What happens to cash when selling a business?
March 15, 2023 ⋅ 10 min read
We talk with dozens of business owners each day that are considering selling their businesses and we see a lot of the same questions pop up. We’ve already written a lot of articles addressing common questions like: Should I use a broker? or How do I prepare for a sale?
One question that continues to pop up is: What happens to cash when selling a business? Technically, anything can occur based on the terms the seller and buyer agree on in the sale agreement or contract. However, what usually happens to the cash sitting in the business's bank account or safe is the seller keeps it all.
Still, the business cannot function without some amount of cash flow. Therefore, it's best to know the amount of a business's cash the new owner should receive by differentiating what is necessary for the business's regular functionality from cash assets (cash that is not needed to operate the business).
What is considered company cash?
A company's cash assets are the existing small (petty) cash on hand and cash held in the business checking and savings accounts. However, since all money belongs to the seller when selling a business, converting other fixed assets into cash or withdrawing cash from the accounts receivable or accounts payable is a deceptive practice.
It's worth noting that businesses may have cash in hand and cash equivalents. The latter refers to the company's assets the owner can quickly convert to cash and may include in the sale.
Still, everything depends on the details the buyer and seller negotiated. Sometimes, the deal requires the seller to leave a particular amount of working capital in the business to allow the buyer to pay pending bills without reaching into their pocket for more cash beyond the purchase price.
Who gets accounts receivable when selling a business?
Often, it's the buyer who gets the account receivables. For example, the cash in account receivables could be prepayment for products and services not yet delivered, such as buying a summer camp that receives prepayments for the following year's admissions at the end of summer.
Is cash an asset in a business sale?
Technically, cash is an asset for the business on its balance sheet. Still, the seller does not usually include it when selling the company unless both parties negotiate the deal's details to warrant it. However, sometimes it is beneficial to have cash as an asset when selling a business, especially where the buyer requires working capital to run the business.
Sellers who have cash and debt in their business can improve the terms of sale in their favor by using the money to pay off existing loans. Even if the seller assumes all business debt, buyers are typically more interested in a business with no existing debt.
Still, what business owners sell or include as assets in the sale of a business can also depend on the industry the company falls into and how it's marketed.
The primary reason not to treat cash as other assets when selling the business is that both parties usually agree on a net working capital figure instead of how to treat each part of working capital.
What happens when you sell your business?
When selling a business, buyers will value it based on its earnings, prospects, and assets. Therefore, the sale price may not be dependent on cash in the bank or the amount of debt owed. In addition, buyers typically don't have to repay business debt since that's the seller's responsibility. That being said, if the buyer doesn’t pay for the debt, the seller will. Sellers should consider their debt when negotiating.
Buyers probably won't pay more or less for a business with a bigger debt liability since they won’t be responsible for the debt. Instead, they will only pay the market price or valuation. As a result, the sale does not affect the buyer's price, but any business debt present will affect the seller's net proceeds.
The structure of business sale transactions is generally on a cash-free, debt-free basis. It means that sellers keep the cash in the business because they could use it to repay debt. But, conversely, they could have borrowed more money to increase their cash reserves and operating capital, making debt and cash interlinked.
Excluding cash and debt from what the buyer purchases allows the seller to keep both. The buyer pays the purchase price while the seller pays for expenses, fees, taxes due, and outstanding debt. Sellers will use the business cash to contribute to these items.
Extracting cash from company before sale
There are multiple ways of withdrawing money from a business, so it is best to consult a professional such as an accountant to determine the best way to do it. In addition, because companies and their internal finance structures vary, it is best to consult your on-hand accountant.
Most business owners withdraw cash from their business through bonus checks or regular salaries. Others focus on deductible expenses, retirement plans, and company benefits to receive payouts because they avoid taxes and provide benefits for themselves and their family.
Sometimes, business owners integrate the withdrawal of cash from the business into their sale contract, allowing them to remain on the healthcare program after selling. Therefore, owners entering retirement don't have to seek private healthcare.
Another reason for consulting an accountant is to avoid costly taxes when withdrawing large sums. Therefore, the accountant can advise on the best way to withdraw the cash during or after selling.
Sale of accounts payable
What happens to accounts payable when a business is sold? The buyer and seller can negotiate the payables incurred before the transaction date to suit the existing circumstances.
If the buyer assumes the responsibility for payables, the amount of accounts payables probably will reduce the purchase price paid to the owner. As a result, the new owner keeps more money at closing and may get a set period of interest-free financing for the payables.
How much cash to leave when selling a business?
The amount of cash a seller provides in a business sale depends on several factors, and working capital usually determines how much money to include.
Asset sale transaction tips
Below are some transaction tips and information on asset sales and their effect on a business sale transaction.
What is an asset sale of business?
An asset sale is a business transaction where a buyer purchases a business's assets, such as equipment, fixtures, leaseholds, licenses, goodwill, trade secrets, trade names, telephone numbers, and inventory. In an asset sale, the seller retains legal ownership of the company, including its debts and liabilities.
An asset sale is a cash-free, debt-free transaction. It does, however, include normalized net working capital – accounts receivable, inventory, prepaid expenses, accounts payable, and accrued expenses as part of the sale.
As a result, an asset sale usually carries less risk for the buyer and allows the seller to perform fair market value due diligence. The final asset acquisition completes the sale. This is typically how small businesses are sold.
Asset sale example
To better understand how an asset sale works, take a look at an example.
Let's say that there is a company called ABC Corporation. This company has two buildings, machinery, and inventory. The owner is looking to retire and liquidate their business.
The owner of XYZ Corporation is interested in acquiring ABC Corporation through an asset sale to expand XYZ Corporation.
In this sale, XYZ gets all of ABC’s assets to expand XYZ’s operations without acquiring any of ABC’s debt. And ABC avoided complicated tax implications by doing a full asset transfer versus selling assets separately. Additionally, the seller should price in goodwill for the business to get to the desired price.
Advantages and disadvantages of asset sales
Asset sales tend to be favored more by the buyer. Since they don’t inherit the seller’s debt and liabilities, there is less risk involved in this type of purchase. The advantages of asset sales are:
Buyers can write off assets for tax purposes.
Buyers are free from the seller’s potential liabilities.
Buyers get a fresh start – credit, reputation, workers comp rating, etc.
Buyers’ costs paid on the assets are depreciable..
However, there may be some disadvantages for the buyer when it comes to making an asset sale. These include:
Buyers have no established credit.
Buyers have to find new or rehire employees.
Buyers must be qualified both financially and operationally.
Buyers must pay sales tax on assets.
The other type of sale that can happen when selling a business is a stock sale. Let’s compare stock sales to asset sales below.
Asset sale vs. stock sale
Most small businesses are sold using an asset sale - it’s important to work with excellent legal counsel to make sure you are protected against liabilities, Baton can help. The main difference between an asset sale and a stock sale is that a stock sale only involves equity acquisitions. In a stock sale, the buyer has to purchase a company in its entirety – including all contingent risks that are known (like debt) or unknown (like future potential lawsuits).
Each has different tax implications, advantages, and disadvantages. Asset sales tend to be preferred by buyers, while stock sales tend to be preferred by sellers, but buyers and sellers may choose an asset or stock sale for different reasons.
An asset sale is not restricted to specific company entity types or business structures.
An asset sale generates significantly higher taxes than a stock deal for the seller.
Costs paid for an asset sale are depreciable for the buyer.
An asset sale may cost the seller more in taxes, but it may be better for generating buyer demand.
Stock sales are exclusive to incorporated entities: C Corporations (C-Corp) and S Corporations (S-Corp).
The buyer assumes the company in its entirety – including all of the company's assets and liabilities.
Selling and transferring company shares is much simpler since you won’t have to negotiate separate terms for each asset.
A stock sale has better tax implications for the seller.
Tax implications to consider when selling a business?
Business owners selling their business or assets must treat the sale as income and pay taxes. The cash received from a business sale, asset sale, or sale of shares is often classified as capital gains. However, the IRS will not tax the profit from an asset sale of a Limited Liability Company (LLC) separately. Instead, the seller will pay the taxes under their personal tax return since they don't treat cash as an asset in a business sale transaction.
Business owners selling their business or assets should structure the sale appropriately to take advantage of tax savings. For example, they may keep account receivables and only pay income taxes after receiving them and not during the sale.
Navigating the tax implications that come with selling a business is not something you have to navigate alone. Working with an accountant or tax advisor can help minimize the taxes on the sale of your business. Baton has a network of tax professionals to support you in a business sale or acquisition.
If you’re thinking about selling your business, you probably have some questions. You may be wondering what to do with the cash in your company account or what could happen to it. That’s why we recommend working with a team of professionals, including tax professionals, who can answer these questions and offer advice throughout the entire process. At Baton, we help business owners and buyers navigate business sales. We assist owners in identifying how much their business is worth and support them throughout their journey to either grow or sell their business. Get started with Baton today!