars vary as some buyers are seeking outright acquisitions while others would prefer to purchase a majority stake with the owner retaining a minority stake and remaining as the operator for some time.

While it is tempting to anticipate the future M&A market with rose colored glasses, there are some potential headwinds to consider. For instance, rising interest rates and economic uncertainty can be potential obstacles for deals.

Many respondents of a recent Deloitte study, “The State of the Deal M&A Trends 2019 Survey”, said that rising interest rates would slow their activity or reduce their ability to execute on deals. However, the “baby boomer effect” does remain a powerful potential tailwind as many of these small business owners ($100,000 to $10 million in sales) are looking to retire soon.

Last year, 36% of small business owners who responded to the survey said they plan to sell or transition their business within the next five years, which is up from 27% just seven years ago.

Therefore, based on Economics 101 – Supply vs. Demand, with a larger number of businesses up for sale over the next five years and with the current economic environment and corporate tax code, the conditions for a ripe M&A market are surely favorable.

LOIs, Earnest Deposits, and Exclusivity

Alright, so you received a Letter of Intent (LOI) with a reasonable offer. Sounds good, right?

Yes, but in addition to the purchase price and deal structure, there are other essential aspects of the agreement that must be discussed and negotiated. Two of the significant terms which other online business brokers might not emphasize are earnest deposits and exclusivity. In this section we will discuss the meaning and importance of each.

Earnest Deposit

It goes without saying that most buyers would prefer not to put down a deposit once the LOI is agreed upon. However, as our client’s broker and advisor, we believe it is a necessity. An earnest deposit is typically equivalent to about 5-10% of the total transaction value and is almost always fully refundable should the deal not get to closing.

The primary reason behind the deposit requirement is really a show of good faith on the buyer’s part that they are somewhat financially qualified to fund the transaction. With a seller providing sensitive financial information and revealing many aspects of the business during the due diligence phase, an earnest money deposit is customary for transactions of all sizes / types as it proves the buyer is serious.

If a buyer refuses to come up with an earnest deposit, which is held in escrow, then that clearly illustrates that they either do not have the money to close or that they are NOT as serious as they have demonstrated. After all, a non-binding piece of paper (LOI) without an earnest deposit is not sufficient for our clients to engage in the due diligence phase, and we advise them as such.

Exclusivity

Some buyers request 100% exclusivity upon execution of the LOI, which means that we can no longer market the business. That is troublesome as there is no guaranty that the buyer will close and if he does in fact back out of the transaction, then we would have to begin our process from square one again.

We understand that the buyer needs some sort of comfort that if he is going to expend a lot of time and money into due diligence, he does not want to risk the seller having the ability to “ditch” him and engage with another buyer. That is perfectly understandable.

That is the reason that we propose to add exclusivity language which is more than fair. The language that we have drafted for this exact purpose clearly gives the buyer an exclusive on the business and ensures that he has the exclusive right to execute or cancel the deal up until the closing date.

So, for instance, on a deal with a 30 day due diligence period, without a non-refundable deposit, a buyer can technically walk away from the deal for any reason on the last day of due diligence while retrieving their entire deposit, which means we would have lost an entire month on this listing.

As a result, we need the ability to continue to field backup offers in case a buyer decides to back out at the last minute. Therefore, if the buyer does back out, I can immediately engage with the other serious buyers who I have cultivated and retained during that month, for that very reason.

If the buyer does genuinely want the business, which most do, then this should not be a concern as the language clearly ensures that they have the EXCLUSIVE first right to execute the deal up until the closing date, and that any other offers received could only be treated as backup offers if they don’t close on the deal.

The Importance of High-Quality Marketing Materials

When it is finally time to sell your online business, your internet business broker is crucial in the preparation of the key materials necessary to effectively market your company. Here at W3 Business Advisors, there are two critical documents that we prepare prior to the listing of your website business.

The first one is an executive summary of your business, also known as the “teaser” or teaser ad. The teaser discreetly summarizes the high-level highlights of the business along with the financial and operational performance, industry, competitive advantages, and other significant aspects which may distinguish and differentiate your business. What the teaser does NOT disclose is the name of your website, business, or any other identifying information and when we draft it, not even a seasoned CIA code breaker would be able to determine such. Many website brokers under emphasize the significance of a professionally done teaser ad, but we understand that many buyers, including private equity firms, strategic corporate buyers and deep-pocketed entrepreneurs might review dozens of ads at a time, so it is vitally important to make a strong first impression as one never gets a second chance to make a first impression.

The second document that a professional internet broker will prepare is a more comprehensive prospectus, otherwise known as a confidential information memorandum (CIM) or “deck”. This is for the prospective buyers who express their initial interest in learning more about the website business. Most of our competitors only prepare a short PowerPoint presentation or a few page PDF of the business. However, we draft an extremely detailed report, usually 10-12 pages long, which illustrates all aspects of the business and contains detailed financial statements and relevant statistics and highlights. It is extremely important to have a professional and transparent prospectus prepared as it will enable buyers to evaluate the business and decide whether they want to move on in the process to a higher-level phase. If a website owner does not work with a professional internet broker such as W3 Business Advisors then his or her online business will not appeal to the right buyers as it may cause many potential desirable buyers to seriously consider their business.

As a potential seller, it can be prudent to ask a business broker for a recent prospectus or two so you can evaluate and compare the quality of their presentation prior to choosing to list with them.

Search Funds – A new Breed of Buyers

If you have never before heard of a “search fund”, don’t worry…. you’re certainly not alone. While its inception dates back to 1984, only in recent years has it surged in popularity. In its simplest form, a search fund is an investment vehicle, through which investors financially support an entrepreneur’s efforts to locate, acquire, manage, and grow a privately held company. A new generation is now emerging from elite business schools and it is comprised of young entrepreneurs who are going to Main Street rather than Wall Street. Instead of the high paying yet high stress finance jobs, these newly minted MBA grads are opting to become CEOs by looking for and subsequently acquiring small businesses. This strategy is seeing unparalleled growth as according to searchfunder.com, the number of search funds has increased a whopping 428 percent over the last five years, increasing at a rate of about 40 percent per year.

This unprecedented growth has been driven by both an awareness of the model and its success. According to searchfunder.com, “More programs about entrepreneurship through acquisition are forming at the business schools, and various universities are having conferences about the model. There’s also the global expansion—now that there have been successful search funds in other markets, people are looking to do that.” The entrepreneurs are largely targeting the small-to-middle market businesses, valued anywhere from $1 to $20 million—deals which might not make sense for the cost structures of traditional PE firms. This influx of young entrepreneurs will likely support valuations of the $1 million + business market for near future.

There are three types of search funds—traditional, self-funded, and fundless sponsors. Traditional funds are those which the “searchers” raise capital from a group of investors in order to look for a company with certain agreed upon attributes. The investors have the right of first refusal on any deals the searcher may find. Self-funded searchers finance their own search efforts but once they find a deal, they then look for outside capital. The terms are negotiated on a deal-by-deal basis, according to searchfunder.com. Self-funded searchers also often utilize SBA loans due to the favorable and flexible terms offered. Lastly, Fundless sponsors raise search capital on a deal-by-deal basis often from a single source or a group of investors. Fundless sponsors are more savvy, experienced and know how to structure deals.

Many industry insiders believe that the industry will continue to boom and this should bode well for sellers of ecommerce, SaaS and other website businesses. If the pool of buyers of a profitable online business becomes more crowded, then an experienced advisor such as W3 Business Advisors will use that leverage to extract the highest possible transaction price.

Why Reducing Business Dependence is Crucial Before a Sale

One of many critical variables that buyers analyze prior to making an offer on a business is whether the business is fully dependent on the seller. If the answer is yes, then it is a much more challenging sale than otherwise, as the buyer must rely (or depend) on the seller for a longer than expected transition, which introduces an additional risk factor to the transaction.

When we speak with sellers that are interested in selling their website, we advise that the best way to reduce the online business’ dependence on them is to begin to delegate many of their responsibilities to their competent staff members.

If they do not have talent capable of absorbing some of their roles, then it can be prudent to bring in the appropriate personnel ahead of a sale. When you transition to more of an absentee owner, it adds a lot of value to the business as it increases the potential buyer pool, especially when the business is on the larger side.

This is due to the many small-to-middle market private equity firms that have ample money to spend but sometimes do not have an operator or manager who can jump right in and take over the seller’s responsibilities.

Additionally, here at W3 Business Advisors we also advise our sell-side clients to properly document important processes and key information so that their staff can run things smoothly both before and after the transaction.

Also, a buyer will feel more confident when processes are well documented as they understand that the knowledge transfer will be more seamless, and they can rely less on the seller post-sale. Owner reliance is just one of the key factors which affect the value of an internet business, which is why it is extremely important to work with an experienced, educated and knowledgeable website broker, who can properly advise you on all aspects of the sale of your business.

Longer track records warrant higher multiples

In some of the older posts, we discuss the different factors that influence the multiple which an online business will sell for. One of the most important factors is the longevity of the website business. Ecommerce and other internet businesses that have a longer track record generally will fetch a superior multiple than ones with shorter track records.

We receive many calls from website owners wanting to sell their online business after only operating it for a year or so. We always advise them that while the site can be sold, it would unquestionably be more prudent to have some patience and operate the business for at least another year or two.

Sure, many other website brokers would not be honest and tell them the same as they would want to just get the listing and whatever commission they can earn. However, at W3 Business Advisors, we would not ethically be doing our job and looking out for the best interest of a client if we did not instruct explain this to them. Sure, as a successful entrepreneurial website owner, it can be exciting building a profitable website business and then rapidly flip it.

However, “aging” the business and operating it for a longer period can certainly increase the multiple from 1.5 or 2.0x trailing twelve months cash flow to 3.0x cash flow. The majority of the sellers do in fact wisely take our advice, keeping in touch with us, and ultimately listing and selling the website with us for a substantially higher price.

An experienced, confident and successful business broker will lead the client in the direction that is best for the client – not themselves! It is their fiduciary and moral responsibility to do so.

Why you should redesign your website prior to selling

One of the most important yet often overlooked things to do prior to selling an internet business is renovating your website.  Website designs are not timeless and should be updated every 2-3 years.  Company logos should also be redesigned every 3-5 years.

While potential buyers will spend a lot of time analyzing the financials and the viability of your business, they will also analyze your website and if it is dated and not up to par with your competitors, then it is likely that they will build expense that into their valuation model.

The cost of updating a site will amount to fractions of the cost of creating a site from scratch as much of the relevant content has already been established.  Therefore, we do tell our clients with dated sites that it makes absolute business sense to touch up the site prior to us listing the business as the minimal expense of the project will be well worthwhile and ultimately equate to a much higher valuation multiple.  The higher valuation multiple results in a staggering return on investment for the update.

If you think about it, websites and logos are not unlike traditional brick and mortar businesses in the sense that they must renovate and update their logos and signage every so often.  A potential retail customer will sooner walk into a competitor’s updated store with a cool and stylish sign just as likely as one will purchase from a competitor with a trendy website.  Visitors will leave a website immediately if it is aged and doesn’t appeal to them.  Updating your graphics, layouts and color schemes may not seem very important and is a rather trivial investment, but it can ultimately fetch you an additional five or six figures when you close on the transaction.

As experienced website brokers, we interact with extremely knowledgeable buyers, including private equity firms, strategic buyers and deep-pocketed entrepreneurs on a daily basis. Therefore, we have an exceptionally broad view of the landscape and are thus able to provide our clients with an unbiased perspective and unparalleled strategy.

Why some online businesses sell at higher multiples than others

In general, most online businesses usually sell within the range of 2.0 to 3.0 times the Seller’s Discretionary Earnings (SDE).  However, there are outliers as there are certain sections of the market (mostly businesses that sell and provide consumable goods and services) that command (and at times exceed) the higher range of these multiples.

Why are those companies selling at premium multiples? Here are the reasons:

Longevity

A website business that has been around for a decade or longer will certainly warrant a higher multiple than a similar one with less operating history. The business will likely have well-indexed keywords which is invaluable to the site’s organic traffic. Buyers will pay extra for a more established online business with a viable future and historical cash flow as there will be less risk and greater predictability.

Wide customer base

Companies that sell everyday products and services such as health and beauty products, sports and fitness products and pet products for instance, have an advantage of being appealing and easily understood by a wide range of potential customers.  These companies might have a wider potential market than other more niche businesses which may only appeal to a more limited market.  Prospective business buyers understand the demand for these consumable products, which customers might use recurrently and then buy again in the near future, which makes the acquisition of that sort of online business more attractive.

Built-in revenue

If a company comes with an established residual revenue base, it will automatically generate a higher price. Companies with strong customer bases create security for a business unlike trend companies where most customers are one-off buyers in a market which might not be hot for long.  Buyers of businesses with recurring revenue streams know they have a viable and sustainable established customer base to work with, allowing for easier expansion; it’s much more efficient to cross-sell additional products or services to an existing customer than to acquire new customers. That is the inherent “low hanging fruit” which is highly valuable. A prospective buyer also knows that reaching and acquiring new customers will be more feasible when having a strong financial foundation as a turnkey platform to work with. Furthermore, reaching and acquiring new customers by exploring new marketing mediums and sales channels is more viable when revenue streams are strong in other areas of the business. Examples of eCommerce businesses with high repeat customer rates would be ones selling consumable products such as razor blades, water filters, pet food and supplies, cosmetics and personal goods, baby products, etc. Some examples of service businesses with high recurring revenues and customer retention rates might be SaaS (software as a service) businesses or digital marketing agencies.

Limited specialized knowledge

A business with a short learning curve and smooth transition – one that a potential buyer with just general business knowledge can acquire and start running immediately will command a higher multiple than one requiring special knowledge.  Generally speaking, the majority of eCommerce businesses do not require too much experience or specialized knowledge and a new buyer can easily take over and manage the business with ease. With some service industry companies, especially when there is a saturated market of companies offering the same service, it may take some specialized knowledge to stand out. An easy way to analyze this variable is by using the simple economics of supply and demand.  With little specific knowledge required, the business can appeal to a larger pool of potential buyers and thus have greater overall reach and demand. On the other hand, should a specific skill set be required of the incoming buyer, then there will be fewer potential buyers available and subsequently less competition for the business.

Passive Income Websites

Another online business that usually demands a higher multiple is an AdSense website; a passive online information portal/web directory which derives 100% of its revenue from advertising displayed throughout the website. With many of these websites, the “heavy lifting” has already been done and the site continues to carry a considerable amount of weight as it relates to organic traffic rankings. Unlike many other internet businesses that are subject to the overhead costs associated with selling tangible products, this sort of business maintains an extremely low working capital structure with steep profit margins. These businesses generally do not require office space and are run from an owner’s home, mostly on autopilot with the owner spending very little time operating the business. This is an attractive business model as the website receives 100% organic traffic and generates revenue as users click on the relevant ads which are placed on the site. In layman’s terms, Google AdSense is an ad network that allows an owner to place ads on his website and profit when people visit the site and then click on the ads. The program uses keywords and other data to place ads which are relevant to the website content. When visitors come to a website and click on an ad, Google earns money from the ad placement and then pays the website owner a percentage of what is earned.  The individuals creating these ads are marketers using Google AdWords, who have decided to expand their reach beyond just Google search.  Therefore, Google reads AdSense websites, analyzes their content, and then targets website visitors with relevant ads, which come from the marketers who are using AdWords to associate their ads with certain keywords.

To sum it up, different prospective business buyers want different things from a business and each has his or her own investment criteria. But in general, companies that maintain the above invaluable characteristics and sell or provide consumable products and/or services needed by a large base of customers command a substantially higher multiple than those with more of a specialized niche.