A privately-owned manufacturer of farm equipment, such as tractors and combines.
The company was valued on an earnings basis. With about $200 million in annual sales, it had a history of profitability, but also some complicated accounting regarding the rebates it received from suppliers. That’s where KPMG Enterprise came in.
The company used a lot of steel, and when it reached a certain level of usage, it would get money back from suppliers for being a high-volume customer. The more steel the company used and the more products it sold, the less it paid for steel. Since the company was growing so fast, using the historical sales figures was somewhat deceptive, because their margins got better the more they grew, since rebates improved expected future earnings. So we had to understand what earnings would be on a go-forward basis and on a normalized basis, and how the costs might change.
As the agriculture industry picked up, the company expanded as demand for its products grew. So you not only had to take the growth into account and what it might do to the cost of sales because of the rebates, but we also had significant expansion potential. With orders already in place and a new factory under construction, we had to factor in the potential sales from that, as well. It painted a totally different picture of the business.
We spent a lot of preparatory time understanding the situation and looking at how it potentially could be misinterpreted. We had to take into account how the rebates worked and how sales were going to grow as a result of expansion. It wasn’t a speculative plan. It was very tangible in terms of what we had in hand, so we took the time to prepare that information and get it down on paper, so purchasers got a complete picture on a pro-forma basis. We prepared a data room in advance of the sale so you could log on from anywhere to access all the essential documents needed – the last five years’ tax returns and financial statements, plus key agreements. It was very effective.
We had some frivolous litigation in this case. We wanted to address this early, because we knew due diligence was coming up. Dealing with it later only delays the process and raises suspicions. Get the advice of legal counsel in advance and deal with it quickly so it doesn’t become an issue.
The tax implications
When it comes to tax structuring, depending on how you sell – shares or assets – the tax attributes of the company sway your decision one way or another. Selling assets should not be dismissed out of hand; some companies have the ability to pay a certain amount of money to shareholders on a very tax-effective basis – on a return-of-capital basis – depending on their situation. It’s important to consult a tax advisor so you understand the situation and know what the implications of various structures are to you.
Another attribute of this company was that it had a lot of cash. For tax purposes, we recommended they get it out of the company before the sale – to either dividend it out or transfer it to another operating company – but leave a little for working capital.
As a final word of advice, make sure the tax installments in the current year are paid up to the time of sale. A common due diligence issue is that tax installment payments often lag in the heat of a transaction and end up being a closing adjustment with a lot of wasted time. You’ve got to watch that.