The final post in our Business Killers assessment focuses on the sixth mistake that business owners make when running their company: failing to anticipate and plan for changing federal and state tax laws.
Answer the following questions to see if your company is vulnerable.
• Has the owner determined his or her financial goals?
• Is the owner proactively planning to deal with changing tax laws?
• Is the owner working with financial experts?
• Will any of the owner’s retirement income be tax-free?
• Does the owner have a written exit plan for the business?
The more “no” answers, the greater the risk. How does your company look?
Many owners assume that you can’t beat Uncle Sam. Thus, they fail to appreciate that tax planning is an important part of an exit strategy. And like most aspects of that exit strategy, the more time you have to plan, the more likely you are to achieve the results you want. The amount of tax owed from the sale of a business depends upon whether the sale proceeds are taxed as ordinary income or capital gains. Profits from the sale of business assets likely will be taxed at capital gains rates, but money paid to an owner for transition consulting services probably will be taxed as ordinary income.
It’s not too early to begin working with your team to estimate the likely tax bite from a sale of the company and come up with a plan to pay those taxes. This will allow you to leave the business on your timetable, with your retirement funding intact.
As business owners, we probably pay more in taxes than we’d like. Plus the rules about exemptions, regulations, fees, and taxes seem to change constantly. But with the changing tax environment comes opportunities to reduce your tax burden if you know where to look. Early planning, however, is required to make the most of this strategy.
The final installment of the Business Killers educational series shows that even successful business owners still need to navigate potentially rough seas to reach their final destination without losing too much of the value that they may have spent years to build.
The scene opens on a business owner in his early 60s meeting with an advisor. The business has successfully acquired another company and profits continue to accumulate as part of healthy business growth.
All of the growth means increased income for the owner, and with it, a significantly higher tax bill. He’s frustrated about what he perceives as a disincentive to success. And with retirement not too far away, the advisor warns him that a sale of the business will result in a much larger tax bill than the one he’s bothered about now. “Stop trying to cheer me up,” the owner half-jokes in frustration.
Having to pay taxes on money that you’ve earned may sound like a “first world problem.” And it’s certainly true that paying taxes because your business is successful is almost always better than not paying taxes because your business is losing money. But there is no reason to pay more taxes than necessary.
Tax Planning is Part of Your Exit Strategy
Tax planning is an important but sometimes overlooked part of an exit strategy. The more time you have to plan, the more likely you are to achieve the results you want. The amount of tax owed from the sale of a business depends upon whether the sale proceeds are taxed as ordinary income or capital gains. Profits from the sale of business assets likely will be taxed at capital gains rates, but money paid to an owner for transition consulting services probably will be taxed as ordinary income. And as discussed in an earlier post, the structure of the transaction (stock sale v. asset sale, allocation of purchase price, etc.) will also have consequences.
In this case, the owner isn’t stepping down tomorrow, but he won’t be working another 10 years either. For him, and for any of you who plan to sell your business, it’s not too early to begin working with your team to estimate the likely tax bite from a sale of the company and come up with a plan to fund that liability.
All business owners invest in their growing businesses and hope that their hard work will ensure a comfortable retirement. But changing times, technological advances, and an increasingly global economy may wreak havoc on those plans.
In the next Business Killers vignette, a sleepless older man is sitting up in bed. His wife asks him what’s wrong and he confesses that he might not be able to sell his business to fund their retirement. Apparently a large international firm has entered the market and is buying up raw materials and undercutting prices. As a result, the prospective buyers that had expressed interest in his company have pulled back. And while he could sell out to the big international competitor, they would only give him about half of what he thought his company was worth. Any retailer who’s dealt with a big box store or a Wal-Mart entering the neighborhood knows that this scenario isn’t good for a small business owner. Now he’s kicking himself for not listening to his financial advisor, who has been encouraging him to diversify his assets instead of plowing all his money back into the business.
Future-proof Your Business
Two takeaways are worth noting. The first is what my friend Steve Bergman, a consultant with Teleconvergence, calls the need for “future-proofing” your business. Steve has developed a few maxims to help business owners understand trends that may affect their industry. According to Steve:
• if it’s wired, it will become wireless;
• if it’s fixed it will become mobile;
• if it’s wireless or mobile, it will become intelligent;
• if it’s intelligent, it will become shared;
• if it starts as a product, it won’t stay that way indefinitely; in turn it will be
• bundled, then
• interfaced, then
• integrated; then
• combined to become multi-functional
• then become firmware
• then become software
• then lose all identity and become an application or a service.
A Failure to Plan is a Plan for Failure
In the Business Killers example, it may not have been obvious that this particular international firm would get into the business, but it probably didn’t take a lot of insight to figure out that competition is always a potential threat. The second is that regardless of how successful a business you are running, you need to begin planning your exit strategy years in advance of the actual retirement.
Had our business owner heeded his financial planner’s advice, he would have set aside money to help fund his retirement from the outset, thus leaving him less dependent on a sale of the business. In addition, he would have been working with a business broker or perhaps a business coach or consultant to develop an exit strategy that might have avoided the “fire sale” that he is likely facing.
Again, a failure to plan has turned into a plan for failure. Don’t let it happen to you – whether you are just starting a new business or nearing retirement, it pays to talk with professionals who can help you realize the wealth that you are creating.
If you are starting to think about retirement or just want to spend less time on your business without giving up total control, consider hiring a temporary Chief Executive Officer. Using an interim CEO lets you see what life is like outside of your business. It also can be a great way to transition to retirement or other new ventures.
Advantages of hiring an interim CEO
Advantages of hiring an interim CEO include the ability to step back in if your inner control freak won’t let you give up the reins. It also means that customers and vendors are still dealing with the same owner. In addition, hiring a CEO is much less complicated than a full-blown exit and may boost the value of your business by demonstrating that it doesn’t need your daily involvement.
Challenges of hiring an interim CEO
A downside of hiring a CEO is that you’ll have to trust someone else to run your business. Not every hire will work out, so you may have a false start before finding the right person. If the new CEO’s leadership style or personality is different from yours (and it will be), employees may be less inclined to work as hard or as well as they did for you. Perhaps the most obvious drawback is that you will need to pay the new CEO a big chunk of the money that you used to pay yourself.
While it may not be the best choice for owners who expect to continue taking significant amounts of cash out of the business, testing the waters with an interim CEO can be a great way to literally buy more time as you refine your ultimate exit strategy.
The most popular exit strategy for small businesses
If family succession planning isn’t viable, and there is no company insider who is willing and able, then an arm’s length sale on the open market may be an option. This is the most popular exit strategy for small businesses. The business owner lists the business for sale and – we hope – ends up with a healthy sales price.
Groom your business for the sale
If you are targeting investors looking for an attractive opportunity, spend some time grooming your business for sale to make it as attractive as possible. A great potential buyer is another business in your industry that is looking for a strategic acquisition to simultaneously expand into a new market while eliminating a competitor.
The key is to target your potential acquirer(s) in advance and position your company accordingly. And of course, convincing your acquirer that your business is worth what you want for it.
Get a professional business valuation before naming your price
There are numerous business valuation formulas ranging from asset-based to future earnings approaches. But no single method can be used in isolation because market trends, economic conditions, and comparable sales also influence what buyers are willing to pay. If you have the resources, hire a professional business appraiser to do a valuation before you set the price. A professional business valuation will increase credibility and may save you legal hassles later on.
Listing your business for sale
After determining the price, an owner can list the business for sale on various business sale websites. Some sites permit sellers to list their businesses directly (think “FSBO” for a house), while others limit access to business brokers. Typically the sites charge a listing fee, but some, such as GlobalBX, are free. Business broker and consultant Eric Williams of Codiligent, LLC recommends that sellers not limit themselves to a single website when listing. Williams notes that many buyers are cognizant of some business sale sites but not others, so to get maximum exposure he recommends that owners list their business on as many as possible.