After a lifetime spent growing a business from idea to thriving enterprise, the owner may dream of selling the company and walking away with enough money to retire in style. But the dream can become an illusion if the owner failed to plan the sale with an eye toward minimizing taxes and maximizing wealth.
The disconnect between hope and reality was highlighted in a recent survey of entrepreneurs who'd sold small companies. Only 8 percent were dissatisfied with the price they got for their business — but a third were unhappy with the personal wealth they gained from the sale, according to the study by Rothstein Kass, a national accounting and professional services firm with an office in Roseland.
Rick Flynn, who heads the firm's family office group, said the answer is that business owners "need to do more extensive financial and tax planning. That is simple to say — but it's not that easy to do."
For one thing, an entrepreneur running a restaurant chain or an aerospace factory may have neither the time nor the inclination for a crash course in estate, tax and financial planning. Experts said planning should begin years before a sale is even contemplated, and should involve a team of advisers that includes accountants, lawyers and financial planners.
Flynn said business owners should approach exit planning with the same commitment it takes to build a business.
"Just like you built your business, you have to be willing to take tremendous focus and make sure you have the right team and the right quarterback of that team so that you can get the result you are trying to achieve," he said.
Other obstacles to rational planning: selling a business is emotionally wrenching, the owner doesn't want to think about retirement and mortality, or there are no family members to take over — or several children are vying for control.
Flynn said it takes time to execute the complex moves that can minimize taxes: transferring stock to family members, arranging for most sale proceeds to get the more favorable capital gains treatment, using trusts to reduce estate taxes. The goal is not to get the highest possible price, but "to keep more of the actual sale price in the family."
Even business owners who are certain they'll never sell may suddenly change their minds if they get an offer they can't refuse.
"That's almost the worst-case situation," said Tom Angell, principal in charge of Rothstein Kass' family business practice. "They're not thinking of selling, then they get an offer and think. 'I'm going to sell this business, put a lot of money in my pocket and not have to worry any more.'" But without sufficient tax planning, the owner is in for a nasty shock from the IRS.
Tax attorney Robert J. Alter, a partner at McElroy, Deutsch, Mulvaney & Carpenter who specializes in federal and state tax controversy matters, said exit strategy planning really should start the day the business is created, since the business' tax organization has consequences down the road when the time comes to sell.
In the case of a "C" corporation, for example, there is potential double taxation to the seller if it sells assets and distributes proceeds to shareholders, resulting in less net after tax proceeds. From a tax perspective, the seller is better selling the stock, so the transaction can qualify for capital gain treatment versus ordinary income.
Alter said the buyer, on the other hand, rather than buying stock, gets a more favorable tax outcome by purchasing the company's assets, since there is then an opportunity to depreciate or amortize the assets acquired, and acquire a cost basis in inventory and receivables that reduces the income recognized when the inventory is sold or the receivables collected.
"There is a tension between the buyer and the seller when their tax consequences are different, and that becomes a topic of negotiation," Alter said. "If the seller can't get the buyer to agree to buy the stock, and it has to be an asset sale, then the seller is going to want more money. The purchase price is going to have to be higher, because the seller is going to leave the table with less money" due to the tax impact.
"You want to find a buyer who will agree to your terms, in addition to the purchase price," he said. "The purchase price is important, but more important is how much of the money you are going to wind up with."
An estate transfer "is a great technique to get the future appreciation (of the business) out of the estate, and transfer the wealth to the next generation," but it's not something you can do on the fly, said Howard Klein, a partner at the EisnerAmper accounting and consulting firm.
Several of his clients don't have any children in their business, which they expect to sell when they retire. In the meantime, they can have a valuation of the company done, and transfer nonvoting stock to a trust. If the company is eventually sold at a higher value, "you have gotten the future appreciation out of the (owner's) estate and transferred the wealth to the next generation," he said.
Klein said he recommends doing estate transfers five or more years before the company is sold. "You don't want to do this within a year or two of the sale of the business," he said, because if the company gets a $5 million estate tax valuation and is then sold for $30 million soon thereafter, "the IRS is going to question that transfer."
The buyer may require the seller to sign a noncompete covenant. Since the value of the agreement is taxed as ordinary income, "you want to minimize the value you put on a covenant not to compete," Klein said.
And, of course, failure to wisely manage the cash windfall from selling your business can easily sabotage the best-planned transaction, experts said.
"One of my clients sold his technology business during the tech boom and made a nice amount of money, but unfortunately, he invested a lot of that money in technology stocks, and then the market tanked," Klein said. Another client "sold his company and then became a day trader and lost a lot of money." The problem: "Many business owners know how to run a business, but they've never had to invest money."
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