Business and nonbusiness income are important concepts in Ohio tax law. Business income refers to the apportionable income among states where the taxpayer’s business is conducted, and it is generated from the business’ operations. Ohio nonbusiness income refers to the earnings allocated to the business’ state of domicile which is generally produced outside of normal business operations. Ohio law favorably taxes business income at a flat 3% and provides for a business income deduction. These tax treatments are not available to nonbusiness income.

Previously, the Ohio Department of Taxation’s position was that the sale of a business interest did not qualify as business income, subject to the favorable flat tax rate and business income deduction, despite the statutory definition of business income including proceeds from a liquidation of a business interest. Taxpayers that claimed business sales’ proceeds as business income, along with claiming the corresponding deduction, were challenged by the Department of Taxation, sometimes resulting in litigation.

To help resolve the disputed interpretations of liquidation proceeds and sales proceeds, HB 515 now provides two scenarios in which income from the sale of an equity interest in a business definitively constitutes business income eligible for the corresponding deduction: (i) if the equity sale is treated as an asset sale for federal income tax purposes (for example, an Internal Revenue Code §338(h)(10) election was made); or (ii) if the seller materially participated in the business activities during the year in which the business is sold, or in any of the five years preceding the sale. Satisfying either of these scenarios will enable the taxpayer to claim the business sales proceeds as business income in Ohio.

It is important to note that legislation is intended to be remedial, such that it will apply to petitions for reassessment, refund applications, and appeals pending on or after HB 515’s effective date, as well as to any sales transaction that is subject to audit on or after HB 515’s effective date.

If you are contemplating the sale of an Ohio business, we welcome the opportunity to speak with you and discuss the impact of HB 515 on your potential transaction, as well as how McCarthy Lebit’s Mergers & Acquisitions team can further assist you with a successful transaction.

Please reach out to request a consultation or call us at 216-696-1422.

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A term sheet typically covers structural, financial, process, and legal matters such as:

• Deal Structure – Asset vs. Equity
• Purchase Price and Terms of Payment – Amount, Deferred Payment, Seller Financing
• Assumption and/or Exclusion of Liabilities – Payables or other obligations
• Due Diligence – Scope and Process
• Timing – Schedule of Events, from signing to closing
• Closing Requirements – Conditions Precedent, required approvals and consents
• Employment Matters – Retention or Termination, of owner and/or other key employees
• Post-Closing Considerations – Working Capital Adjustment and Business Transition Matters

The term sheet provides a road map for the parties as well as their counsel and advisors moving forward through this process. It will form the basis for drafting definitive documentation. If the parties disagree on certain terms, they will look back to the term sheet for guidance. This will help alleviate potential misunderstandings or sources of conflict.

That is not say that the term sheet is written in stone. Situations change during the course of due diligence and re-negotiation may be necessary in those instances. In such a case, it is appropriate to revisit the term sheet and revise accordingly. Absent such circumstances, however, it is considered bad form to re-trade terms previously agreed-upon in the term sheet as it may sour the relationship between buyer and seller or even derail the transaction.

While most terms are non-binding, there are certain provisions which are binding upon the parties such as:

• Exclusivity – Buyer has the exclusive right to consummate a transaction for a set period of time
• Confidentiality – Agreement not to disclose confidential information
• Non-Solicitation – Seller will not seek or entertain other offers
• Governing Law – Which State law governs with respect to interpretation of the letter of intent

The term sheet is the critical first step for a transaction and will set the path going forward. Before signing, a seller should consult with counsel and financial/strategic advisors to confirm that it accurately reflects their understanding of the pending transaction and properly accounts for all the material deal points.

For assistance reviewing your term sheet, please reach out to request a consultation or visit Mike’s bio for his contact information to reach out to him directly.

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Change in Control, (CIC), agreements have become a common feature of management-level compensation packages. In an era of increasing consolidation and private equity involvement, a potential for merger, acquisition, or sale is a huge area of concern for employees. If key employees know the company is positioning for sale, how do you keep them fully engaged and committed, especially when such a transaction might result in their own job loss? How do you prevent the high-level employee from losing objectivity about a potential sale when closing the deal will likely result in unemployment? To retain top talent in an environment of M&A uncertainty, HR leaders often turn to CIC agreements.

CIC agreements, generally speaking, provide that a designated employee will receive a set amount of compensation upon the occurrence of certain contractually defined events. Typically, CIC agreements are either “single trigger,” meaning that the payout occurs upon the sale of the business or a change in control, or “double trigger,” meaning that the benefit pays upon the sale or change in control, plus a job loss or material reduction in role or responsibilities within a certain time thereafter.

If, however, the employee is permitted the opportunity to remain employed by the surviving entity, in a double trigger agreement, the CIC benefits are not paid. Increasingly, modern CIC agreements are double trigger.

Benefits under a CIC agreement often take the form of a severance payment that is in excess of standard company policy. CIC benefits are typically expressed in terms of a multiple of base salary — the more essential the executive is to a consummating sale, the higher the multiple. It is not uncommon for bonus and fringe benefits to be paid for a like period of time.

In addition to or in lieu of severance pay, CIC agreements may involve accelerated vesting of equity that pays upon sale. This is an important consideration for those who have long-term incentive plans that involve multiyear vesting cliffs. Accelerated vesting of all unvested units can be of tremendous value and may allow an employee to realize the value of grants that would otherwise be subject to forfeiture upon separation from employment.

CIC agreements vary widely and should be tailored to create a true win-win for the company and for the executive in whom the employer hopes to inspire loyalty.

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This series breaks down the sale of a business into three distinct phases:

1. Phase 1 or the Infancy Stage – the business owner (the “Owner”) starts to think about his succession plan and begins to prepare for Phase 2;
2. Phase 2 or the Childhood Stage – the Owner proceeds down the chosen path towards the sale/transfer of his business; and
3. Phase 3 or the Adulthood Stage – the Owner sells his business and fulfills post-closing obligations, if any.

Phase 1:  Infancy

In the next 10 to 15 years, approximately 12 million businesses owned or control by the baby boomer generation will close or change hands.  A 2016 survey of small business owners found that 90 percent of small business owners anticipate selling or transferring their businesses, as opposed to closing them.  This same survey found that 72 percent do not have a current succession plan and are not taking any action at the moment in anticipation of a sale.

Owners must first sketch out potential transfer options.  There are countless ways to structure a transfer, but some of the most common are:

1. Transferring to children that are active in business;
2. Purchase by a current management team; or
3. A third-party sale.

Owners must also decide what role they see themselves taking on post-sale.  The Owner may wish to retire altogether, stay active but transfer all or most of the ownership, or the Owner may desire to remain with the company in a reduced capacity for a period of time.  Often times the Owner takes a role as a transition consultant while retaining a piece of ownership for a potential second bite at the apple.

As the Owner begins to formulate succession options, there are some steps the Owner should take to maximize the value of the business and facilitate a smoother transfer.  The company’s books and accounting records for the past three to five years should be in order and prepared in a consistent manner, and the Owner should discuss with his accountants the possibility of a transfer or sale. The Owner should take a thorough look at operations to determine if there are efficiencies not being utilized.  The Owner and his attorneys should review material contracts and the Company’s compliance with laws.  Phase 2 will touch more on these issues, but it is crucial that the Owner begins to think early in the process about all the various facets of the company that a potential buyer’s due diligence team will scour.

As the Owner begins to formulate his succession plan, it is imperative that he brings the right team to the table.  Engaging qualified and experienced advisors in Phase 1 is crucial to the success of a sale. The right investment banking team can add significant value to a deal by determining the fair market value of the company, guiding the Owner through the transaction, and locating potential strategic buyers or private equity buyers. Experienced M&A attorneys help the Owner navigate each turn in the arduous sale process and strive to minimize the Owner risk while maximizing value.  Lastly, the Owner should confirm that his accounting firm has relevant M&A experience to ensure that the deal structure is tax efficient for the Owner and that the firm can assist with the transaction as needed.  Rather than focusing on price, Owners contemplating a sale should concentrate on the value that each advisor brings to the transaction.

Lastly, the Owner needs to step back and determine what they want from a transition and what they need.  A seven-figure sale price might not be sufficient for an owner in his early sixties if he was previously taking a generous salary and regular distributions from the company.  Factor in taxes, the cost of healthcare, and the Owner’s retirement dreams and what the Owner needs from a transfer may be different from what he gets for his business. The sooner the Owner’s goals and necessities are determined, the quicker the Owner and his team of advisors can chart the path toward realizing those goals.

Next month’s blog will discuss Phase 2 – Childhood and Adolescence.  Phase 2 consists of finding the right suitor, preparing for and surviving due diligence and negotiating the deal terms.

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