Before you put your business on the
market, you should evaluate the entity
structure and perform a “presale tune-up” to maximize your gains and ease the burden of transaction taxes.
Depending on your business structure, you
could prevent millions of dollars from disappearing when you close the deal.
“Entity structure really sets the tone and
direction of the company,” says Floyd
Trouten, III, CPA, director in the transaction
advisory services department at SS&G
Financial Services, Inc. “How you structure
the business drives your net profit from the
business sale. And, the better you plan
upfront for that eventual day when you sell,
the happier you will be with your earnings.”
Smart Business spoke to Trouten about
the business sale process and ways to glide
through the transaction and reduce the
“shrinkage” from gross to net earnings.
What processes should be followed when
selling a company?
You can enlist a third-party broker or investment banker to sell the company, or you can
do it yourself with the help of an attorney or
accountant. After valuing the business to
determine its market worth, you will create a
‘teaser’ that highlights attractive features of
your business. This should entice a potential
buyer with regards to the company’s profit
potential. If a buyer is interested, he or she
will sign a confidentiality agreement and, perhaps, make an offer subject to successful due
diligence and acceptable financing.
Once due diligence is completed without
major issues discovered, the buyer and seller
will negotiate a purchase agreement. Once
an offer is accepted, a timetable for closing is
developed. The buyer’s accounting firm and
attorney will further research your company,
then the buyer will complete financing and
sign the purchase agreement and any other
agreements required to close the deal on the
designated date. As this snapshot indicates,
the sales process requires careful planning
upfront in order to advance smoothly.
What common roadblocks do sellers face?
Selling a company is not ‘business as usual’
for owners, and there are numerous complexities involved. It is important to set up the
most efficient tax structure possible, which
generally means creating a ‘flow-through’
entity. Owners tend to look at the top number
(gross dollars) and don’t focus on the net
after-tax dollars they will earn from a sale.
For example, C corps are subject to double
taxation. The C corp is first taxed at up to 41
percent on its net earnings, including gains
on the sale, and then its shareholders are
taxed at approximately 21 percent on its net
distributions.
What can sellers do to mitigate such ‘shrinkage’ when they sell the business?
Set up the most efficient tax structure possible. You may decide to set up an LLC or
partnership, which allows ‘special allocations’ to ensure that owners walk away with
a fair cut. For instance, if you own a business
50-50 with a partner, but you do 90 percent of
the work, you can create a special allocation
that ensures you will get 90 percent of the
sale dollars. The same arrangement is possible for LLCs. S corps are a bit different
because the entity structure mainly applies to
owners. S corp owners must be given profits
based on the exact percentage of ownership.
Special allocations are not possible with this
arrangement. The key is to examine whether
your entity structure is such that you will
maximize your earnings from the sale and
mitigate the tax burden.
When should you restructure the business?
Ideally, restructure the entity before you
begin the selling process. However, you can
change the entity structure during the sale. If
your business is an S corp and you wanted to
restructure to a partnership, you may be able
to freeze that S corp and set up a new partnership. Switching from an S corp to a partnership is deemed taxable at fair market
value. Because restructuring is considered a
taxable event, you may be able to utilize
another entity for the sale.
What if the seller has significant debt?
Many business owners forget that they
must clear debt or it will cost them when the
transaction closes. If your business is worth
$5 million but you have $3 million in debt on
the business, you won’t ‘cash out’ with the
full business value. We recommend a presale
tuneup, which is essentially an audit performed by an outside accounting firm. This
informs the seller of problem areas in the
business. If all goes well, the buyer will have
greater confidence that he or she is purchasing a solid business with no ‘secrets.’
What post-sale considerations come into
play after the transaction is complete?
During the post-transaction period, you collect money owed to you and pay transaction
taxes. There may be continuing representations and warranties (typically referred to as
reps and warranties) that serve as an assurance that the business was represented as
promised. From there, you may consider
retooling your estate plan and properly managing new liquid assets. Generally speaking,
post-sale is a new chapter for owners whose
wealth was tied up in the business for years
— and a chapter that requires as much attention to planning as to the sale.
FLOYD TROUTEN III, CPA, is a director in the transaction advisory services department at SS&G Financial Services, Inc.
(www.SSandG.com). Reach him at (800) 869-1834 or [email protected].
