Ca$hing Out 10: Preparing the books for an exit

"Cashing Out" Week 10.   Dan Humiston and Dena Jalbert from Align Business Advisory Service are joined by attorney Larry Mishkin from Mishkin Law and CPA Jim Marty from Bridgewest CPA's to discuss how to prepare a company's books for an exit.   They also share strategies how best to minimize a company's post-sale tax obligations.   At the end of the show Jim and Larry get sidetracked with Grateful Dead and Phish stories.   

Produced By MJBulls Media 

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Jim Marty:
So you sell your company's water and not in dollars and your basis in the stock is one hundred thousand dollars then you would have a long term capital gain. So we were in that business for more than a year. Long term capital gain which is has more favorably than the ordinary income.

Dan Humiston:
Hello everyone welcome back to cashing out brought to you each week by hoban law. With me today we have a full house in the MJBulls studio. As always we have our co-host Dena Jalbert from Align business advisory services. Hey Dena. Hey Dan and our legal adviser Larry Mishkin from the Mishkin law and hoban law. Hi Larry.

Larry Mishkin:
the see you guys here.

Dan Humiston:
And last but certainly not least is an old friend who stopped by CPA Jim Marty from Bridge West CPA.

Jim Marty:
Hey Jim everybody has to be aboard.

Dan Humiston:
Great to have you Jim. For our listeners you may remember Jim. He was a guest on the MJBulls things to know when Raising Cannabis Capital series back in September. Jim founded one of the first cannabis accounting practices in the early days of cannabis and built bridge west accounting into one of the largest cannabis accounting firms in the country. If I remember correctly of locations in every state where cannabis is legal.

Jim Marty:
So obviously a client not so much office locations. We have clients in every state that has some form of legal cannabis do the tax and accounting work for about 250 licence holders nationwide.

Dan Humiston:
Well that's up because I think when you were on the show back in September it was like two hundred. Good for you Jim.

Jim Marty:
That was Oklahoma. Put it up. Well good for you. A lot of licence holders in Oklahoma.

Dan Humiston:
Well let's talk today about selling a cannabis business and we're going to keep it pretty loose and Larry and Dina if you want to jump in at any time just please do. I guess I'll get it kicked off as Jim you know when you're preparing for an exit. What are some accounting or tax snaps that a business owner can take to sort of facilitate the process and maybe reduce their ultimate tax liabilities.

Jim Marty:
Great question. And lots of ways you can get your business ready for a acquisition. One is you want to have everything in very good order your tax returns cleaned up and ready to be shown to the potential buyer once you're under a mutual non-disclosure agreement. I GUESS I'LL BE THE FIRST THING A MUTUAL non-disclosure agreement but then having your tax returns up to date your sales tax returns ready and available now for larger companies if you can provide audited or CPA prepared financial statements that can not only facilitate the sale but it can increase the value of your business because the potential buyer knows that you can rely on the financial statements being up to date. Also in regards to your keys you're standing operating procedures if you're a cultivator your grow techniques. If you're an extractor your standard operating procedures and recipes for extraction and finished goods like edibles or bait pans having all those and three ring binders and up to date and ready to go are very important to help you enhance the value of your business and also expedite the sale.

Jim Marty:
You mentioned audited financials and I know that this question comes up occasionally. Can you explain to our listeners the difference between reviewed statements and audited statements.

Yes. Well the most important concept is whether they're ordered it or review the financial statements are the company's financial statements or not the CPA first. And so the CPA firm is opining that the financial statements prepared by management are presented fairly. That's an audited financial statement a review of financial statements is a lesser in scope in that the CPA firm is helping to ensure the financial statements are in accordance with Generally Accepted Accounting not necessarily as the opinion that they're presented fairly.

Dan Humiston:
I'm assuming and audited financial statements are more expensive because there's a lot more detail involved.

Jim Marty:
Well that's it exactly the parties financial statements the CPA firm has the numbers to make sure that there's no material misstatements. Well when I reviewed financial statements they accept the management's financial statement and put them into the form of generally accepted accounting principles but don't necessarily take responsibility that they're presented fairly without any material mistakes as you would in an audit. Some states require moderated financial statements. So that's what gets us involved them doing audits. Also the deals are getting so big now especially these reverse mergers on the Canadian Stock Exchange were ordered as financial statements are required all the way through or the investors are asking for audited financial statements because the deals are 20 30 30 million dollars. Some of these deals if you're following the Canadian exchange you're going to have to prepare audited financial statements through your filings on the Canadian exchange. And there's even some cannabis companies trading on the overseas see the over-the-counter market in the United States. This has all come so fast. I think everyone on the panel will agree. They never thought that the cannabis industry would come so far so fast. We're now we're looking at publicly traded companies coming in with very large sums of capital. I'll let the others make a few comments.

Dan Humiston:
Yeah Dena maybe you can jump in. I know you had some questions for Jim.

Dena Jalbert:
You know when businesses are going through a transaction when things become that I think this would be good for you and Larry to maybe talk a bit about the taxation and tax compliance and then indemnification on how that will be a going into the transaction making sure that you're compliant but then also Larry maybe you can talk is the tax liability from any candidate whether or not they're down their taxes and what indemnification that is a Barry you might want to pay again in the next salary you need to be aware of.

Larry Mishkin:
Correct. So as we were talking about previously that's one of the ways that we make sure that certain representations for certain things are taken care of by the other side by saying that they don't take care of us and they're going to be responsible for the damage that occurs as a result of their failure. So you know typically and I'm sure we can correct me if I'm wrong but mostly deals like this one there's outstanding tax issues those tax issues have to be resolved before you can. The deal. Illinois. When you're selling a retail business from one person to another department of revenue issues was told they both sell stop order and the seller is responsible for getting this document prepared by the Department of Revenue that verifies that the ownership of the property is changing hands on that date and that's the deadline. Prior to that date it's about the seller's responsibility after that date. That's the way to deal with the Department of Revenue keeps track. So we have indemnification provisions in there that will say if you've lied if you haven't done it the right way. If there's liabilities goes back as a result you went down the fire and do it the other way to say to the new owners look if you failed to collect your sales tax after the closing and for whatever reason they try to reach back to us then you're going to indemnify us from that.

Jim Marty:
We have something similar in Colorado with our MEP our Marijuana Enforcement Division. There are a department of our parliament of revenue the tax collection agency of the Colorado government and before they'll approve a transfer of a license to a new owner. They're going to make sure that all the taxes are filed and paid or if you owe money to the IRS that there's a installment payment plan in place. So very similar to what Larry was talking about. Now as far as tax liability goes there's basically two ways to structure the sale of any small business. One is a assets sale and one is a stock sale. As a general rule the seller prefers a stock sale because they can get long term capital gains treatment on anything above their investment in their own company's stock. So it's more favorable for the seller. Buyers on the other hand are very interested in just purchasing the assets purchasing the license purchasing the grow facility the extraction machine the fixtures and cash register as a retail operation. And the reason that buyers want to buy assets is there's two reasons one. It does help break the liability chain on the taxes. So if the seller a year or two after the sale gets audited it should not affect the buyer because they put the assets in a brand new company breaking the tax liability chain. The other reason they like to buy the assets is because they can depreciate those at the price they purchase them for. So those are some of the things that buyers and sellers look for in a transaction. Usually it's a negotiated item. Most small business sales end up as asset purchases.

Dan Humiston:
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Dan Humiston:
Do you bring up something that I'm always puzzled by in its defining basis explaining to somebody what's the basis in this company when they accidentally receive a payment.

Jim Marty:
Is it less the basis that it invested in the company since it is a confusing subject as basis as a moving target. And the way you calculate it varies based on whether you're a corporation or a partnership which would be two general forms that you see the data starts out with your original investment and then an increase for profits of the company and it's decrease for cash that you take out of the company. It's a lot more nuanced than natural births of base of structures so you start with your investment it's increased for the profits of the company while you are on the increase for cash distributions or dividends that you take out and that's very simplified. But that's the concept of basis and then say you sell your companies were not in dollars and your basis in the stock is one hundred thousand dollars and you would have a long term capital gain. So we get in the business for more than a year. Long term capital gain which is has more favorably than ordinary income it's about half of tax rate. It varies some depending on your tax bracket and other things like that and a round number between federal and if you have state taxes you know you're 20 25 percent for long term capital gains versus about thirty six percent for ordinary income getting larger on capital gains treatment under sell your business is very favorable and there's also now this is brand new to within the last year is Opportunity Zones where you can sell any small business economic cannabis business and then reinvest those proceeds in an opportunity zone.

Jim Marty:
You don't have to pay tax on the profit of your small business. Well if say in the opportunity zone for 10 years you don't pay any tax on the sale of your business 10 years earlier or the profits on the business and the opportunities. So the opportunities are very exciting. They just came in to like the end of last year but a lot of the cities and towns including the city I was in LA. Rhino we have a very large opportunity zone and we're looking at seeing some exciting things there like maybe CBD water factories and other things so check out these opportunity zones it's a pretty interesting concept in its own right now.

Jim Marty:
Yeah that's really interesting. So just to wrap up basis so you said if you had a basis of 100 grand and you sold your company for a million so your capital gains would then be a nine hundred thousand. Yes. OK. So in that same line of questions for an LLC or a partnership at the end of the year the members get key ones. Maybe you should explain key ones before I move on.

Jim Marty:
Okay one is a partnership or Subchapter S shareholders proportionate share of the profits for that year.

Dan Humiston:
Okay let's just say the company lost money or a few years of losing money and you were receiving negative key ones. Would that add to your basis.

Jim Marty:
Well it actually takes away from your basis because as I said even though your basis is increased for profits if their losses they decrease your basis. Okay. Because like me you're borrowing money to cover those boxes driving down the value of the company because now it's time debt. Losses decrease for basis.

Dan Humiston:
So you don't get to carry forward on those losses.

Jim Marty:
The next step depends. That depends on a lot of things. The answer is yes possibly. You might have loss carry forwards you might have losses that you're unable to use the carry forward. Needless to say the U.S. tax code is very complicated and how you figure those carries forwards and what losses you're able to take a CPA or tax attorney really to figure those things out. That's very complicated arena of the tax code is basic issues and carries knowledge.

Dan Humiston:
Yeah I think there's a lot of people that just are thinking OK we're going to make this much money when I sell my company but then they don't really work through all the other details like so Larry. Any questions for Jim.

Larry Mishkin:
Hello. You. I just sit here and take notes when he talks to me to learn how to do and phish going to go on tour again. As a matter of fact they announced their summer tour and they're coming to see me. They're coming to Chicago so we're looking all over the place and of course I've got addiction September. You just pull in there for the weekend when that happens and it's are doing six shows a Bonnaroo. I heard about that. Yes yes yes. That's how I was a young man's game Larry and I aren't doing loitering and accounting.

Jim Marty:
We enjoy are Grateful Dead and our.

Dan Humiston:
You're not the only one in this industry that's for sure.

Jim Marty:
Yeah. When people came to me and said you know will you sign our tax returns for the cannabis industry after to being lucky enough to see Jerry Garcia 45 times before he died I said How could I say no to these people. They're my people. Yeah that's right. That's part of what motivated me to get them be cannabis is many years of enjoying and toying around with the Grateful Dead. I'm a little older than some of our people listening to this as I can probably tell by having seen actually so many dead shows some Sarah's been gone now for quite some time.

Larry Mishkin:
And when you do they'll turn you a seat while you slide Jerry you're a lighter that makes me feel old.

Dan Humiston:
Dena Do you have anything for Jim before we wrap up.

Dena Jalbert:
No no I think you had another major point. Thank you so much for sharing all that knowledge. I know a lot of people who didn't know some of those kind of key items especially. I know it's one of those are a lot of things you doesn't have to explain to clients as you go through the process. I think that's really helpful information.

Dan Humiston:
Well let me say quickly because I almost always forget if anybody is listening or any of her listeners have any thoughts or ideas please email I said connected Mjbulls that come and I'll have all of Dena's Larry's and Jim contacts information and the MJBulls website.

Dan Humiston:
So if anybody wants to follow up with any of them after the show you can go to the website. I also want to thank Jamie Humiston for composing the music as always. Guys thanks. Appreciate you guys spending the time we are in today.

Jim Marty:
Thank you very much. Yeah. Jim will you come back on the show as we move along. Absolutely. Yes absolutely. I'll catch up with you down the road. You bet. All right. Thanks guys. Thank you OK. Bye.

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