Exit planning for business owners: Start now, maximize benefits later

Exit planning should begin three to five years before divesting. That is not naïve or idealistic, but rather simply sensible business planning. (Of course, even if three to five years is not possible or practical, still aim to start planning as early as possible – talk to your professional advisors as soon as you think about selling or are approached to sell.)

Business owners should take time to properly evaluate options, alternatives, and scenarios to best realize the benefits of their entrepreneurship. Consider the following questions to start the process:

• What is the value of your business today? What factors could impact future value?
• Will your exit plan include estate or legacy planning to benefit future generations?
• Are you taking advantage of the current estate and gift tax exemptions (for 2023, $12.9 million per person) that will expire on Jan. 1, 2026?
• Are there other people in the business you want to protect or plan for, even if you’re not running the business?
• What do you want to do with the after-tax proceeds?

These are complicated, multi-dimensional questions deserving careful consideration and analysis. The first step is evaluating company operations and finances to be clear-eyed about the business’s value to potential buyers and what changes are needed to make the business most desirable.

Entrepreneurs are notorious for their hands-on control over all aspects of their business, from marketing and financial strategy to customer relations and sales. However, that tightly controlled business is not necessarily sustainable or appealing to buyers without the controlling owner. The three-to-five-year time frame allows company leaders to reorganize management, delegate responsibilities, and hire professionals that would make the business more attractive at a higher sales price, such as a sales and marketing team, CFO, or COO.

Similarly, business owners often need to make financial adjustments to report and reflect actual business value. Legitimate tax minimization strategies that effectively depress earnings and reduce taxable income can hurt a company’s “curb appeal.” And many businesses pay themselves higher-than-normal rent if they own their office space. Again, while perfectly legal, such expenses can depress business income and make it seem less financially attractive. A sell-side analysis, also known as a Quality of Earnings report, can normalize earnings (EBITDA – earnings before interest, taxes, depreciation, and amortization). Normalizing earnings means adjusting for policy decisions about legitimate expenses –such as auto reimbursements, meals and entertainment, or health benefits – that a buyer might want to tighten up. Similarly, the Quality of Earnings report can adjust for unusual transactions or other nuances to help provide estimated company performance in the buyer’s hands.

Prior to going to market, tax returns and tax positions should be reviewed by a CPA team that has experience in tax sell-side, multi-state due diligence. Buyers look for potential outstanding and future tax liabilities to lower the purchase price. With the Supreme Court ruling in the Wayfair case several years ago, multi-state taxation has become much more complicated. Have all state and local tax positions – whether filing or not – for potential state income taxes and sales tax been quantified? Has the potential for any changes in accounting methods or unclaimed property reporting requirements or options been considered? Have employee payroll and benefits practices and independent contractors been accounted for in a proper manner? These are some key areas that can be reviewed and any changes or filings implemented prior to the sales process to help alleviate some of the buyer’s inquiries.

Once complete, these operational changes and financial analyses will help position your business to attract the highest multiple possible. And once your personal estate planning documents have been updated, you and your family can enjoy enhanced financial security. You can rest comfortably knowing that you are ready to respond to an offer or seize an opportunity.

The next step is to determine where to market your asset. Review these questions, and discuss them with your professional advisors, to help evaluate your options:

• What is your price expectation? Will you accept a payout over time?
• Would you like to sell your business to employees, a business partner, family members, or a third party?
• What type of buyer would you prefer? (e.g., private equity, competitor, vertical company)
• Do you want the company to remain independent, or are you willing to have another business absorb it?
• Will you stay active in the business even if you are not the primary owner? If so, in what capacity, and for how long?
• What portion of the business are you selling? If less than 100%, restructuring may be necessary to create a more beneficial tax arrangement with an investor.

While evaluating these issues, remember that employees may get nervous with sales talk. Consider incentives to keep your key people in place to preserve company value and institutional memory.

When talks begin, expect the potential buyers to request a significant amount of financial and operational data. Your advisory team may provide (or review) a non-disclosure agreement (NDA) to protect your information and help you create a polished, professional company profile that accentuates its value and future potential.

Once you’re ready to entertain a Letter of Intent (LOI), make sure that your advisors evaluate the proposed transaction’s state, federal, estate, and gift tax impact to confirm that it is “tax efficient”; that is, beneficial to the seller and at least neutral for the potential buyer. Don’t sign an LOI without language stating that it must be structured as a “tax-efficient transaction” for the seller, unless the buyer is providing consideration for the tax consequences to the seller.

Tax efficiency is unique to every transaction and each party. The seller’s tax profile and business operations help determine tax efficiency. Factors may include:

• How much debt is on the balance sheet?
• What is the company structure? Partnership? S corp? C corp?
• Where are the employees and/or offices located? Where are products sold?

During due diligence, the buyer’s team scrutinizes a seller’s financial and operational documentation. Your sell-side advisors should act as your advocate and envoy, clarifying questions and assuaging concerns that could negatively impact price, timing, or terms during contract negotiations.

Contract terms have real-life impacts that can be overlooked in a rush to close the deal, which often prevents buyers and sellers from understanding the complete lifecycle of their investments relating to income and loss allocations between parties, preferences, and tax distributions. Allow enough time to develop well-integrated advisory teams that will work together from start to finish to make sure the contract benefits their clients and achieves the stated goals.

As illustrated here, an exit is a complicated process, with a long list of adjustments to make and factors to consider before you can successfully transition your business to the buyers, keep your customers happy and loyal, take care of the people who matter most to you, and feel confident that you have the financial resources to enjoy your life and provide for your family.

But remember that you need not be alone as you approach this finish line: You can rely on your various advisors to work collaboratively and cohesively toward a well-conceived and executed process. From initial planning to finalizing a transaction, accountants do more than review taxes; lawyers do more than read and draft legal agreements; and financial planners do more than develop investment strategies. Accountants, for example, will also add value during negotiations by making sure that all parties understand the practical effects and potential unintended consequences of specific language, company structures, and operating agreements.

Contact your advisors for more information or to start your exit planning journey.

Teri M. Kaye, CPA, Partner

561.886.5262