5 Things You Should Know Before Selling Your Business
I’ve spent the past 20+ years working with financially successful families, many of whom created their wealth as entrepreneurs. And while some are fortunate enough to pass their business on to their children, often there are no heirs that have the same desires as Mom and Dad did when it comes to running the business. Couple that with an environment where Private Equity buyers are scouring the country for small businesses they can purchase and “roll up,” and you can see why there is such a high demand for Advisors that can help navigate the sale of a business.
Now to be clear, the sale of a business requires many cooks in the kitchen. The number of players and roles varies greatly depending on size, and may include a:
CPA
Business Attorney
Business Broker (<$5M business)
M&A Attorney and/or Tax Attorney (>$5M business)
Wealth Manager
As I mentioned, I have worked with many entrepreneurs selling a business. And when I look back at these experiences, I see a common theme in how many of them found me.
They had their portfolio with a Financial Advisor who limited their focus to investing, which led to a point of frustration. Because when they told that Advisor they were finally ready to sell the business, their Advisor said, “Great! Call me when the wire comes in and we can invest the proceeds.” Not exactly the service a client worth $20M+ was expecting to receive.
That’s why I include the Wealth Manager in my list of players to include when selling a 7-figure business, because their job is to both understand all facets of the business sale (tax, legal, post-sale earn-out compensation, benefits, etc.), and quarterback the entire process, bringing all of the outside experts together to get the deal done.
Against that backdrop, here are 5 Things You Should Know Before Selling Your Business:
The differences between an Asset Sale and a Stock Sale
How to get the most after-tax dollars, not necessarily the highest sale price
What deadlines really matter (estate planning, children’s trusts, LOIs)
How post-tax dollars convert to retirement income and what this means for your lifestyle post-sale
The emotional toll all of this will have on your life and your family’s life
Each one of these areas could warrant an entire college level class, so my description is purposely brief and somewhat over-simplified.
If you are considering selling in the next 5 years, now is the time to get a Wealth Manager that can help you think through all of this. If it took you 30 years to build it, spend a few years preparing for the sale.
With that, a brief explanation of each area:
1) The differences between an Asset Sale and a Stock Sale
Let’s assume your business is structured as an S-Corporation.
The business assets could be tangible (equipment, machines, trucks, etc.) or intangible (the client list, your reputation, an agreement not to compete post-sale).
A buyer may want the stock of the S corporation or they may want the assets of the business.
As a seller, for both tax and legal reasons, the difference of what gets sold matters greatly to you. And not understanding this could cost you hundreds of thousands of dollars and impact your legal liability post-sale if not planned for in advance.
2) How to get the most after-tax dollars, not necessarily the highest sale price
I see this firsthand in my own industry. Private Equity has discovered the world of financial advice and started buying up individual advisory practices as well as entire firms. Because this is a world I am plugged into, I often receive calls from Advisors letting me know how much they were offered.
Each of these offers has wildly different structures, and once you model them out in Excel, it is often the case that the highest sales prices don’t equate to the most after-tax dollars in the seller’s pocket.
While it sounds impressive to say “I sold for $25M,” what really matters is how much you get to keep when the deal is done and the taxes are paid.
And, sale structure matters a lot!
When the Buyer is Private Equity, a typical structure I see is a combination, which usually yields a high pre-tax sales price:
Upfront Cash + Rollover Equity + Contingent Earn-Out + Consulting Fee for 1-2 years post sale = Total Purchase Price
Upfront cash is seemingly straightforward, but this is where sale structure (Asset vs Stock, purchase price allocation) matters a lot. Not to mention issues like how Working Capital is defined.
Rollover Equity: The goal here is simple. The buyer has to outlay less cash up front, and the seller gets to tax-defer part of the purchase price AND increase total sales price if the value of the equity grows over time. As you can imagine, how the contract is written matters greatly here and could either cost or save you hundreds of thousands of dollars (or more!)
Contingent Earn-Out: Imagine a $10M business sale with $8M payable upfront and $2M payable in 24 months, assuming certain metrics are achieved (e.g. client retention, revenue growth). The Seller may assume these targets will easily be achieved, and that the total sales price will be $10M because of that payment they’re banking on. Unfortunately, I’ve seen contracts written with fine print to ensure that second payment is never made, even with the best of results.
3) What deadlines really matter (estate planning, charitable trusts, LOIs)
Let’s assume your Business Sale is going to cost you several million dollars in taxes. You’d probably want to know the ways to legally reduce this tax bill, right?
Believe it or not, it’s possible to learn about these tax savings strategies BEFORE the sale goes through, and have it still be TOO LATE to implement them.
As an example, let’s assume you have 3 adult children who are all in a lower tax bracket than you. I will make a lot of assumptions here, so bear with me.
You decide that it makes sense to transfer some of your corporate assets to them prior to the sale, allowing them to reap some of the benefits and presumably pay taxes at a lower rate than you would.
Well before the business is actually sold, you sign an LOI for this, but it may be too late to use this strategy.
4) How post-tax dollars convert to retirement income and what this means for your lifestyle post-sale
A few years ago, one of my clients was approached about selling his business. In the previous 5 years he had been through 2 tax audits (one IRS, one FTB), and 2 frivolous employee lawsuits. Needless to say, when the Buyers came knocking, he was all ears.
We crunched some numbers and he was shocked to learn that selling his business and living off of the proceeds would reduce his monthly income!
He was also a bit sanguine when he thought about the expenses in his life that were currently tax deductible, and would no longer be after the sale.
What many business owners don’t realize is that their current compensation is a combination of their day-to-day job + the profits the company creates (equity) + the fringe benefits associated with owning a business (like health insurance, a vehicle, a retirement plan).
It’s quite common to see a Seller take a pay cut after they sell their business. That doesn’t mean it’s not worth doing, it’s just something they should understand before the deal is contemplated.
5) The emotional toll all of this will have on your life and your family’s life
Running a successful business, while stressful at times, provides meaning and purpose in one’s life. We are creative beings and we get immense pleasure from building something and watching it thrive.
So, selling a business and walking away can leave an emotional vacuum for some entrepreneurs. I’ve had some clients tell me it’s like becoming an empty nester.
Again, this doesn’t mean it’s not worth doing, it’s just something they should understand before the deal is contemplated.
Preparing for this years in advance is much better than waking up one day to find out that one of your primary purposes in life is no longer there.
The two big take-aways from this are as follows:
Selling a business is complicated and there is a lot more to know than just what the Purchase Price is going to be.
This will likely be the largest single financial transaction of your life. You need a team of professionals that has done this before, and at least a year’s notice between the time you decide you want to sell and the day the deal closes.
Before you start this process, I would highly recommend sitting down with a Wealth Manager who understands investments, tax planning, and estate planning because you need to factor in all 3 when making these decisions.
If you or someone you love is seeking this kind of advice around wealth and complexity, please send me an email at rob@swrpteam.com
Finally, our specialty is helping successful families navigate wealth and all the complexity that comes with it. We want to continue to write about the topics that are most important and interesting to readers like you – so if you have questions or blog article ideas, please reach out to us and let us know - rob@swrpteam.com
This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.