OWN The last article about business transition examined the most important issues pre-sale owners should consider when planning to exit their businesses. Here, we examine six key considerations.
This can make or break a successful transition.

Is the business being sold or transferred?

In many ways, a business owner is like a family member. Deciding to sell the business to a third party (instead of passing it on to a child or key employee) can feel like getting a divorce or kicking an unfair child out of the house. A divestiture is often the best option to maximize revenue and eliminate family resentment, but without proper planning, a divestiture can wreak havoc on family dynamics and cause significant employee turnover.

In addition to determining the terms and timing of the best deal, you need to help owners understand the best way to invest the windfall before the funds come in. tsunami of free time, plan their legacy and give to the causes they care about most.

As the old saying goes: “Good judgment comes from experience, and experience comes from bad judgment.”

Entity structure

Many owners are surprised to learn that the entity structure that served them so well while starting and growing the business may not be the best structure for selling it. For example, C corporations have many advantages for going concern businesses, but can cause tax challenges during a sale, such as “trapped profits.” Because of poor planning, the C corporation often owns real estate and has significant accumulated earnings on those assets that will be double taxed when the corporation is liquidated. The corporation must first recognize (and pay tax on) the gains related to the sale of real estate. If the business owner sells the company's assets, there will be a second large tax on these trapped profits.

Also, accumulated business profits (which are already taxed at the corporate level) will be taxed as ordinary income when distributed to shareholders, including the owner. The only way to avoid double taxation is to sell the shares. But most buyers want to start the depreciation clock as soon as possible to take advantage of the tax savings. They also want to eliminate any hidden liability in the corporation. That is why they insist on buying assets. Solving this problem may disrupt the sale of the business, however, due to the conflict of economic interests.

One solution is to convert the entity from a C corporation to an S corporation (S corp). It takes five years for retained earnings within the C corporation to convert to S corporation taxation. However, since assets can be distributed without a second level of tax, the sale of assets can continue. That's why you want to add a qualified CPA or tax attorney—preferably one with experience in business transactions—to your client's planning team. Often, the client's longtime accountant or attorney lacks the necessary transaction experience and important issues are missed. As your client's quarterback, however, you're in an excellent position to build the right team, soothe bruised egos, and get all the experts working in harmony.

Walkaway money vs. sale price

Another challenge that business owners face is that the after-tax income from sales may not be enough to support the lifestyle they are used to. Assume the owner paid himself $600,000 per year (in addition to other benefits such as a car, country club, and entertainment expenses). It would take about $15 million at 4% interest to produce $600,000 annually before taxes. Your client's company may have received an offer of $20 million, but the owner may make $12 million after tax. That's an annual income of $480,000, which may not be enough, especially when they have to start paying out of pocket for all the benefits that were once provided through the business.

Whether the result is reduced taxes or significant locked-in profits, it's important to correctly model the sale to show the owner what they can expect to earn. The tax consequences of different exit strategies can be very complex and will significantly affect the seller's net income – that is, their “street money”.

ADVISORS Industry knowledge

Every industry has unique considerations that can affect valuation, who might be potential buyers, and deal structure. Understanding these considerations is important when deciding whether or not to sell. An important question is to ask if the owner's advisors have industry knowledge. Do they have the experience of dealing within the industry to know what is reasonable and common? If not, they could rub potential buyers the wrong way or cause your client to leave significant money on the table.

Family Dynamics

Eventually, every owner must start thinking about who will take over their business. In some cases, they may have competent children already working in the business who are well trained and understand the nuances of the business. But if the owner doesn't have family members interested (or able) to take over the reins, they have to look for outside buyers. This adds a layer of complexity because the owner must begin updating the books, documenting business processes and addressing outstanding business issues or the sale will not go through.

Structure of the agreement

You can add significant value by helping your business owner client decide between an all-cash offer, an installment sale or a stock exchange. Each has its pros and cons. It starts with helping the owner to clarify their goals. Do they want to take some chips off the table, or do they want to put their value into a bigger nest egg or de-risk and diversify market share?

The specifics of how a deal is structured (for example, earnings and vendor financing) can have major implications that can only be fully appreciated with M&A experience. Ultimately, the owner wants flexibility and income. They may want to stay involved in the business and sometimes retain partial control. These are important considerations to iron out before the sales process begins. Better start planning several years before a potential sale date. Soon, many owners (and their advisors) underestimate this time frame.

As a wealth advisor, you want to help clients create the optimal portfolio for investing their post-sale proceeds to replace the family income they have enjoyed for many years. But you should tread carefully around any specialist in the team who believes that he is the owner's most reliable adviser. You may also want to bring in an organizational behavior consultant to help long-time employees cope with an ownership transition and a family consultant to help family members deal with the loss of the family piggy bank and the grief of the transition. to take the reins.

Dr. Guy Baker IS founder of Wealth Teams Alliance (Irvine, CA).