Business Succession – Where to Start

You’ve spent a lifetime building your business and now it’s time for retirement. So, where do you begin?  When developing your business succession plan, it’s important to consider all of your options because each will have a significant impact on your estate plan, taxes, family, and financial well-being.  Here are a few helpful tips to get started.

Valuation

Regardless of whether you sell to your family, third-party, or employee, you will need a comprehensive valuation of your business.  Many business owners commonly overvalue their business because they place an emotional value on the blood, sweat, and tears they’ve spent working instead of what the company is actually worth in the marketplace.  To avoid this common misstep, it’s imperative to get a third-party analysis to better understand what your company is actually worth, and who is willing to pay for it.

When evaluating, a third-party attorney or financial planner will consider several approaches to your company’s worth:

• Market Approach – Revenue Growth, Profitability, Company size, and Liquidity

• Income Approach –Revenue Growth, Profitability, Cost of Capital, Leverage; Working Capital Efficiency; Low Capital Expenditures

• Asset Approach –Asset Intensive, Leverage, Scarcity, Time

After using all or one of these valuation strategies, you then must consider the most tax efficient method of selling while also providing a secured payment structure.

Let’s consider the following options:

Lump Sum

Selling your business for millions of dollars is every business owners dream.  However, this may not be a viable option for a number of reasons.  First, if selling to employees or family, the buyer will likely not have enough capital or credit to purchase your business’ asking price.  In addition, selling your business outright will result in a large capital gain and tax consequence compared to taking payments over time.  Most notability, it could actually place you in a different tax bracket entirely.   Thus, when considering selling for a lump sum, you should weigh the tax consequences of a lump sum with the potential stream of income over time.

Lump Sum + Installments

If a lump sum will create an unfavorable tax consequence, then you can structure the deal to take a smaller lump sum up-front, and then payments over time.  Most commonly sellers will take a lump sum that is just under the threshold of a tax bracket.  Installments can be made over a number of years that is consistent with your retirement plan.  Here you can increase the number of buyers by avoiding a high-cost lump sum for buyers.  In doing so, this may entice inside employees and/or family members who have worked hard within the company but cannot afford your asking price.  And because there is a partial payment up-front, buyers are motivated by their initial investment.

Installments Only

If selling to family and/or employees, installment payments are an affordable way to sell your business and avoid a lump sum tax burden.  However, business owners are often still involved using this method because employees don’t have as much “skin in the game.” This method often requires the owner’s expertise in maintaining operations.  In other words, you won’t get paid unless the business is able to sustain itself with its successors.  This strategy is recommended for smaller companies where the owners are able to work part-time and still have some degree of authority. It’s recommended that certain provisions be implemented that would cease payments in the event of a “dead beat” buyer/employee.

Self – Cancelling Installment Note

You can give your employees a business in exchange for a promissory note by using a “self–cancelling installment note.”   The promissory note is usually coupled with a personal guarantee signed by the employee.  Payments are then made over time but cease when the business owner passes away.  This option reduces capital gains and estate taxes.  However, the payments made will be set at a premium set by the IRS mortality tables to account for the business owners’ lifetime.  If the business lives past this time, the payments cease.  If the owner dies before this timeline, the payments cease.

For more information or to request a free consultation with a business and/or estate planning attorney, call Baron Law LLC at 216-573-3723 or dan@baronlawcleveland.com.