Should owners of closely held businesses plan for the ultimate sale of
their business from the outset or as the sale date appears on the horizon? The
answer: They should do both, says Peter G.
Dolbee, corporate tax partner with Haskell
& White LLP.
Dolbee says that both short-term and
long-range planning are vital when it
comes to achieving the optimal return
from ownership and the subsequent sale of
a closely held business. Planning should be
an ongoing owner activity that starts
before the business is launched and ends
only after the business is sold and the final
check is cashed. Along the way, there are
strategies and supporting activities that
can help owners achieve the maximum
return on their business investment.
“The problem is that owners generally
think about short-term tax-savings opportunities without considering the long-term
consequences,” says Dolbee. “Effective
exit strategies are conceived from the outset, and they should be considered when
the business is first formed. Very few owners do this well. I have seen sales transactions where we structured the sales strategy about 12 years before the business was
sold, and it resulted in millions in tax benefits for the owners.”
Smart Business talked to Dolbee about
how owners can achieve maximum return
by conducting short-range and long-term
planning around the sale of their business.
How does the initial selection of the business
entity impact return when the business is
sold?
It’s important to think long-term when
planning for the sale of your business, and
an important consideration when selecting
the appropriate form of business entity is
how long you intend to keep the business.
Many owners think that if you’re only going
to keep the business short-term, it’s best to
structure as a C corporation, but that can
be a bad strategy for closely held corporations because a sale or liquidation of the
assets by a C corporation results in double
taxation. Structuring as an S corporation or
an LLC is a popular alternative because the
tax consequences resulting from the sale of
the business are more favorable than those
resulting under a C entity. However, C corporations that convert to S status within 10
years of the sale may be subject to built-in
tax gains at the highest corporate rate.
Also, don’t be ambiguous by structuring
one component of your operations as a C
and another as an S corporation. I’ve seen
this before, and it makes no sense because
you may not be getting the advantages of
either type of entity. Last, keep your personal and real estate assets out of the business.
If you wish to purchase such assets, do so in
your own name and then lease them back to
the company. Otherwise, when the business
is sold, any assets will be taxed based upon
their appreciated value.
What type of presale planning benefits business owners?
First, consider if you want to transfer the
wealth resulting from the sale of your business to your heirs. Valuations of the business made in advance of the sale can be
substantially less than at the time of the
actual deal, and waiting until the sale is imminent imposes negative tax consequences. Anticipation and planning are vital, because when the gift is made well in advance of the sale, you can employ estate-planning techniques allowing you to transfer substantial value to your heirs at
reduced gift-tax levels, and valuation principals decrease the amount of the gift.
Second, consider transferring a minority
interest in your business to charity before
the transaction to get the full benefit of the
deduction without the taxable gain. You
don’t want to make a gift with after-tax dollars. Third, consider transferring ownership to your children before the transaction, which can save substantial taxes
resulting from the sale.
What records are needed to complete the
transaction?
Once the deal starts, things happen quickly, and the better organized the seller is, the
more likely the deal is to close. Get a list of
what records you need to keep and how
long you need to keep them before you
launch your business. Organize the files for
easy access because recreating documentation is costly and delays can kill the deal.
Also, document all employee compensation agreements in writing. There can be
substantial confusion as to what was
promised once the deal is imminent, and
having properly executed contracts in
place will eliminate misunderstandings
and ease the transaction
Where should owners go for advice?
Don’t assume that your traditional advisers are the best ones to turn to when you
need advice about selling your business.
You want to select lawyers and accountants who specialize in mergers and acquisitions, and they should know the latest techniques. To select competent advisers, consider asking these questions:
- Should I do a stock sale or asset sale?
- Do you know what constitutes typical
representations and warranties, indemnities, and sale provisions? - Do you know what a basket, cap, claw-back and antichurning mean?
Asking screening questions like these will
assure business owners that they are
selecting the right team when it comes
time to sell their company.
PETER G. DOLBEE is a corporate tax partner with Haskell &
White LLP. Reach him at [email protected] or (949) 450-6307.