Many business owners are dependent on the value of their companies for funding their retirements or pursuing other desirable financial goals. But successfully liquidating a business can involve much more than taking the maximum payout from a purchaser. Whether the owner intends to pass management and/or ownership to a family member or valued employee or to simply sell the business to the highest bidder, several tax, succession, and estate planning matters should be carefully considered. Additionally, it may be important to the owner to ensure that long-time employees will be taken care of or that important community and business relationships will be maintained.
For all of these reasons, selling a business requires a planned approach that requires adequate time to unfold. Structuring an exit that maximizes value at the point of sale while also safeguarding the long-term health of the enterprise for those who depend on it requires some key strategies during both the pre-sale and post-sale phases to help owners exit successfully while ensuring continuity for employees, customers, and successors.
Before the Sale
1. Administrative and operational transfer. Three to five years before the intended sale date, key operating procedures should be documented as the owner begins empowering key employees and/or intended successors to assume administrative, management, and operational functions. This matters even more when leadership is being assumed by a younger family member. At the same time, the seller should consider ways of making the business as operationally attractive as possible. This might include attending to matters such as optimizing cash flow, expanding the customer base to reduce dependence on key customers, increasing efficiencies, and other operational considerations.
2. Financial readiness and valuation. At least three years before the intended sale date (and preferably more), the owner should begin gathering key documents: audited P&Ls and balance sheets, tax returns, and operating statements. These will be essential for informing prospective buyers of the viability of the enterprise. Additionally, a professional, third-party valuation of the business is essential in most cases. It shouldn’t be surprising that many owners place a higher value on their businesses than an objective valuation will justify. Typically, buyers—especially external parties—will be reassured when the business’s value has been assessed by an objective third party such as a Certified Valuation Analyst or a person holding the Accredited Business Valuation certification.
3. Tax planning. Two to three years before the sale, careful planning around maximizing the tax efficiency of the sale for the seller should be completed and updated as the date of the sale approaches. The legal structure of a business has major implications for the taxation of the transaction and, thus, how much the seller actually nets from the sale. If the business is organized as a corporation, the seller may wish to explore strategies such as the qualified small business stock (QSBS) exclusion (applicable to C corporations). For pass-through entities (LLCs, S corporations, partnerships, and sole proprietorships) sale proceeds, while typically not subject to double taxation, may often be taxed at higher individual marginal rates rather than the long-term capital gain rates available for C corporation stock sales. In some cases, an installment sale arrangement may permit the owner to spread the tax liability over several years (and this may also be attractive to buyers who prefer to conserve cash). The amount of value allocated to goodwill as opposed to depreciable inventory is an important point for negotiation between seller and buyer, as goodwill retains a more favorable tax treatment for the seller, while the buyer receives a greater tax benefit for the purchase of inventory.
4. Preparing the Seller. One to two years before the sale, sellers need to prepare themselves personally for what their lives will be like after they hand the keys to the buyer. Though not directly a financial consideration, a lack of personal readiness on the part of the owner causes many business exits to falter, according to research. The Exit Planning Institute estimates that roughly 80% of business owners have no formal transition plan that integrates personal financial planning, estate planning, and post-exit life objectives, and nearly 75% report regret within a year of completing the sale. Also, many are unprepared for the emotional shift that comes from stepping away from a role that has defined their identity and daily purpose for many years. It’s important for the owner to address these considerations well before a transaction by clarifying lifestyle needs, developing a comprehensive post-sale financial plan, exploring charitable and family wealth strategies if applicable, and intentionally designing a meaningful next chapter.
After the Sale
1. Transition planning and execution. Even though the sale has closed, the seller still has some important work to do. A clear transition plan is needed to bridge the gap between the sale by the owner and the assumption of leadership by the buyer. This period is important for reducing employee turnover, preventing loss of customer confidence, and avoiding operational disruptions. The seller and buyer will both want to ensure a comprehensive transfer of knowledge and, in many cases, thorough introductions to key customers, lenders, key employees, and other stakeholders vital to the success of the business. The seller can help the buyer tremendously by providing clarity around company culture, history, and position in the community and marketplace. In some cases, the terms of the sale may even include a period where the seller provides consulting services for the buyer, typically for a fee.
2. Invest sale proceeds strategically. Diversifying net worth away from over-dependence on the value of the business is a key objective for many sellers. Many small business owners have up to 80% of their net worth tied up in the business; a successful sale allows them to untangle what is for many a dangerously concentrated position. This is the point in the process where a professional, fiduciary financial advisor can be of tremendous benefit to the seller. By helping them design portfolios that align with their position in the accumulation-decumulation cycle, their ability to tolerate risk, and their lifestyle needs, fiduciary advisors can help sellers broaden their wealth-building base for retirement and other important financial goals. While diversification cannot eliminate risk, it can work to mitigate volatility in the portfolio.
As a fiduciary financial and wealth advisor, Mathis Wealth Management has the experience, expertise, and knowledge to help make your business sale and transition a success for all concerned. Please let us know if we can answer questions or provide guidance.
