Selling your business is a complex financial and emotional endeavor and it’s easy to feel overwhelmed by the prospect. To help demystify the process, Abacus Chief Financial Officer Dave DeWolf offers his insights on the 7 areas every business owner should focus on when considering a sale.
What role do capital gains taxes play in the sale?
There are typically two paths to minimizing capital gains taxes. The first is individuals and companies can relocate ahead of time to limit state taxes on business sales. For example, California is taxed at a rate of 13%. If you relocate to TX, the state tax is 0%. Many people consider that a 13% increase in the value of their business.
On the federal side, sometimes you can structure the sale in installments over several years to fall below certain income limit thresholds, but even then the tax won’t be completely alleviated. By and large, you simply won’t be able to avoid paying capital gains tax at the federal level.
The second path to minimizing taxation is through personal financial planning. If your goal is to earn $5 million dollars out of a sale to enable retirement, then realistically you may need to generate a $7 million dollar sale to net the $5 million you desire. Figuring out your ‘must have’ number is essential when selling your business. Finally, you can sometimes gift a portion of your business to your children to ease some of the tax burden, but overall taxes are difficult to avoid entirely.
When packaging your business, what assets are (or are not) included in the sale? How do you decide?
More often than not a buyer hopes to procure all the assets of a business without taking on extended liabilities. These can include obtaining customer lists, recurring revenue, and intellectual property. To help decide what to ultimately include, we highly recommend business owners work with professionals who focus on exit planning. Why? Because it’s usually a 5 to 10 year process to make your business attractive for a sale. Business owners who we’ve worked with have generally experienced a high return on exit planning investment. Sometimes this is referred to as Business Succession Planning; there’s a terrific website called Build It Backwards that outlines how it can help in this area.
As a business owner, are your books and records readily available?
This should be an essential component for all business owners. You’ll generate even more credibility if you conduct an annual review of all of your books using a third party accounting firm. This helps in several ways. First, it can help your banking relationship which may require it for any loans you get, so you’ll be in compliance. But secondly, if I’m a buyer looking at a company, this kind of review gives me better assurance that a company’s numbers have been put together properly. It’s not a full audit so there can be things missed, but it’s a Generally Accepted Accounting Principle (GAAP) most will look for. Frankly, if a company doesn’t have this it’s a red flag.
Ask yourself how will you receive payment?
This question brings up a lot of complex challenges. The answer honestly depends on who you’re selling your business to. If you’re selling the company to employees or current management, you’re inevitably going to have a liquidity problem. For example, if my business is worth $10 million and I want to sell it to my employees, they likely can’t come up with that amount of money. At that point you get into a lot of seller financed situations where payment will be doled in smaller distributions over a fixed number of years.
Obviously, it’s much easier if a private equity firm gives a buyer $20 million in cash and says, “Here, go buy it.” But that doesn’t happen too often, so it’s normally going to be a real challenge with the buyer’s financing. A seller has to be flexible and realistic in their expectations and accept the fact they’re probably going to get paid out over a 3 to 6 year period.
Can your business continue to succeed if you’re not involved?
This should be almost every business owner’s goal. If you can create something that isn’t dependent on you personally you can create something with much more value. For example, a lot of smaller service businesses are dependent on the owner’s connections. If the business owner goes away, the connections go away. Early on, Abacus was completely dependent on our owners Brent and Spencer, but they’ve spent the last ten years creating something that will survive them. When you do that, your business is much more valuable and likely to sell for a much higher multiple.
What professional assistance will you need to facilitate the sale of your business?
Depending on the company’s size you may or may not want to use a business broker as they’ll be an important advisor. For instance, if Abacus wanted to sell next year (which we don’t), we would likely engage a broker who specializes in selling finance companies. Or sometimes a broker might specialize in companies with revenue between $2 million to $10 million dollars.
Your CPA should also be heavily involved as you’ll run into issues understanding tax liability, so a proactive CPA is key. You’ll need a business attorney to ensure you’re properly protected from liabilities. And your own financial advisor will still be important, mostly because an advisor is like having your own personal CFO. You’ll often also want an evaluation expert who evaluates revenue growth and overall expenses. Basically, if you say your company is worth $4 million this expert will conduct an independent assessment of the true worth of the company.
Any last words on selling your business?
If you know you eventually want to sell your business you should start planning for that sale a good 5 to 10 years in advance. We have seen businesses who have had a real struggle trying to do this. Why? Mostly because if you own something, you tend to value it more than someone who doesn’t. It’s a classic behavioral finance ownership bias that has even been confirmed with academic studies. If we own it, it must be special.
This emotional element is a genuine hurdle most business owners will have to overcome. More often than not this is remedied by sound planning. A good advisor might say, “I know you think it’s worth $10 million, but if you can get $7 million here’s what that will accomplish: security for you and your family for life. Is that enough? What do you value most?”
Wait, that was only 6 things, what’s the 7th?
Part II will be dedicated to this exact question, perhaps the biggest question of all about selling your business: What do you want to accomplish most, and what will your life look like after it’s done?
In the meantime, if you have any further questions, reach out to an Abacus financial advisor and feel supported as you move forward with selling your business.