We’ve written previously about the risks imposed on small business owners when the majority of net worth is concentrated in the business. But how can business owners structure 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? The discussion that follows outlines key strategies across both the pre-sale and post-sale phases that can help owners exit successfully while ensuring continuity for employees, customers, and successors.
Building the right strategy is central to the success of selling a business, but unfortunately, this basic step tends to be neglected by many small business owners. According to statistics compiled by the Gallup organization, most small business owners, notwithstanding that over half are at or near retirement age, have no succession plan in place to ensure the ability of the business to continue after they cease day-to-day involvement. But there’s no need for this to be the case. Following some basic steps and paying attention to some key concerns can help small business owners prepare for and execute a successful exit strategy, diversifying their wealth and leaving the business in a position to continue to operate profitably.
Before the Sale
1. Financial and operational readiness. Preparation for the sale of a business should ideally commence at least three years prior to the intended sale date. The owner will be gathering key documents, such as clean, audited P&Ls and balance sheets, tax returns, and operating statements. At the same time, key operating procedures will be documented and the owner will be empowering key employees and/or intended successors to assume necessary administrative, management, and operational functions. This can be especially important when the objective is for the business to be assumed by a younger family member. The more the owner can separate the success of the business from her personal involvement, the more attractive the enterprise is likely to be to prospective buyers and the more likely it is to succeed after the departure of the original owner.
2. Know and enhance the value. A professional, third-party valuation of the business is essential in most cases. It should hardly be surprising that many owners place a higher value on their businesses than can be justified in the harsh light of marketplace reality. For this reason, most buyers will be reassured when the business’s value has been assessed by a disinterested, professional party, such as a Certified Valuation Analyst or a person holding the Accredited Business Valuation certification. 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.
3. Consider tax-efficient strategies. 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. 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 received a greater tax benefit for the purchase of inventory. In all cases, maximizing the tax efficiency of the sale for the seller should be carefully discussed and planned before the sale is consummated.
4. Personal readiness and life after the business. While financial and operational preparation are essential, research suggests that many business exits falter due to a lack of personal readiness on the part of the owner. According to studies cited by the Exit Planning Institute, 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. Owners often underestimate the complexity of transitioning from business income to personal wealth management, have not clearly defined philanthropic or legacy goals, or 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. Addressing these considerations well before a transaction, by clarifying lifestyle needs, developing a comprehensive post-sale financial plan, exploring charitable and family wealth strategies, and intentionally designing a meaningful next chapter, can materially improve both financial outcomes and long-term personal satisfaction.
After the Sale
1. Plan for a smooth transition. Even though the sale has just closed, it’s not time for sellers to dust their hands and walk away. A clear transition plan is vital to bridge the gap between the consummated transaction and the “new regime” instituted by the buyer. This period is also key to 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 will do the buyer a tremendous service 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. Deploy assets strategically. Perhaps the owner’s principal benefit of selling the business is the ability to diversify net worth. Typically, 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.
Your Rothschild advisor can be a key resource if you are considering the sale of a business. From maximizing value before the sale to effective deployment of assets after the sale, our fiduciary advisors work with clients to provide strategies that place the client’s benefit foremost at every stage.
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