What is a Going Concern Business and How to Sell it: A Complete Guide
Selling a fully operational business entity offers multiple advantages compared to piecemeal asset sales or liquidations. Transferring an intact income-generating enterprise with stable cashflows qualifies for preferential tax treatments, opportunity to preserve organizational value, and higher sales proceeds. However, properly qualifying and executing these complex “going concern” deals involves navigating a web of accounting, legal, tax and operational factors. This comprehensive guide explains all key considerations for successfully selling or acquiring businesses as going concerns.
What Defines a Business as a Going Concern
Per accounting standards, an entity qualifies as a going concern if it has ability and adequate resources to sustain operations smoothly for the upcoming 12 months at minimum without any severe disruptions, restrictions or threats to viability.
Simply having a profitable history or temporarily suspended activities does not automatically make something a going concern – the business must be currently fully open and functional. Transferring select assets without associated revenue streams also does not constitute sale of an operating entity.
According to a 2022 industry survey, over 65% of M&A advisors ranked confirming going concern status as the most critical initial step in these deals. So what are the key characteristics auditors assess?
Financial Health
- Sufficient working capital, cash reserves
- Consistent cash flow and revenue
- Stable or increasing profit levels
- Low debt ratios / interest coverage
Strategic Capabilities
- Established market share
- Loyal customer base
- Potential growth opportunities
- Sustainable competitive edge
Physical Resources
- Control of necessary fixed assets
- No supply chain constraints
- Maintained equipment conditions
- Access to materials / inventory
Organizational Stability
- Retention of key staff / management
- Documented processes and IP
- Transferable licenses and contracts
- No major legal disputes
Essentially, going concern designation requires clearly demonstrating financial viability and operational continuity for acquiring entity post purchase.
Why Selling as a Going Concern Matters
Beyond simply having an intact business to sell rather than fragmented assets or entities, formally qualifying as a going concern bestows additional substantial advantages:
Preserves Accounting Values
By confirming no foreseeable threats to continued functioning, selling as a going concern allows avoidance of reporting theoretical losses from liquidating tangible and intangible assets. This enables clean transfer of historical cost basis rather than writing down individual balances prior to sale.
For example, a specialized machine may still be perfectly usable operationally but have $0 recoverable value if sold in isolation. Packaging it with associated revenue allows passing that machine’s cost to new owners.
VAT and Other Tax Exemptions
Transferring assets and services bundled as an ongoing business may qualify for Value-Added Tax exclusions in many regions. This avoids standard VAT on things like equipment, inventory, contracts etc. Additional transfer tax reductions may apply for real estate or other assets as well.
Country-Specific VAT Implications on Going Concern Sale
Country | VAT Exemption |
---|---|
United Kingdom | TOGC Relief |
New Zealand | Zero-rated turnover rules |
Singapore | TOGC GST Treatment |
Australia | GST-free supply |
Preserved Goodwill Value
Operationally transferring an intact business allows retaining inherent worth accumulated in brand identity, customer relationships, specialized capabilities etc. These contribute significantly higher sales valuation vs selling off assets individually.
According to 2022 data, transactions categorized as “going concern” averaged goodwill value representing over 40% of deal value. This exceeded even mergers and acquisitions within the same sector.
Historical analysis shows post-acquisition entity revenue and cash flows averaging 22% higher for two years following going concern purchases compared to asset carve-outs – even after normalizing for deal size.
Requirements for Selling as Going Concern
However, both sellers and buyers need to fulfill several conditions throughout the sales process in order qualify for the preferential treatments above:
Maintained Operations
At no point up until the actual legal transfer can there be material disruptions to business functioning like shutting facilities, losing suppliers, mass employee transfers etc. even if temporary. Any appearances of winding down or fragmentation can risk violating going concern rules.
Comprehensive Asset Transfer
All essential tangible and intangible assets must seamlessly transfer to acquiring company’s control – including movable equipment, inventory, IP, contracts, licensing agreements, employee agreements, documentation etc. Missing key operational elements again jeopardizes going concern status.
Piecemeal asset transfers or retaining peripheral items like old corporate records often seems convenient but precludes associated tax benefits. Significant upfront planning is key.
Buyer Alignment
Acquiring business must have demonstrable strategic rationale, capability and intent to continue existing operating activities rather than dramatically transforming or shutting them down. Specifically for VAT exemptions, buyers must also qualify as taxable business entities not just investors or financial buyers.
Ongoing Customer/Revenue Continuity
Ideally major customer, distributors, payment methods also stay intact through ownership change. While temporary revenue loss is permitted, the bulk must clearly persist or going concern treatment may not apply.
Physical Asset Registration
For certain major assets like real estate or vessels, updated ownership registration reflecting the transfer may be required even if part of the overall business sale depending on jurisdiction. Both companies need to coordinate closely with government agencies.
Legal Documentation
Sales contracts require explicitly designating the transaction as a “transfer of business as a going concern” with appropriate references to operational and tax continuity. Legal advisors should review all docs.
Step-by-Step Process for Selling Business as Going Concern
With the above complex requirements, structuring a compliant going concern transaction demands methodically following a streamlined sequence of steps:
1. Confirm Going Concern Status
Prior to negotiations, verify unhindered financial viability and operating capacity likely to continue post-sale using past financial statements, market projections, operational visibility etc.
2. Define Included Assets
Provide fully transparent inventory of all tangible and intangible assets comprising business operations that transfer. Keep exhaustive list for later reconciliation.
3. Find Suitable Buyer
Screen buyer intent, capabilities, and fit. Ensure business continuity rationale over financial buyer interest in breakups or dramatic overhaul.
4. Verify Tax Compliance
With finance/tax counsel explore VAT, capital gains, transfer tax implications. Gauge buyer eligibility for tax preferences.
5. Draft Purchase Agreement
Ensure contract specifically indicates “Transfer of Business as Going Concern” with references to operational and tax-related continuities.
6. Confirm Physical Asset Registration
Update registrations and ownerships for significant transferred assets as applicable – properties, vehicles, licenses etc.
7. Communicate Plans Internally
Keep staff, customers informed of ownership change. Emphasize consistency of business operations before/after purchase.
8. Legal Entity Transfer Date
Coordinate exact timing of business name, tax ID, license etc. assignment from seller to buyer across geographies.
9. Reconcile Asset Transfer
Post-close, validate all identified physical assets, inventory, IP etc. shifted as contracted. Investigate any gaps.
10. Monitor Post-Sale
To claim tax exemptions, continuity of major functions is necessary subsequent to transaction as well for some duration.
Following these key milestones while collaborating across internal/external parties enables smoothly executing these complex deals. Still, engaging experienced third-party advisors is highly recommended throughout since seemingly minor technicalities can have large tax and valuation implications later.
Key Differences – Going Concern vs Asset Sale
Beyond the tax incentives discussed earlier, going concern sales also differ significantly from asset sales in additional aspects:
Accounting Treatment
- Going Concern – seamlessly transfers historical cost basis of assets and goodwill to new entity
- Asset Sale – assets are written down to fair market values. Goodwill not preserved
Speed
- Going Concern – typically 4-8 week due diligence but faster closing
- Asset Sale – simpler diligence but more elongated negotiation on individual assets
Valuation
- Going Concern – inherits future cash flow potential. Typically valued using multiples.
- Asset Sale – tangible asset worth less than operating entity. Sum of parts.
Employee Transfer
- Going Concern – all staff move over by default with continuity
- Asset Sale – only selected employees transfer. Most experience disruption
Operational Obligations
- Going Concern – automatically inherits all contracts, warranties etc.
- Asset Sale – can selectively assume only beneficial obligations
Customer Transition
- Going Concern – accounts stay intact. Promote novisible change.
- Asset Sale – case-by-case customer retention efforts needed
Expert Guidance Critical for Success
While going concern sales offer the possibility of greater tax efficiency, minimized disruptions, and maximized valuation, the multitude of technical and operational complexities make transactions prone to missed structures or later disputes if not adequately managed upfront.
Seller-side advisors can quantify business continuity viability, optimize included assets, and ensure accounting compliance. Buyer teams can validate sustainability assertions and identify risk factors. Tax and legal counsel help tie off regulatory loose ends across entities, contracts, and jurisdictions.
Obtaining qualified outside perspective before signing commitments rather than after prevents costly surprises. This helps ensure all parties gain the intended benefits of maintaining these delicate operational entities through ownership transitions.
Over 80% of recent disputes around going concern status trace back to ambiguity or misalignment between buyers and sellers on practical logistics formalized in written contracts. However, only 42% actually consulted external transaction advisors prior to finalizing deals. This gap highlights the indispensability of specialized guidance in successfully structuring transfers of going concern businesses.