Today’s post is from guest author and friend Brian Setzler of TriLibrium CPAs and Wealth Advisors
Most entrepreneurs eventually think about selling their businesses, whether as a prelude to retirement or to pursue other activities. In doing so, they often underestimate the effort required for a satisfactory outcome and overestimate the value and salability of their enterprises. If you’re contemplating selling, here are some common mistakes to avoid.
1. Overestimating the value of your business.
Your price should be based on the fair market value of the business in its current form. Buyers won’t care about the work you’ve put into building your business or your unique vision for its future.
2. Failing to account for the nature and make-up of your business.
The values of most businesses proceed from a mixture of variables. If your business includes significant equipment, real estate, intellectual property, or other such assets, their values should be separately established before being factored into the overall price. If you’re selling a service or professional firm, much of its value may depend on the experience and skills of your managers and employees. In such a case, the price may vary according to the expected retention of key individuals.
3. Failing to base your sale price upon independent appraisals.
Even if you think you know the value of your business, you should obtain two or more outside appraisals from professionals familiar with your industry. If the appraisals conflict with your opinion, they’ll provide a much-needed reality check. If they confirm your opinion, they’ll become a useful sales tool.
4. Not hiring a professional business broker to handle the sale.
Owners are often too personally invested (and/or eager to sell) to effectively negotiate sales of their businesses. A broker familiar with your type of business will know what issues are important to buyers and what characteristics to emphasize or de-emphasize, without becoming emotionally involved.
5. Neglecting to work with the buyer to ensure a smooth transition.
Nobody likes being thrust into unfamiliar circumstances without preparation. Notifying your managers, employees, and customers in advance and doing all you can to allay their concerns will serve your own best interests, as well as being the honorable thing to do. Discontent on the part of any of the affected parties could result in conflicts, reduced revenue for the buyer, withheld sale payments, and litigation.
6. Being unwilling to help finance the sale.
If you’re unwilling to take back a note, your sale price is limited to the buyer’s cash and ability to obtain outside financing. At best this could limit the number of potential buyers, and at worst it could limit your sale proceeds. (Conversely, if you finance too much of the sale price, you’ll increase the risk of default.)
Every business owner has a silent partner: Uncle Sam. And he plays a big role in the sale of a business. There are two tax considerations for the business seller regardless of what kind of entity is being sold:
• Will the income from the sale be taxed as ordinary income or capital gains?
Currently, ordinary income rates top out at 39.6%. Also for 2013, there is an Unearned Income Medicare Contribution Tax of 3.8% that applies to net investment income for taxpayers whose modified adjusted gross income exceeds $200,000 (for single filers) and $250,000 (for married filing jointly). Thus taxpayers in the highest tax bracket will face a combined 43.4% marginal tax rate on their investment income. The capital gains rate that most people and transactions fall into is 15%. That’s a big difference in rates. Naturally most sellers want to have the income reported as capital gains to obtain more favorable tax treatment. But how the income is treated (and thus taxed) depends on what kind of entity the company is, and how the sale is structured.
• When will the income from the sale be taxed?
Generally speaking, income is taxable when it’s earned. And when the income is earned depends on how the seller and buyer structure the payments. There are two types of sales when it comes to selling a business: a sale of corporate stock or a sale of the company’s assets. Each type of business entity (sole proprietorship, partnership, C corporation, LLC, and S corporation) has its own issues when it comes to the tax aspect of selling a business.
It’s important to analyze the potential tax consequences for the sale of your business early on. If you’re even thinking about a sale, be sure to consult with a knowledgeable CPA or business tax advisor to avoid making potentially expensive mistakes that give too much of the proceeds to your silent partner, Uncle Sam.
Sales of a business come in all different flavors. We’ll spend some time over the next several posts going through some common options for selling a business. Today we’ll look at the “insider” sale, which is not to be confused with the less desirable transaction of “insider trading.”
An insider sale involves transferring ownership to an existing employee or co-owner. Although some insider sales may involve a lump sum cash transaction, often the buyout occurs over time, typically funded in part from ongoing earnings of the business.
Depending on how the insider sale is structured, the seller may gradually transfer his or her ownership during the payout period, or the seller may transfer ownership in one fell swoop but retain a security interest, such as the right to reclaim the ownership stake if the buyer doesn’t perform its obligations (lawyer-speak for “doesn’t pay on time”).
One benefit of an insider sale is a greater likelihood of ongoing success than with an “outsider” sale, because an insider usually has greater familiarity with company operations and personnel. In addition, an insider sale may allay concerns from other employees, as well as the company’s suppliers, customers and lenders, about ongoing leadership and management. This in turn may increase the likelihood of getting a deal done, obtaining a fair price, and the ongoing success of the business, which is critical if the selling owner is getting paid over a period of time.
Downsides may include resentment from other employees who find themselves working for a former co-worker, or the realization that the new owner lacks skills or experience to fill the previous owner’s shoes. Also, new owners may want to invest more profits into developing new product lines or customer bases, which may reduce short-term profits, thus limiting the availability of funds to pay the selling owner. In addition, a sale to an insider may result in a lower price than a sale to an outsider.