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Devise Your Exit Strategy – An Early Start Helps Ensure A Good Outcome

Man with Route to get Out of Maze

Every company owner needs an exit strategy — whether that involves transferring the business to family members or selling it to a management team or a third party. Regardless of the strategy you choose, the earlier you begin planning your exit, the smoother the transition will likely be. And if your ultimate goal is to sell to a third party, starting early gives you time to maximize the company’s value and minimize the tax consequences of the sale.

  • Enhancing value – Start by obtaining a current valuation of your business. Doing so will help you understand the various factors that drive your companys value and identify any weaknesses. Armed with this information, and sufficient time, you can take steps to enhance the value of your business.
     
    Suppose, for example, that your management team is weak in certain areas or relies too heavily on your management skills. By bringing in new management talent or providing training to your existing team, you can increase the companys value to prospective buyers.
     
    Or, suppose that a high percentage of your jobs are concentrated in a particular industry or a few key customers. By better diversifying your jobs, you may be able to reduce your businesss risk and enhance its value.
     
    These are just two examples of the many ways planning can increase the value of your business. Keep in mind that the right strategies will depend on the types of potential buyers you expect to target. For instance, a strategic buyer may be less concerned with the quality of your management team than a financial buyer is.
  • Reducing taxes – The tax implications of a business sale depend on a number of factors, including the organizational structure of your company and the way the transaction is structured.
     
    If your business is a corporation, for example, you can structure the transaction as a stock sale or an asset sale. Selling stock is advantageous because your profits generally are taxed at lower capital gains rates. Asset sales are typically taxed as a combination of capital gain and ordinary income, depending on how the purchase price is allocated among various assets. Also, C corporations (or, in some cases, S corporations that have converted from C corporations) are taxed twice: once at the corporate level and again when the proceeds are distributed to shareholders.
     
    Unfortunately, few buyers are willing to take stock. For one thing, they don’t want to acquire all of your company’s potential liabilities. Plus, buying assets generally gives the buyer a higher basis in depreciable property.

Assuming that a sale of your business will be structured as an asset sale, two ways you can soften the tax blow are:

1) Purchase price allocation – Allocation of the purchase price among various assets has a big impact on a transaction’s tax consequences. To pass muster with the IRS, the allocation must bear a reasonable relationship to the assets’ actual value, but the parties have some leeway for negotiation.

As the seller, you’ll want to allocate as much of the price as possible to assets that qualify for favorable capital gains tax rates, such as real property. The buyer, on the other hand, will favor allocations to property that can be depreciated quickly, such as equipment and vehicles. This is usually undesirable for a seller, however, because gain on fully depreciated property is taxed as ordinary income.

One planning strategy is to allocate a portion of the purchase price to personal goodwill.

2) Alternative payment forms – Alternative payment structures may allow you to defer taxes on a portion of the sale price. For example, you might negotiate an installment sale or an earn-out provision (under which a portion of the sale price is contingent on the buyer achieving a certain level of earnings).

Another option, if your business owns real estate, is to exchange it for income-producing real property in a tax-free exchange.

Taking your time – To improve your chances of a satisfactory exit, start planning now. There are many strategies you can use to enhance the value of your business and reduce taxes. But, in many cases, these strategies take some time to implement. © 2015

If you would like to learn more about implementing an exit strategy for your business, contact me at mgellman@mercadien.com or 609-689-9700.

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