Selling Your Business
With so many people self-employed I wonder if we should talk about selling the business?
Many self-employed people are more concerned about making a living than selling the business – but it could become a consideration. The software you design or the sticky notes or the list of clients you build up could end up having substantial value someday – or not, depending on how you handle the contracts you sign, business growth and type of business entity you set up.
What would you do if you got an offer for your business of a million dollars? Celebrate? Probably. Would you agree to sell before you understood what kind of a buy-out was being offered? If so, you could end up paying taxes at the 36% rate instead of 15%. The bottom line - $210,000 more taxes and money lost to you. The million-dollar sale would net you $570,000 (including NYS tax at 7%) instead of $780,000. What bargaining chips would you have? The buyer has tax concerns, too. The more ordinary income you pay (36% tax bracket), the bigger the buyer’s current tax deductions. The money they pay you that works out to be capital gains (15% tax bracket to you) must be amortized by the buyer over a 15 year period.
Your business may be your biggest financial asset – but hopefully not your only asset. We’ve seen terrific personal losses over the past 5 years as businesses folded from mismanagement, market changes and competition. Bad business advice is plentiful. Third world countries are emerging as players in formerly local markets. The government (EPA, SEC, NASD, Elliot Spitzer) is getting tougher on regulation that may make you just want to pack it in – and retire early. Costs of doing business are going up constantly. Colleges are churning out doctors and dentists, MBA students, lawyers and computer geniuses. One thing that is certain is change – change that may affect you positively or adversely.
There are three main questions that need answers before the sale of a business:
A tough economy makes people think about retirement – what happens if you’re self- employed?
If your business is small and has no saleable customer list or good will, you just shut it down. If the business has value, you try to find a buyer. The first big question I would ask if I were selling my company is – what’s it worth?
A business could have several different values at any one point in time depending on the transfer technique being considered. A sale to an outside buyer or a charitable remainder trust would best be at max value. Reorganizing or moving into a Family Limited Partnership (FLP) may be done to reduce the company value for estate tax purposes. In a FLP, the creation of minority interests in the hands of your ultimate heirs would reduce the business value. Minority interests are less valuable than majority interests because they can’t be sold for as much – the IRS allows discounting – sometimes as much as 50% of the value.
There are generally seven different types of buyouts that you can structure to sell your business. I’ll give you a quick list – and we’ll go into a little more detail through the week – but don’t expect a treatise or how to on this – the tax landmines and the complexities require you to seek professional help on a business sale. One way to tell if you have the right professional (even if they’ve done this before, they may not be comprehensive in their approach) is if they give you a list – like the following one – and discuss all the different options – of course that assumes you meet with them before you do something stupid – like signing a contract without discussing it and having them review it first.
So here’s the list of who would buy your business:
We’re talking about the complexities of selling your business. You can find this radio text and that of the past three years on the web at www.planningsense.com
When you are selling a business, after you get an answer to the question of how much is it worth, the next question is how to structure the sale to minimize your tax bite. There are a number of ways to do this.
Sometimes businesses are sold on an installment basis. That can stretch out the income and the taxes. There a several concerns in a case like this. First, you don’t have the capital to invest. If you really wanted an income from the deal, you would do well to consider a tax-free sale to a charitable trust or gift to a non-profit in exchange for a partially tax-free annuity and a big tax write-off. Let the non-profit sell the stock. They won’t pay any tax and you’ll get income from 100% of the sale price instead of what’s left after taxes.
Another concern is – will the new owner run the business into the ground, declare bankruptcy and leave you with nothing. If you are going to do an installment sale, I seriously suggest you not sign any agreement without getting a credit report and all the financials of the buyer. If they are not independently wealthy, or if they are asking you to hold paper on the sale because the bank won’t give them the money at a good interest rate – or at all – this is not a buyer you want to be involved with.
If you are transferring the business to your kids and don’t really need the cash, consider a private annuity. You set up a buyout based on Fair Market Value (FMV) and the kids pay you a predetermined income from the business each year. When you die (or you and you spouse, if you structure it that way), the income stops and the business is theirs.
Getting the best return on your business sale means understanding contracts, down payments, multiples of revenue, earn-out periods.
That’s just the tip. Before you accept an offer to sell you have to think through the tax consequences of each type of sale. If you’ve never much been up on the tax end of things – now’s the time. If you are a C corporation it can be especially important to understand the tax law as it relates to capital gains and the sale of your customer base. If you accept an offer and then find out you’ve been short-changed by the huge amount of taxes due – it is too late to go back and restructure the deal.
Right up front you need to know what you’re selling: Customer list, the company name and goodwill, a covenant not to compete, real estate, furniture and equipment , and how about your ongoing services for the transition? The tax price tag varies based on the type of property being sold.
And what about liability – for future lawsuit, for example. What if the business is sued or the property it sits on ends up having some kind of toxic waste from oil dumping – or whatever. Buyers will often try for an asset sale – that way they leave any future liability for the past to you. A stock sale is usually preferable for the seller because you pay stock sale capital gains and transfer all liabilities to the new owner.
Past business practices become an important consideration here. The type of business entity is important – are you a Sub-S corporation or a C Corp? Some owners of cash businesses shoot themselves in the foot by illegally removing cash from the business and not reporting it, making their profit level so small that they can’t get a fair price at the time of sale.
Your business may be your biggest financial asset – but hopefully not your only asset.
We’ve seen terrible business failures over the past 5 years as businesses folded from mismanagement, market changes and competition. Bad business advice is plentiful. The cost of doing business is going up constantly. Colleges are churning out all kinds of people who will be your competition. Maybe you’ll decide you really DO want to retire someday. Best to plan for it now – it gives you the options later when you actually want to sell the business.
Reasons for the sale of a successful business include:
Who would buy your business:?
Please remember, if you are thinking about selling the business –s ee the most qualified advisor you can find – first. It could save you hundreds of thousands in unnecessary taxes and headaches.