Avoid this Costly Mistake When Selling an Amazon Business
Selling an Amazon business, which is a growing trend, not only do you need to evaluate the items to maximize your deal but consider the major item that will kill a deal. There are many new investors looking to buy a profitable Amazon business. It is also a popular benefit for new Amazon sellers entering this business with the possible benefit of “cashing-out” and selling the business one day.
Since Amazon changes the “rules of the game” seemingly monthly, and with more competition and uncertainty, selling and cashing out of a profitable business may be the safe and smart play, because who knows what could happen to your niche 12 months from now, with competition and changes. What happens if your profits nose-dive? If it does, will your valuation nose-dive?
When selling an Amazon business for maximum profit, there are several factors that come into play. Those include and are not limited to:
• Are you selling a proprietary product (vs resales and private label)?
• The age of your business, 2 years is the minimum recommended age to consider selling.
• Are all your IP’s (trademarks and patents) in place?
• Profitability. This is a key factor that will determine your overall sales price.
• Growth. Showing consistent growth, year after year will affect your multiple.
• Diversification. Multiple products, each tracked with its own profit margin, is ideal.
• Reviews. Quality and quantity are key.
• Competition. Less is better, and, of course, this is subject to change.
• Low return rates
• No outstanding legal liability
• Change to accrual accounting method. This drives evaluations. It is important to understand your true profitability and working capital.
These factors and others will help determine if you are able to sell your business for a 3-5x multiple of your net profits. The term often used is EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, which is a more specific measurement of a company’s overall financial performance.
In general, if your Amazon business had profits of $500K per year, x a multiple of 3, that means you are looking to sell for $1,500,000. There is more involved in the sales process and ultimate pricing, but this is a general example.
Why Consider Selling Your Amazon Business?
When you start a business, it makes sense to have goals. Typically, the goals are around profitability, which, in the end, is the only reason to start a business. You don’t start a business to work more hours, have more debt and focus on gross revenue. You may have heard, “Start with the end in mind.”
What is your end goal with your business? If it’s to maximize profits, and you are selling on a platform that changes the rule of the game often, with more competition, having your end goal is to sell your business for a higher multiple will only have you focus on the steps required to get your business in the best position to sell. What is the downside if you change your mind?
You would have a very profitable business that is in compliance. What is so bad about that? The challenge is most sellers do not have a goal (profitability) and they are really operating a hobby, meaning they are not running it like a real business, they don’t use financials to determine profits or losses, and they only focus on gross revenue and cash flow.
Usually, there is a mix of unrealistic expectations with the amount of time and money involved, and the result is 50% (if not more) go out of business within the first 1-2 years. Building to maximize profitability and with the vision to sell (and repeat with another brand) is not a bad idea.
Will a Lack of Sales Tax Compliance Kill Your Sale?
You may share the opinion that many other Amazon sellers share, which is that Amazon should have been collecting sales tax on your sales all along, as a third-party seller. You may feel it was unfair for you to figure out which states to register in and collect and remit sales tax when you had no control over the flow of your inventory or stock.
When it comes to selling your business, especially trying to sell to the huge influx of larger investment firms looking for solid opportunities, they don’t care about your opinion; they care about legal and tax compliance, minimizing risk, which helps lead to maximizing their return on investment (ROI). Buyers are very clear about their criteria and have no interest in investing in a hobby. They want to buy a profitable, in-compliance business!
Lack of compliance kills evaluations and deals. A growing trend in selling Amazon businesses is the business brokers making recommendations for companies to provide the proper due diligence. In fact, at the recent Prosper Show in Las Vegas, this year, a large percentage of booths were business brokers or buyers of Amazon businesses. The buyers all had their own team in place for due diligence to ensure that the numbers added up and that the business they were buying was in compliance.
Running your Amazon business without paying attention to sales tax laws is very different than a serious investor looking to buy your business. It would be similar to you “hoping” your “books” on spreadsheets are good enough for them to evaluate your real costs and real profits.
Key Point: You might be thinking… in 2020, Amazon is collecting sales tax in 41 of the 42 marketplace nexus states so there is very little risk. What about those Amazon businesses that have been around for 2+ years with no sales tax compliance?
California recently passed marketplace nexus which went into effect in October of 2019, and they fully plan to uphold their laws. In California, the general statute of limitations is three years for taxpayers who have filed tax returns. That means the BOE has three years within which they can audit those returns. However, if you fail to file tax returns, the statute of limitations is eight years.
If you choose to run your business while not being in compliance, that is up to you… but real analysis needs to take place when real money exchanges hands.
Since the June 2018 Wayfair vs South Dakota, U.S. Supreme Court Case, sales tax has become more complex. No longer is it only when you first had stock as an Amazon FBA sellers that first created nexus in a state, now there are guidelines for economic nexus, notice and reporting, and the states where Amazon is collecting (called marketplace facilitator states). Even in some of the marketplace facilitator states (where Amazon collects), the third-party seller is still required to register for sales tax and file a sales tax return. Other states do not require it (assuming you are ONLY selling on Amazon).
Along with the 2018 Wayfair vs South Dakota case, the learning curve by tax and accounting firms has dramatically increased. It is no longer just sales and local tax (S.A.L.T) experts who are on top of your sales tax requirements. This means buyer tax firms are now more educated and dealing with sales tax now is a real issue. In fact, speaking with our colleagues, they mentioned a high increase in deals that fell apart when potential buyers found out the profitable Amazon business they were buying did little or nothing about sales tax compliance.
It is now recommended that buyers invest in their own sales tax nexus study on a business to determine when it first had nexus in all the states and what their sales tax registrations should have been. Many sellers who decided to get into compliance with sales tax, simply registered with a current date to avoid the past sale tax, due to cash flow reasons. This could be a potential issue for you, the seller if audited. In the end, a serious buyer/investor will rarely consider buying an Amazon business that is not in compliance with sales tax.
What is Successor Liability?
An investor will look to make an asset purchase vs a stock acquisition of your Amazon business. This is common with most business sales. One benefit, in general, is that the buyer of an asset purchase is not subject to future liabilities of the business.
But there are exceptions when it comes to state taxes. State tax statutes typically pass on the seller’s liability for unpaid sales and use taxes, and sometimes corporate tax liabilities, unless the buyer satisfies the requirements set forth in the state’s successor liability statute. The only limitation is the full purchase price.
Connecticut, Massachusetts, New York, and Rhode Island have specific statutes governing the liability of a buyer for a seller’s unpaid sales and use taxes. While each state has its own unique requirements, the uniform premise is that a buyer is liable for all of the seller’s past sales tax liabilities, unless a tax clearance letter is obtained.
This is the part that kills an Amazon business sale. It is the buyer’s responsibility to request from the seller or obtain a letter from the state revenue authority to acknowledge that there are no outstanding liabilities. This is often referred to as a “tax clearance certificate” by the state. This basically gives the buyer assurance that the state taxes have been paid. If this does not happen, the BUYER remains on the hook for the SELLERS UNPAID Taxes.
Will Your Purchase Agreement Protect the Buyer?
Sometimes, buyers will make the mistake of assuming they are protected by the purchase agreement, which contains an indemnity by the seller to hold the purchaser harmless from any taxes owed by the seller at the time of the closing.
The seller also generally represents and warrants that there are no such taxes due (which may not be accurate).
Purchasers should be aware that these provisions may give the purchaser a legal claim against a seller, who may be liquidating its holdings and moving to a remote jurisdiction, where legal action will be expensive. This means you must chase the seller and it costs, on average, $25K just to say “hello” in litigation.
The best approach is withholding a portion of the purchase price until all assurances from the taxing jurisdiction are received (the tax clearance certificates).
In the end, if you’re looking to build a real brand and sell for maximize value, make sure your business is in compliance, especially with sales tax. If you’re not looking to sell and have a high-risk tolerance, continue moving forward with the crowd that lets Amazon collect and hopes the states ignore past sales tax due (some may do that, but not all).