Wayfair; Enterprise Valuation; M&A Considerations
Wayfair, the online retailer, was recently involved in an important and far reaching Supreme Court decision. The case changed the previous standard for nexus, resulting in the need of sellers of goods and services to collect and remit sales tax even when there is no physical presence in the state. What is of a particular interest is how the Wayfair decision impacts M&A deals in terms of due diligence, valuation, and post transaction requirements.
To fully understand the implications of the Wayfair ruling, it is important to understand the background of the nexus standard. Historically, states had a right to collect sales tax if a nexus standard was met. Typically, this meant that the seller had physical presence in the State where the sale of goods took place. The Court decision overruled a previous decision in this matter (Quill), finding that the physical presence standard is “unsound and incorrect”. This case involved legislature in South Dakota imposing tax collection obligations on remote sellers who sell tangible property, products transferred electronically, or services delivered in the State. Wayfair challenged this legislature, which eventually made it to the Supreme Court. The Court decided in favor of the State’s ‘substantial nexus’ standard: namely, a seller (including those selling through marketplaces) is subject to sales taxes if they meet one of the following in either the current or prior calendar year:
- Gross revenues in the state exceed $100,000 or,
- Seller had more than 200 separate transactions in the state.
This decision constituted a fundamental change to sales tax nexus standard previously in place for more than 50 years. As expected, virtually all states have been taking notice and passing legislation, guidance, rules, etc. with some notable variations. Most are already effective, while others have announced future go-live dates.
What impact does the Wayfair ruling have on sell side and buy side M&A transactions? With this ruling, to be compliant, companies will now have to register, collect and remit sales and use taxes on qualified transactions with in-state customers, regardless of the seller’s physical presence. What is important to point out is that although the levy of these two taxes is generally against the purchaser, it is the seller’s obligation to collect and remit the tax to the state (typically monthly). Although the liability is joint and several, it would be highly impractical to pursue customers years after the sale. Moreover, if the seller failed to collect and file returns in the state, the statute of limitations in certain states remains open indefinitely (add to that penalties and interest). This translates to these requirements:
- register and file with the state(s);
- be compliant prospectively;
- determine, negotiate, reserve and pay for past due sales and use tax.
If you are trying to position your company to be sold, this will certainly be an item of interest to the buyer. If you are the buyer, a much deeper due diligence is now necessary, as well as quantification and understanding of the liability you are assuming. Filing, tracking, collecting and remitting the sales and use tax will require robust resources that have not been part of the P&L, further impacting the valuation of the enterprise. Informing your customers that you will now be adjusting your invoices and pricing to allow for collection of these taxes will present an entirely different set of challenges. Buyers of effected sellers will now want to consider negotiating specific representations and warranties, possibly obtaining insurance coverage, and larger and longer escrow amounts and periods.
You would think this cannot get any more complicated, right? Well, it does. There are more than 10,000 US sales tax jurisdictions. While most are administered at the state level, some local jurisdictions administer their sales and use taxes independent of the state, requiring separate filing/compliance requirements.
Historically, sales tax focused on tangible personal property, including services to install, maintain and service such property. With the growth of digital commerce (think cloud services; etc.), however, many states now also tax “digital goods” accessed over the internet. This trend will likely continue.
In conclusion, as a result of the Dakota Court decision, companies which engage in interstate commerce (including those that are exempt from sales and use tax), will now need to carefully evaluate the impact of Wayfair on their businesses and be prepared to:
a) file in the relevant jurisdictions; quantify historical liability; and negotiate payments;
b) design and implement ongoing compliance protocols, internal controls, and/or exemption procedures; and,
c) address the matter with customers.
Buyers of companies which engage in interstate commerce will want to carefully analyze compliance, costs to implement prospectively, and determine any historical liabilities that may exist. With “all else equal”, the impact of Wayfair, at a minimum, will result in an overall lower enterprise valuation.
Joe Alouf is an inspiring executive with distinctive experience and capabilities in business model scaling, reinvention, and operational and financial optimization. With over three decades in a multitude of industries, Joe has developed a demonstrable track record helping companies in transition maximize their operation and financial value potential, complemented by hands-on expertise and contacts related to debt and equity capital raising.