Let’s Make A Deal

The most important items to consider when selling your club—or buying one!

For any business owners, but even more so for club owners in our particular industry, the sale of the business will likely be one of the largest events they encounter during their life.  Accordingly, our hypothetical club owner needs to take the time to understand this decision process with the guidance of his or her CPA, or even a tax attorney who has a lot of experience with business sales to lower that tax liability and maximize the profit on this sale.  We are going to take quick peek at the most obvious and common types of deal structures that a business owner will use when selling their club. And let’s be really clear here: Read this, then holler at your CPA, or get a good one, and get a good transaction attorney to represent your side of the deal.
While there are many variations of deal structures available, the vast majority of deals fall under one of two broad categories that are addressed below: (1) asset sales; and (2) stock sales.  One of the main factors to consider when deciding between an asset sale and a stock sale is the tax consequences and question of liability.
For our little discussion here, when I say “stock,” I am referring to any kind of corporation, any LLC, or any entity that an investor/owner will sell directly to the Buyer as opposed to a specific asset sale.

The “Asset Sale”

A CPA and your attorney will tell you an asset sale results in the best tax benefit and least liability risk for the buyer.  In an asset sale, our buyer purchases only the identified assets of the business that it wants to or needs to purchase to continue and operate the business, and the price paid is spread out and allocated to any of a bunch of identified items. These include the real estate, the “FF & E” (the fixtures, furnishings and equipment) and last but not least, the almighty and god-awful kitchen-sink term, “goodwill”.  The buyer’s new tax basis in all the purchased assets will be equal to the total purchase price at closing—the sale price, essentially.  The buyer’s “basis” for each asset is going to be that amount that the parties agree to allocate to each of the assets purchased, provided the allocation is accepted and agreed to by both parties. (You don’t get to go back and fudge the numbers after the sale for reporting purposes without mutual agreement.)
Since our club is a real, physical structure, there are really two parts on this deal: the real estate of the club … and everything else. So you’re going to sell the real estate, and that sale is either the physical building or sale of the lease on the building.  Why do I say you can “sell” the lease?  The lease has value to the buyer, because that lease allows a sexually oriented business to operate there at that particular address. It has value that you and the buyer can agree on, and of course, now you have the landlord to consider in this deal if your real estate is leasehold. Watch out for the greedy landlord!  I have seen great deals get killed by shortsighted landlords.
And now, for every club owner who does own the building personally, do this now (unless your attorney or CPA says not to for some reason): Set up your ownership of your real estate in some separate entity, like an S Corp or pass-through entity, and lease it back to your club! This will protect you and your assets in the event of a problem or liability, and even help the sales process when the time comes.
In general, the buyer will want to allocate the most money to assets that depreciate on the shortest depreciation schedule. He will want to allocate more of the total sale price to just about anything besides the real estate. The seller will sell an item at that “depreciated” value, but an asset sale will benefit the buyer more so when taking depreciation and will also help the buyer in the future when he decides to sell.
What do I mean? Your real estate (but not the land itself) is depreciated over 39.5 years. Your FF & E all can get hit with differing depreciation schedules (anywhere between three to seven years, or even longer in some cases), or can get “expensed” outright in the first year you purchased something. Goodwill, in short, is simply anything above the cost of identifiable tangible assets in the sale.

The big liability question: What can bite the buyer—and the seller?!

The buyer wants to do an asset purchase also for one other really important reason: potential legal liability.  As we are all aware, there are mercenary attorneys who have started making a cottage industry out suing clubs for labor and employment liability issues. Or there may be a liquor liability Issue. Or there may be a sexual harassment issue …and on and on.  The buyer, and the buyer’s attorney, will look to insulate the purchase by buying only assets, not the corporation or business entity itself. That buyer will want to leave, or stick that liability question with the seller.
Obviously, our seller wants to sell the whole operation, and let the buyer assume any and all questions. However, in some cases, the buyer will choose to—or may be forced to—buy the corporation or the business entity because the SOB license could be tied by grandfathering or some other residual mechanism directly to the operating entity. If the buyer does an asset sale, he or she may find that the SOB or adult-use designation does not continue, and consequently be truly screwed.  This can also happen in some states with regard to the liquor licensing, and in others to established prior nonconforming use, which gets to the business licensing and permitting in a city or county. The takeaway on this is, if you’re the buyer make sure your closing transaction attorney is not just a good closing attorney, but that he or she is experienced in SOB or licensing questions, and/or has got the blessings of a FALA attorney on the deal!  Just do it, please.

Environmental liabilities

All of the above relates to business liabilities essentially, but as a commercial real estate broker, I have to hit this one other potential liability question: environmental.  This affects both the buyer and seller.  Know what in the hell is under the floor—i.e. underground—and what is in your building.  As a seller of the real estate, ignorance is not a defense on environmental issues. And if you know, and don’t disclose, the buyer sues you or unwraps the deal. The buyer is expected to be smart enough to check on environmental liability during the due diligence period, or to be indemnified on this aspect before closing.
And just so you know now, if you’re just leasing the building, and you sell the club business knowing there are unidentified environmental problems (asbestos, lead paint, mold, etc.), you can get yourself in a world of hurt with that buyer if he runs into a problem in the future. Since we know that a lot of deals are owner financed, and not “bank” vetted, there is a tendency to not address the environmental questions, or to even do a Level One Environmental Assessment, but this is something you just have to at least be mindful of.

The “Stock Sale”

A stock sale is typically beneficial to the seller.  In a stock sale, the buyer will get a basis in the stock. The seller pays taxes on profit on the deal at lower capital gains rates. However, now we do have to take into account the 3.8% taxes on investments for the Affordable Care Act (aka “Obamacare”).  While the lower capital gains rates make a stock sale beneficial to all the forms the seller can have, a stock sale in real life in our industry is not really as an option unless the seller is a C corporation and tied to that double taxation structure.
On the other hand, the tax consequences to the seller in an asset sale are not as favorable.  The tax treatment to the seller in a stock sale is usually a better deal for the seller regardless of how the seller is set up as either an S, C, or a pass-though entity. Again, like a broken record, talk to you CPA!
Bottom Line: The Asset Sale is the norm in our industry. Be aware that there are some unusual reasons why a “stock” sale is what has to be done for both parties involved.  Consult your professional! Your comments and suggestions are very much appreciated.