As a business owner, your company has been your life’s work, and you’ve likely spent years investing immeasurable resources into that company, strategizing for success. At some point, however, owners invariably find themselves in a situation where they need to begin thinking about a succession plan that will help them achieve their future objectives, whether that’s generating liquidity to fund the next business venture or simply retiring. Regardless of objectives, succession planning can be one of the most arduous decisions in a business owner’s life.
So how do you begin the succession planning process? One of the first steps is gaining a deeper understanding of the company sale process and specifically the different types of buyers that might be involved when selling your company. Becoming familiar with the characteristics, objectives, and processes of each type of buyer, will help align your vision for the future of the company with that of the buyer.
The following are the typical potential buyer types for your business: strategic buyers, financial buyers, and employee buyers (through an employee stock ownership plan, or “ESOP”).
A strategic buyer may be a competitor in the same industry or a company that operates in an adjacent or related field. They generally look to acquire an established business to increase market share, diversify their product or service offering, or expand into a new geography. They’re typically able to pay a “premium” for the acquired company due to perceived synergistic value, but that often comes with expectations that may conflict with those of the current owner(s). Below are some key benefits and considerations of selling to a strategic buyer.
- Highest value consideration. A sale to a strategic buyer will likely generate incremental value to the current owner compared to a sale to a financial buyer or ESOP given the synergies that may be recognized through the purchase
- Loss of strategic and operational control after the transaction is complete
- Future of existing management and employees unknown due to possible redundancies with acquiring buyer
- Intellectual property and best practices shared with competitor(s)
- Longer execution time to complete the transaction (six to nine months)
Financial buyers, which include private equity groups and other variously purposed investment firms, comprise the second primary classification of buyer. Financial buyers seek to acquire or make investments in companies principally to generate an economic return on the investment by driving growth and operational efficiency. They are in essence professional “buyers” who typically have deep experience within the industries in which they focus. Their objective is to buy and hold a company for typically a three- to seven-year period, followed by their own exit, often also a company sale. In most instances, financial buyers will keep the existing company practices and management team in place, while leveraging their own industry experience, resources, and personnel. Below are some key benefits and considerations of selling to a financial buyer.
- Well capitalized partner
- More predictable future for existing management and employees
- Opportunity for reinvestment or “rollover” into the acquiring entity, allowing participation in future growth
- May receive lower purchase price versus selling to a strategic buyer
- Potential disruption and turnover risk to existing employees
- Longer execution time to complete the transaction (six to nine months)
An employee buyout, often in the form of selling the business to an Employee Stock Ownership Plan (ESOP), is a unique exit strategy. At its core, an ESOP is a qualified retirement plan that offers business owners an exit path while also creating wealth for the company’s employees. Although the transaction requires careful planning and analysis, selling a company to an ESOP can offer an incredibly impactful exit option for owners looking to maximize cash at closing while maintaining stability for their employees and preserving the owner’s legacy. Below are some key benefits and considerations of selling to an ESOP.
- More control over your legacy. The business name and employees remain fully intact
- Attract and retain employees, while boosting employee morale
- No disruption to the business, which can occur in a third-party sale
- ESOP-owned companies are eligible for tax advantages, which among other things, make the repayment of debt associated with the transaction much easier
- Potential capital gains tax deferral for the seller through a “1042 rollover”
- The transaction can be structured in phases, so the owner does not have to sell the entire business all at once
- Shorter execution time to complete the transaction (four to six months)
- May receive lower purchase price versus selling to a strategic buyer (but still at fair market value)
- Potential for lower cash at close depending on how the transaction is financed
Clearly, selling your company is an incredibly momentous and nuanced process with ramifications that extend far beyond your own wealth and estate planning. If you are contemplating a sale, be sure you know all the options available to you so you can make the most informed (and rewarding) decision possible.
If you are interested in learning more about your potential sale options, to request a complimentary sale feasibility analysis for your business.
An Employee Stock Ownership Plan (ESOP) has always been regarded as an attractive exit strategy for business owners who are looking to defer capital gains taxes, preserve their legacy, and incent employees through employee ownership.
However, with President Biden’s proposed tax increases on the wealthiest Americans and business owners, an ESOP just got a whole lot more attractive for owners who are considering selling their company.
Let’s have a look at the numbers
President Biden’s proposed tax increase could raise capital gains taxes on the wealthiest Americans from 20% to up to as much as 39.6%. Therefore, upon an exit from a third-party sale, most business owners would wind up paying nearly twice as much in capital gains compared to what they would pay today if they sold their business.
The new tax plan would also raise the corporate tax rate on businesses in the United States from 21% to 28%, triggering $1.7 trillion in new tax revenues from C Corporations and another $370 billion from pass-through entities over the next 10 years. Business income tax collections would rise to the highest level in 40 years, according to data from the Congressional Budget Office (CBO).
Furthermore, President Biden has also proposed to phase out the section 199A deduction for individuals making more than $400,000, a 20% pass-through deduction for qualified business income (QBI) available to owners of sole proprietorships, partnerships, S corporations, and some trusts and estates engaged in qualified trades or businesses.
None of President Biden’s proposed tax changes bode well for business owners, but there is no need to panic. If you are considering a sale, the potential tax advantages available through an ESOP might be right the fit for your company.
How can an ESOP provide me with tax advantages if I’m considering selling my company?
Unlike a traditional third-party sale to private equity or a competitor, an ESOP can offer you unique tax advantages. In a third-party sale, if you sold your company for $50 million, you would pay a 20% capital gains tax (which could almost double under President Biden’s proposed tax increases), a net investment income tax of 3.8% (Affordable Healthcare Act), along with the capital gains tax for the state in which you operate your business. We will use 6% for illustrative purposes. Net proceeds to the seller in this scenario are likely around $35.1 million (not including attorney, accountant, and advisor fees). If Biden’s tax plan is passed, a business owner would be looking at around $25.3 million in net proceeds, less fees.
With an ESOP transaction, as long as an owner sells at least 30% of the company to the ESOP and reinvests the proceeds of the sale in other securities, they can defer any tax on the gain. The tax deferment is available through IRC 1042 election and reinvesting the sale proceeds in Qualified Replacement Property (QRP), which is a security issued by a domestic, taxable operating company. The securities can include stocks or bonds and often come with floating-rate notes issued by the company.
The floating rate notes were created specifically for ESOP transactions to meet the requirements of the 1042 capital gain deferral and act as collateral for a margin loan issued by your investment advisor. This means you can invest in floating-rate notes, defer capital gains from the sale for an extended time, and still access up to 90% of the proceeds from your sale. This allows the seller to defer 100% of the capital gains over the rest of their lifetime.
One caveat is that the company will need to be structured as a C Corporation to realize these tax benefits, which can be done prior to the transaction in consultation with a qualified tax advisor and legal counsel.
There are many tax advantages for the company and its employees
- Contributions used to repay a loan the ESOP takes out to buy company shares are tax-deductible.
- Contributions of stock are tax-deductible, so the company gets a current cash flow advantage by issuing new shares or treasury shares to the ESOP.
- A company can contribute cash annually on a discretionary basis and take a tax deduction while using the funds to retire obligations to current owners or to build up future reserves.
- The dividends used to repay an ESOP loan, passed through to employees, or reinvested in company stock are tax-deductible.
- Employees pay no tax on the contributions to the ESOP and can roll over their distributions into an IRA or other retirement plan upon leaving the company.
There are many other benefits and considerations you will need to weigh before deciding if an ESOP is right for you. Owners are encouraged to work with an advisor to understand the range of considerations pertaining to value, current market dynamics, liquidity needs, tax planning, and any qualitative objectives they’d like to achieve in a sale process. Analyzing all these factors may lead an owner to wait and instead pursue near-term opportunities to increase profits while capitalizing on economic trends. Working with a team of economic experts like ITR Economics can further bolster a company’s forecasts and growth plans, and with a 94.7 percent forecast accuracy, they’re one of the best resources available.
If you’re considering selling your business, one of the services we provide to business owners is our feasibility study analysis. This free service helps sellers learn more about the structure and the results for shareholders as well as the potential outcome for management and employees if you were to sell your business to private equity, a strategic buyer, or into an ESOP structure. We use the analysis to help you and your team see what ifs, and the benefits associated with each transaction type.
If you are contemplating your options or looking for a second opinion, click here to learn more about our complimentary feasibility analysis.
Most owners who are thinking about selling their business generally know of two options: you can sell your company to a private equity firm or to a competitor (strategic buyer). There is a third option that offers significant tax advantages, which every owner should be aware of before making one of the most important and critical decisions in their lifetime, an Employee Stock Ownership Plan (ESOP).
Owners should understand all three alternatives, including the financial benefits of each type of sale, and other considerations such as protecting your legacy and your employees after an exit.
When interviewing advisors, most investment banks don’t even mention ESOPs as an alternative to a third-party sale. At ButcherJoseph, we are dedicated to executing the best option for our clients, whether that be to a strategic buyer, private equity or and ESOP sale. Our goal is to ensure owners have access to all their options as well as an advisor who has expertise and can deliver on all of them. This philosophy has enabled us to help hundreds of clients get the best possible outcome available to meet their unique needs.
If you haven’t assessed each of your sale options, we’d be happy to provide you with a complimentary feasibility analysis, so you have a full understanding of all your alternatives as well as the benefits and potential drawbacks to each. Just click here to submit a request.
What Does a Feasibility Analysis Include?
- The first component of a feasibility analysis includes a preliminary valuation that provides owners with an initial assessment of your company’s potential range of value.
- The next is a transaction scenario, which provides you with details on how a sale can be structured and financed.
- The third component illustrates transaction results. The value you and your employees can likely expect after the transaction is completed.
- And lastly, process overview. This illustrates the breadth and scope of relevant transaction processes needed for a successful execution, including an outlook of what you can expect regarding timing and deal-team responsibilities.
If you are interested in learning more about your potential sale options or if you’re interested in a second opinion, click here to request a complimentary feasibility analysis for your business.
What will the new rate be? Will it be enacted retroactively? Is there any chance changes won’t go into effect until 2022?
These are some of the questions swirling the sleepless minds of business owners contemplating the sale of their company this year. Imagine being a founder who’s poured fifty-plus years into building a company from nothing, and the tax swing resulting from the sale of your $50 million business could be in the neighborhood of $11-22 million depending on the proposed changes to capital gains.
For owners who already survived the last recession and managed to keep the lights on through a pandemic, odds are they thought there was a legitimate chance at retirement soon. Unfortunately for owners, no buyer is going to gross up the purchase price to cover their taxes due on the sale proceeds. This is a real and extremely stressful predicament for owners right now. So what’s an owner to do? Sell and pay now, wait it out and pay later? Or maybe it’s possible to pursue a different plan of succession that reduces near-term stress and uncertainty?
Most owners pursuing a sale understand the common buyers likely interested in their business—family members or the company’s management team, competitors or strategic buyers, private equity funds or other investment firms; however, few owners are familiar with employee stock ownership plans (ESOPs) and their related tax advantages.
When selling a company to any buyer other than an ESOP, the seller(s) will pay capital gains tax on proceeds from the sale. When a company is sold to an ESOP, the seller(s) may be able to defer the capital gains tax. As a result, the net proceeds to a business owner from the sale to an ESOP may be more than the net proceeds available from the sale to a strategic or financial buyer after taxes are paid.
Selling to an ESOP can offer owners initial liquidity through the most tax-efficient strategy while creating a succession plan that allows them to work towards a full exit. When it comes to determining if now is the right time to sell, there are more variables to consider besides tax, and it’s important to understand that ESOPs are not a fit for every company.
Owners are encouraged to work with an advisor to understand the range of considerations pertaining to value, current market dynamics, liquidity needs, tax planning, and any qualitative objectives they’d like to achieve in a sale process. Analyzing all of these factors may lead an owner to wait and instead pursue near-term opportunities to increase profits while capitalizing on economic trends. Working with a team of economic experts like ITR Economics can further bolster a company’s forecasts and growth plans, and with a 94.7 percent forecast accuracy, they’re one of the best resources available.
Any successful business owner who has been in business long enough has likely experienced the “unsolicited offer” for their business. It’s not uncommon for owners to receive these offers as they typically come in one of several ways, from one of several types of groups. Simply because an offer is unsolicited doesn’t mean business owners can’t be ready for it.
Whether or not your company is currently for sale, you need to understand what should happen when offers are made or solicited. Owners who plan ahead and prepare for potential discussions with buyers are more likely to extract higher values and receive a higher probability of a successful transaction.
We invite you to watch a special on-demand webinar hosted by NCEO and facilitated by Alberto del Pilar, Managing Director, to discuss:
- The various types of unsolicited offers — serious offers versus marketing ploy — and red flags to look for
- Types of buyers groups: broker, financial, strategic
- Strategies to plan and prepare for potential discussions to receive a higher probability of a successful transaction
WATCH THE FULL WEBINAR BY FILLING OUT THE FORM BELOW:
With a strong U.S. economy and a presidential election on the horizon, 2019 will be a pivotal year for selling your business. According to Deloitte’s annual M&A trends survey, a record number of respondents were confident they would receive a favorable offer if they sold today, but the decision to sell is complicated and should not be taken lightly.
Selling your business is typically contingent on a variety of factors, including, but not limited to, the favorability of the overall economy, your company’s financial performance and if you are emotionally ready to begin planning your exit. Rarely will all the factors align at once, but in 2019 the market for selling is ideal.
If you’re considering selling your company, you should begin the process sooner rather than later. Depending on the variables specific to your transaction, it can take 6 to 9 months or longer to complete the sale. If you wait too long, you could miss your window of opportunity to take advantage of optimal terms.
1. Is NOW the time to take action?
While the current economy remains strong, the favorable conditions won’t last forever. As we approach 2020, it’s anticipated that the growth of the GDP will slow and the U.S. economy could stall.
The upcoming Presidential election also brings up a variety of questions that could impact future transactions: What will the tax policy be in the future? Will deregulation from the Trump administration be unwound? Are investors going to be less aggressive with their capital?
Due to the amount of activity in the debt capital markets, there are a variety of loan structures and terms available to middle market companies. Deloitte’s 2019 M&A trends survey reported that 69% of respondents have more cash on their balance sheet than they did two years ago, and their primary intent is to fund M&A opportunities with that cash. However, M&A intent, as well as the availability of capital, could change if problems emerge in the financial condition of middle market companies.
The recently published Financial Stability Report provided two important data points indicating the potential near-term reversal of investor sentiment:
- Ending issuance grew by 20% in 2019
- Middle market companies have become dangerously over-leveraged
No one truly knows when a tipping point might be reached, so it never hurts to be prepared to act.
2. What is your business worth?
Take the time to understand the items that motivate a potential buyer in choosing your business over others in a crowded market, such as upgrading equipment, removing obsolete inventory and even your ability to recruit and retain a skilled workforce in this environment of record-low unemployment. According to a new report from the International Business Brokers Association (IBBA), M&A Source and the Pepperdine Private Capital Market Project, 28 percent of business advisors say the talent shortage is hurting their ability to sell their clients’ companies.
3. Are your financials prepared for a sale process?
Even though the economy is favorable, business owners shouldn’t rush to sell their businesses before making sure your documentation (balance sheet, income statement, cash flow statement, tax returns, etc.) is in order. Potential buyers will take an in-depth look at your operations and financials, specifically covering the last 36 months.
With such a large number of potential buyers seeking high-quality businesses, buyers are doing their due diligence and scrutinizing the long-term profitability of every opportunity. While revenue declines may not be significant, it’s important to have a good explanation for any variances.
Regardless of which type of buyer you pursue, now is a great time to plan your exit and prepare your company for a sale. All indicators point to 2019 being one of the best in recent history to sell your business. With banks eager to loan money, buyers can likely obtain the loans they need at optimal rates.
At ButcherJoseph & Co., we recognize the increasing need to educate current and prospective clients on opportunities within the market and the potential implications to their businesses and personal wealth. Let us help you perform a valuation of your business to find out what your business is worth today and what types of buyers fit your objectives.
In the lifecycle of every company, owners must face the question of ownership succession. Many alternatives exist and circumstances specific to the business owner’s interests and preferences typically dictate the chosen alternative. Although more highly publicized ownership succession strategies are usually at the forefront of consideration, lesser-known strategies should be given equal consideration. One of those strategies could be selling to an Employee Stock Ownership Plan (ESOP). Some of the top reasons to consider an ESOP are as follows:
You want to sell part or all of your company.
An ESOP is an alternative buyer to a strategic or financial buyer. In addition, since most third party buyers are only interested in buying the entire company, an ESOP provides a business owner with an opportunity to facilitate a partial sale of the business.
You want to preserve the company’s legacy.
Strategic buyers and private equity firms often will make changes to the organization post-transaction. In many instances, those changes involve employee layoffs, new leadership brought in from outside the company, a change in company culture, and even a name change. The potentially negative implications on a company’s employees and management, corporate culture and values, and communities can be unappealing to business owners wishing to preserve a company’s legacy. Conversely, selling to an ESOP facilitates a sale of the company for the benefit of the employees. Employees receive an economic interest in the company and are able to financially participate in the company’s future success. As a result, post-transaction is generally business as usual with no immediate change to headcount, management leadership, or company culture and values. An ESOP is a buyer that preserves the pre-transaction operations of the company post-transaction.
You are interested in the tax benefits.
When you sell your company to any buyer other than an ESOP, you will pay capital gains tax on proceeds from the sale. However, when you sell your company to an ESOP, you may be able to defer the capital gains tax. As a result, the net proceeds to a business owner from the sale to an ESOP may be more than the net proceeds available from the sale to a strategic or financial buyer after taxes are paid. Furthermore, an additional tax benefit inures to the company. If the ESOP purchases all of the common stock of the company and is an S-corporation post-transaction, the company will be exempt from paying Federal and state income taxes. If the ESOP owns stock in a C-corporation, the company will be able to make tax-deductible contributions to the ESOP that reduces taxes. In either scenario, the absence of tax payments enables a company to retain more of its earnings that can be used for other purposes, including debt repayment, capital expenditures, working capital, etc.
You are interested in attracting and retaining employees.
Because employees have an economic benefit in the success of the company, numerous studies have shown that ESOP participation can be a great tool for motivating performance, retaining employees, and attracting new employees. As a result, additional research shows enhanced productivity as employee ownership participation incentivizes best practices and efficiency.
You are interested in providing employees with a wealth-creating benefit.
An ESOP is governed as a retirement plan that provides for broad-based participation upon an employee’s achievement of eligibility requirements. Once again, numerous studies of employee ownership have shown that the economic benefits created for employees through in an ESOP are far higher than economic benefits created through more traditional retirement plans.
As a business owner, if the aforementioned reasons are consistent with your own personal goals and objectives, then a deeper discussion with a qualified financial advisor regarding ESOPs may be warranted.
For a business owner, their company is their life’s work. They’ve spent years becoming an expert in their industry and strategizing for success. At some point, all owners find themselves in unfamiliar territory: designing a succession plan that will achieve their objectives. Whether the goal is generating liquidity to fund the next business venture or simply retiring, planning for succession can be one of the most challenging strategic decisions during a business owner’s career.
Perceptive business owners know that deciphering the market takes time and analysis; the market for a business sale is no different. So, how does one begin the succession planning process? The initial steps involve gaining an understanding of the spectrum of available buyers, current market activity, and how the business would be valued in light of the company’s performance – and especially the company’s future opportunity. This article discusses the broad universe of buyers. Generally speaking, most business owners will find the following parties as potential acquirers in their respective markets: a strategic buyer, private equity group, management buyout, or employee buyout.
What is a strategic buyer? Simply put, this buyer may be a competitor in the same industry or operate in a related field. Strategic buyers are usually looking to acquire a ready-made business to increase market share, revenues, and service offerings while expanding their current brand. They’re typically able to pay more for the acquisition, but that often comes with the price tag of expectations that may conflict with those of the current owner(s).
Private investors account for another type of buyer, frequently categorized as financial buyers, most often in the form of a private equity group or investment firm. These buyers look to invest in a company and hone in on rapid growth opportunities for the purpose of selling, often within a specified time period ranging from three to seven years. In many instances, private equity groups may keep the existing management team in place while bringing industry experience and resources to the table; though these buyers don’t usually pay as much as a strategic buyer.
In a management buyout, the owner sells the company to the current executives. This transaction maintains stability for the current employees and ensures a high level of confidentiality around the business. On the flip side, the management team lacks access to a pool of available capital to fund the sale from the current owner(s), and would likely need to secure outside financing to complete the transaction. In the same vane, management teams probably won’t have the excess capital to invest in strategic growth objectives for the company. Current owners will often help finance a management buyout, which is referred to as seller financing. This may appeal to owners possessing the utmost confidence in their management team, but it wouldn’t offer any significant liquidity right away.
An employee buyout, often in the form of selling the business to an Employee Stock Ownership Plan (ESOP), is a unique exit strategy. At its core, an ESOP is a qualified retirement plan that offers business owners an exit path while also creating wealth for the company’s employees. Although the transaction requires careful planning and significant analysis, selling a business to an ESOP can offer an incredibly impactful exit option for owners looking to maximize cash at closing while maintaining stability for their employees and preserving their legacy.
Interested in learning more about exit strategies? Flip through the SlideShare below:
Take the First Step
“Start the process with a preliminary question: what are the owner(s) most critical objectives?”
While there may be different roads a business owner can take when stepping away from the company, beginning a succession planning process with clearly defined objectives will paint a clearer picture of the most appropriate buyers. Start the process with a preliminary question: what are the owner(s) most critical objectives? Maximizing cash at closing? Preserving the business’ legacy? Keeping the business in the family? Contributing to the economic health of the company’s community? In order to successfully address their objectives, owners should enlist the support of their current advisors in addition to hiring experienced outside advisors who will guide them in completing the right transaction.
Preparing to exit a business can be a daunting task. Once the seller has gone through the process of determining the right time to sell, it can take a considerable amount of time and resources to prepare for the transaction before finalizing all the details.
Here are a few tips for business owners when contemplating the sale of a business:
Ask for a helping hand
Some owners might compare the process of selling their business with selling a home. When a homeowner chooses to sell, the entire infrastructure of the housing market, with brokers, agents and banks, are all ready and willing to complete the sale. Each state has extensive legislation regarding the buying and selling of housing, while the majority of the paperwork for the process consists of standard, boilerplate forms.
This is not the case with selling a business. Selling a business is more complicated, and involves a variety of professionals at every stage of the transaction. Typically, a business owner will only undergo the process of selling their business once during their lifetime, leaving no room for a learning curve. Engaging a trusted advisor with significant experience leading transactions provides guidance and peace of mind in an overwhelming process.
Leave on your own terms
Successfully exiting a business means leaving when the time is right for both the business owner and the company, rather than waiting until external matters force the owner into retirement, such as an unexpected illness or an adversarial relationship with business partners. Having a plan in place early can allow the owner to leave on his or her own terms. Even if they may not be ready right away, drafting an exit strategy early on will better prepare a business owner when it is time to sell.
Be engaged in the process
Not every business eventually sells, but the ones that do rely on owners and their advisors to be involved in the process and willing to go the extra mile to get the deal done. Some transactions may take anywhere from 6 months to well over a year to finalize. Owners who wait until they are already burnt out and ready to exit might find they don’t have the energy to continue running the business while simultaneously preparing the company for sale. If the owner isn’t fully engaged in the process at this late stage, the transaction will never come to fruition.
Ready to start planning your exit? Download our complimentary white paper to understand your exit planning options.
After years of dedication and investing the majority of their wealth in their company, no business owner wants to settle for less than the full value of his or her business. According to a study by the Small Business Administration (SBA), many owners are counting on their company to provide a nest egg for retirement. When they decide to sell the business, owners need to maximize the company’s value to generate the greatest opportunity for liquidity on one of their largest assets.
Another study by the SBA showed that small business owners plan on retiring at age 72 on average, compared to the average age of 68 for non-owners. A number of factors contribute to identifying the right time to sell a business. If business owners could exit the business sooner than later, they can create more leeway when it comes to selecting buyers.
Interested in learning more about the importance of pursuing a valuation? Flip through the SlideShare below:
Here are four ways to increase a company’s valuation before a sale:
1. Increase profitability
While the goal of every business is to increase profits over time, special attention should be paid to demonstrate to potential buyers the current profitability of the enterprise and its projected growth. Reducing overhead and improving efficiencies are surefire ways to increase the value of the company. In addition, owners should identify key growth markets to show buyers that the company has the potential to expand and continue to boost profits.
2. Develop recurring revenue agreements
Finding new clients and establishing sales agreements, or shoring up pending customer and vendor contracts, will help potential buyers understand the company’s revenue trends. Understanding how and when a business makes money must be clearly demonstrated to potential buyers, which often entails using generally accepted accounting principles (GAAP).
“Buyers want to know the best possible people are in charge.”
3. Build a dream team
Buyers want to know the best possible people are in charge of the company. Business owners may need to either hire new talent, shuffle around the existing management team, and possibly evaluate their recruitment, training and retention practices. Since the owner wants to maximize the company’s value, they may want to consider offering stock options or other plans designed to act as golden handcuffs to members of the executive team in order to remain with the company long term. In other situations, owners may have to “promote” themselves to a new position, like Chairman of the Board, to open up a seat for a new CEO.
4. Perform sell-side due diligence
Any serious buyer will go through the due diligence process to obtain a realistic valuation of the company and establish its assets and liabilities while analyzing its potential for continued success. Middle Market Growth recommended that sellers also go through the due diligence process as buyers. This will provide a consistent and validated figure of earnings before interest, taxes, depreciation and amortization (EBITDA) that investors are likely to bid on, which reduces the chance of receiving disappointing offers while identifying serious buyers.
When a business owner decides to sell the company, there are different scenarios to consider to ensure the sale benefits the seller as much as possible. When selling their business, owners should understand the tax implications related to the company’s corporate structure.
Owners who operate a proprietorship, partnership or limited liability company are only subjected to a single tax level. These entities must report taxes, but they do not pay them. Rather, the individual partners or members pay taxes on their portion of the profits. If an owner sells one of these types of businesses, the sale proceeds are taxed at the individual level.
If the owner operates a corporation, however, the tax issues become a bit more complicated. Unless the owner filed an S election, most corporations are C corporations by default. These companies are taxed on their own income at the current corporate tax rate, while individual shareholders are then taxed on any corporate distributions, such as dividends, BizFilings noted.
“Owners may find it more advantageous to sell stocks rather than assets.”
When it comes time to sell a C-Corp, owners can either sell the assets or the stock. For tax purposes, however, owners may find it more advantageous to sell stocks rather than assets. Selling the assets and then distributing the sales proceeds to shareholders can result in liabilities for both a corporate and shareholder tax rate that could exceed 50 percent. A shareholder’s sale of stock, on the other hand, would only incur a single tax, which could potentially be as low as 15 percent.
Buyers, on the other hand, may prefer to buy assets over stocks. True successor liability accompanies the purchase of stock, leaving the buyer open to lawsuits and potential backlash over previous corporate liability. In addition, stock sales do not depreciate and buyers could be left with a low asset basis locked inside the company.
According to the IRS, for federal tax purposes, owners form S corporations to pass on corporate income, losses, deductions and credits to their shareholders. By electing this status, shareholders will report the flow-through of income and losses on their individual tax returns, while the IRS assesses tax at individual income rates. This ensures that S corporations avoid double taxation. However, they must still pay certain taxes for things like built-in gains and passive income at the entity level.
If you are considering filing as an S corporation, your company must be a domestic corporation that only issues one class of stock and cannot have more than 100 shareholders. Of those 100, the company can only have allowable shareholders, such as individuals, certain trusts and estates. It should be noted that partnerships, corporations and non-resident aliens are not considered qualified shareholders for the purposes of an S-Corp. In addition, certain financial institutions, insurance companies and domestic international sales corporations do not qualify for S corporation status.
What are the differences between S corporations and C corporations? Flip through the SlideShare below:
Understanding the differences between selling a C-Corp and an S-Corp empowers owners to prepare their company for a sale that meets all of their objectives. An experienced corporate finance professional can structure the transaction to reduce the selling shareholder’s tax liability and ultimately provide more liquidity for the seller.
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