Tax Planning & Your End Game: What Business Owners Need to Know

We can’t stress enough the importance of having an exit plan for your business from the start. An exit plan allows you to lay out transition of ownership and passing of responsibilities associated with your business. Ultimately, it will give you peace of mind as you work on your business, knowing you already have your end game in motion.

Plus, by working on your end game early on, you can hopefully save yourself some time and headache later. One of the key areas where this is especially applicable is taxes. Without the proper planning, taxes can trip you up at the end if you haven’t planned from the beginning.

Here are a few common exit options and some key tax issues:

Buy-sell agreement.

A buy-sell agreement lays out a roadmap for what happens to the business should a specified event occur (we’re talking retirement, disability, death, etc.). Among other things, it can lay out methods for setting a price for owner shares, allows for business continuity and provides a buyer with a way to fund the purchase of the business.

But what about the taxes?

Life or disability insurance associated with the business often helps fulfill the need for funding the purchase. One of the biggest advantages of utilizing life insurance this way is that proceeds are generally excluded from the taxable income of the beneficiary (the person receiving the benefit from the life insurance policy).

Family succession.

You do have the ability to transfer your business to a family member. This is done by giving them interests or selling them interests in your organization (or both).

But what about the taxes?

There’s an annual gift tax exclusion which allows you to gift up to $14,000 of ownership interest under your gift tax annual exclusion without incurring federal gift tax consequences.

ESOP.

Some individuals choose to transition their business to their employees through an employee stock ownership plan (ESOP). An ESOP is a qualified retirement plan created to purchase your company’s stock.

But what about the taxes?

There are all sorts of tax implications and benefits for ESOPs. Check out the National Center for Employee Ownership for a list of some of the major tax benefits of going this route.

Sale and acquisition.

You’ve built something from the ground up and now you’re ready to sell it. Or maybe, you’re ready to add on through acquiring another company. Either way, you need to have your business in a ready state, including transparent operations, updated financials and streamlined processes and procedures.

But what about the taxes?

Here are a few tax considerations to think about:

  • Asset v. stock sale
  • Tax-deferred transfer v. taxable sale
  • Installment sale

The moral of the story.

It’s safe to say taxes have far reaching implications on your business, including how you plan to transition out of that business. That’s why it’s important to consider your end game early and prepare for the tax implications that come with it.

A trusted tax adviser can help you navigate all these circumstances and discuss what will work best for your business and your goals. That way you’ll prepared for the end, before you actually get there.

A version of this post first appeared in our 2017-18 Tax Planning guide.

Meet the Team: Amber Ferrie (@berferrie)

fgo_ferrie (2)What is my role? My role is to help business owners write the next chapter in their lives and their business’ adventures. That may be selling, transitioning to a management team or a succession plan involving family. When businesses are going through transitions, I come in to help guide them through.

Why are numbers important for business? Numbers tell the story of where you have been, where you are and where you are going. Understanding the numbers associated with your business can help you capitalize on certain opportunities and/or avoid disasters that may be lurking. Buyers always want to hear the story of your business, but they also crave the numbers and love metrics. Understanding these for yourself can help your business have a huge advantage.

Why do I enjoy what I do? Selling your business is a huge deal (no pun intended) not only from a financial perspective, but also from an emotional stand point. Being a CPA, this is one area that you can use more than just your love for numbers. You also see the personal side of transitioning a business and I find that incredibly interesting. Nothing in the M&A world is black and white. Each situation between a buyer and a seller is unique and has its own characteristics and challenges. Seeing all of those play out can be really fun.

#MidwestIsBest The majority of my work is actually not in the immediate area, but that doesn’t mean I don’t feel the love around here. The Midwest in general is an underserved market in the M&A world, and I see a lot of opportunity to serve these fabulous businesses. I truly believe these people and businesses are the best, and Eide Bailly is lucky we get to work with them.

 

Inspiring Confidence with Financial Statements!

Yes, you read that title right. Financial statements do a lot of things (we’re hoping you’ve learned that from this blog). But can they inspire confidence? Absolutely!

You may be thinking that financial statements are just numbers and nothing more. In a literal sense, you’re right — financial statements are a set of numbers. But when you understand them, they tell a story of where your business has been and where it’s going.

This story has many important tales to tell, and it is important to pay attention as your business grows and changes. It can also give you warning signs of disaster, and can help you stay on track to avoid this.

While working in the mergers & acquisitions department, I’ve come to understand the value of financial statements and that they can really instill confidence. Let me tell you a little secret friends: buyers WANT to feel confident when they write a check for millions, and financials play a big role in the confidence they feel.

A healthy bottom line gives buyers the warm fuzzies about their future with your company, but what else do financial statements provide?

  • Cleanliness | You have to have cleaned up financials before you decide to sell your business. A myriad of adjustments to wade through can raise some serious red flags and, frankly, make people wonder what’s really going on behind the scenes.
  • Timeliness | Being casually late works at times, but not all the time. When July’s financials are not ready to review until October, this gives some very negative signals to buyers. Its shows missed opportunities and the inability to react to the market … both of which will keep your buyers up at night.
  • Processes and procedures | No one wants to buy a circus, so make sure you have processes and procedures in place to get things done. If things are three to four months late, it’s an indication that maybe your buyer should run or reduce the offer.

And in case you’re wondering, we’re not talking a one-time thing. The sales cycle for business can take anywhere from 6-12 months, so the buyer will get a chance to really see how things are done and make assessments along the way. It’s best to always have your best foot forward so your buyers get the true picture of your business.

At the end of the day, your financial statements should help you run or sell your business, not hinder you. Let your financial statements give you confidence and tell the story of your hard work and success by making sure they’re up-to-date, cleaned up and timely.

Shameless plug: If you don’t understand your financial statements and what they mean … or have no idea what this blog is talking about, we can help.

The Path to Buy/Sell Happiness

You’re going along, building your empire and running your company when all of a sudden, there’s a knock on the door. You open it to find someone asking to buy your business. You’re honored, flattered even. After all, someone just showed interest in the thing you’ve poured your blood, sweat and tears into. But in addition to the spring in your step, you also feel an ulcer coming on … what’s next? Where do I go from here?

Yes, the above situation is slightly exaggerated. But someone reaching out, completely out of the blue, with an offer to buy your business does happen. So it’s best to be prepared. Selling your business is more than a tour of the office, a handshake and exchanging a check. It’s complicated, often messy, and intense. We’re talking six months (yes, you read that right) of data gathering, negotiations, analysis and emotional upheaval.

Now, before you freak out, let’s take a step back and walk through the process. Consider it like a relationship.

First, let’s talk about the parties involved. The buyer is the person who wants to buy your company (clever right). They really want to date the seller (that’s you).  Other parties can include financial advisors, transaction advisors, banks, lawyers, etc. (otherwise known as the peanut gallery).

Step One: Getting to Know You

Once interested, a buyer will need information to determine the price they are willing to pay. After all, they want to be prepare for the date, not just fly blind. It’s up to you as the seller to decide how much information to give them and when. While this question is enough to constitute its own blog post, here’s the short answer: NOTHING.

You should give a potential buyer NOTHING until they sign a non-disclosure agreement (NDA). This is a legal document that protects your information as the seller and ensures the buyer is only going to stay on the up and up (read, use the information you give only to formulate their offer).

Only after a NDA is signed should you (with the help of your trusted business advisor), formulate a plan to give the buyer the information they need to understand your company. Note, this does not mean just giving them everything they ask for, but instead enough for them to submit a range of value offer.

Step Two: A Promise

After preliminary due diligence (using the information you have supplied them with as well as other research), the buyer will typically give a range of value in the form of an Indication of Interest (IOI).

Consider it like this. You’ve had some initial dates and things went well. The IOI is like a promise ring in your relationship with the buyer. It’s not always done or necessary, but it signals you’re ready to move to a more serious place, without making any concrete plans related to time, date or dollar amount.

Step Three: Opening Up

 If you like the indication of interest made by the buyer, you accept the promise ring and let your guard down a little more, allowing yourself to be more vulnerable. This means you give the buyer more access to information surrounding your company. This information may include key contracts or agreements, customer lists or more detailed financial information.

Step Four: The Engagement

This vulnerability or sharing of information allows the buyer to see a cohesive picture of your business and hone in on a more precise value. These terms are then laid out in the Letter of Intent (LOI). The LOI can be compared to the sparkling rock that accompanies the proposal in a relationship.

At this point, you both largely agree to the terms put forth. The LOI typically covers the purchase price, the structure of the deal, whether it is an asset or stock sale, the escrow parameters, the working capital allowance and other details that your advisor can help you understand. As a note, while the LOI is a very intentional document, it’s non-binding.

Step Five: Going to the Chapel …

After negotiation, review of legal terms and final due diligence, it’s time for your big day. Cue Canon in D and begin your walk down the aisle because you’ve made it to the marriage portion of the journey. Known as the Purchase Agreement, this binding agreement is agreed upon by both parties and will be a road map for how thing play out once the deal is closed.

The Selling Relationships (1)

This blog illustrates high level the transition through the selling journey. There will be bumps along the way (similar to a relationship), but it’s important to remember a few things as you go through:

  • Know your end game. This business is yours and you’ve put a lot of hard work into it. So know what you want from your business and a potential sale, as well as what you don’t.
  • Engage the peanut gallery. Don’t enter this relationship alone. Get advice from trusted business advisors and people who have gone through these situations before. They’ll help you navigate the bumps along the way and make sure you go down the aisle with confidence.

 

 

 

Is it time to join the SELL party?

As a business, you have a lifecycle. This cycle includes fun steps such as startup, growth and maturity, as well as a few growing pains like decline and rebirth/innovation/closure. One of the ways to continue this circle of life (anyone else have Lion King stuck in their heads now?) is through merger or acquisition, as this allows you to pursue new growth or get a fresh start with new ownership.

Now you may be thinking, my organization is far too small for M&A (that’s fancy speak for merger and acquisition) activity. We understand where you’re coming from. After all, business media often reports on large size M&A deals and transactions, supported, brokered and executed by investment banks. The names of the organizations involved sound familiar as they often appear on a little list known as the Fortune 500.

Well we’re here to tell you that M&A is a viable tool for growth in smaller sized businesses. You are welcome.

The Lowdown on M&A

The reasons for deciding to sell in any merger or acquisition is similar, regardless of size, geography or industry of a business. In other words, all of these things are like the other.

Here’s a few common reasons why firms consider M&A:

  1. The owner(s) would like to say ‘hey hey hey, goodbye’ and exit the business by passing on the operational responsibility to family, the management team or an outside buyer.
  2. Desire to combine with a strategic competitor or similar company to gain market share or to create synergies and increased profits. Keep your friend close …
  3. A need for additional capital to continue growing, innovating and expanding.

Why Sell Small?

First, a few definitions. Middle-market companies are typically defined as firms with $50 million to $1 billion in revenues. Lower middle market firms are defined by $5 million to $50 million in revenue.

As you can see, the reasons for M&A activity can be applied to any size company. Now, more than ever, owners and managers of lower-middle and middle market should consider the benefits of using the M&A space as a means of building wealth. After all, it’s trendy.

What do we mean by trendy? Well, professionals at the Faegre Baker Daniels 2015 M&A Conference described the M&A space as “frothy” and “hot” (no, they weren’t describing their Starbucks choice), followed by the same individuals projecting that “hotter” and “pricey-er” would be adjectives to define the space through 2016.

This is occurring because of a few things:

  • Record-high multiples and all-time high selling prices which are being driven, in part, by unused capital. This capital is used for investment by Private Equity Groups (remember them?). In other words, the money’s burning a hole in their pockets.
  • Strategic buyers looking for strong add-on businesses. Don’t remember what a strategic buyer is? We’ve got you covered.
  • Shortage of high-quality sellers. We know there are solid companies operating in the lower middle market without an exit plan. Those without an exit plan are either hoping to live forever or are fine with the company dying when they do. Even those that are contemplating a potential sale are often unsure of how to go about it. We understand selling your business can be a daunting task filled with change, emotion and uncertainty.
  • The increasing EBITDA margins of smaller companies. Largely through the use of technology, smaller companies have been able to post high margins. This allows companies with lower revenues to still attract private equity attention.

The moral of the story … it’s becoming an increasingly lucrative time to sell. But wait, there’s more. Because this is such a fun party to be at, family offices have also entered the market as interested buyers. This competition forces buyers to be prepared, expediting the transaction process and generating higher sale prices. Think about it like this … you’re the guest of honor at a party, where everyone else has arrived to see you and you alone.

Are You Ready to Sell Your Business?

This party is happening, regardless the size or industry of your organization. Rather buyers are looking for management who know what they’re doing and defendable growth projections. You can easily have these, regardless of your size. There is no formula or magic metric that can define the ‘perfect’ time to begin the process of looking for a buyer for your business. Hey, we’re not going to give you all the answers.

Rather, you have to look at your own long-term business and personal financial goals. This will be your trigger to join the M&A party. But we will caution you with this. The transaction process is more than just a snap of your fingers. It’s complex and time-consuming. So make sure you bring a guest to your party … a trusted business advisor you will advocate for your best interests.

sell sell sell

 

We are FAMILY: What You Need to Know About Family Offices

Let’s pause for a moment and think about your family. Now let’s imagine that your family had a substantial quantity of wealth (maybe they do, in which case, we should probably be friends), and they wanted to invest that wealth into companies … startup companies to be precise. Wouldn’t that be awesome?

Welcome to the world of family offices, “the little-known money managers that run the fortunes of the world’s richest individuals … to team up with likeminded peers for direct investment in companies” (source). Now you may be thinking, I’m never going to run into these types of people. In recent years, family offices have become much more prevalent, especially in the startup and entrepreneurial scene. They’ve traded their traditional secrecy and instead have embraced venture capital like deals, but without charging the high fees generally associated with private equity or venture capital firms.

Okay, break it down for me. What exactly is a family office?

A family office is a private investment firm established specifically for the purpose of managing a family’s wealth.

So what exactly do they do?

Family offices allow wealthy families to directly invest their wealth in private companies or through other investments. Often, their investments are the result of entrepreneurial drive. Many made their money from starting companies themselves, which allows them to provide guidance and strategy, as well as investment. Until recently, they had used third parties to choose their investments (read, private equity firms). Now, however, they are choosing to invest more directly and gaining more control over their own investments.

In 2014, 77 percent of respondents polled by McNally Capital said they preferred direct deals over going through private equity firms. This is up from 59 percent in 2010.

In addition, family offices often have other responsibilities, such as managing the philanthropic pursuits of the family and their estate plans.

What are some reasons I would consider this?

As with any business decision, there are both pros and cons. Here are a few to consider:

  • Long term partnership. For sellers (that’s you), you get a long-term partner with industry expertise. In other words, they built their own company and now they want to share that experience with you.
  • Building a legacy. Family offices are often more invested in legacy issues, which gives sellers peace of mind, especially if you’re not planning to exit the business fully.
  • Potentially lower fees. There could be lower fees because they’re investing directly, rather than through a private equity or venture capital firm.
  • Less control and influence. Most family offices consider themselves passive investors. What does this mean? They typically want to invest, but not take over control of management and operations.
  • Investment bias. Families often bring “substantial investment biases to how they want to invest the money” (source), which may lead to high risk investments, requiring a large amount of due diligence in advance of the investment.
  • Flexible timelines. Because they’re controlling their own wealth, family offices can make quick decisions and alter timelines and investment deals as things occur. One example of this is their ability to hold companies for longer periods, allowing them the access to capital they need to fully realize their intended strategies and goals.

So these sound pretty great. Where do I sign up?

The most important thing you can do is really consider what you want from a sale or investment in your business. There are a number of factors to consider including:

What percentage of the business do you want to own?

How much say do you want to have in your business?

Do you want to exit fully or stay on board?

These are just a few of the things to consider when looking at investment and sale opportunities. No, it’s not an easy decision. But it’s an important one.

 

Sell Your Business Once? Or Twice?

It’s never too early to begin with the end in mind. After all, there’s so many things to consider when planning for your exit, especially if you’re going to sell.

For instance, did you know there are different types of buyers? Yes, there’s more to it than who will offer you the most money. Let’s have a discussion about strategic versus financial buyers.

A strategic buyer is often a competitor, supplier or customer of your firm. When you sell to a strategic buyer, you almost always sell 100% at once and then go on your merry way.

A financial buyer, on the other hand, is a group such as a private equity firm, venture capital firm, hedge fund, family office, etc. Selling to a financial buyer such as a private equity group (PEG) may result in selling your business twice. Why? PEGs invest in companies they feel they can grow and increase their marketability for a future sale. Typically, PEGs will look to buy 75 to 80% of your company’s equity. Current ownership will retain the balance. When the PEG sells the company five to seven years later, you will be paid out your remaining equity and in some cases this 15-20% will be the same or more than the original sale of 75-80% of the company. This is referred to as the second bite of the apple.

So how do you know what’s right for you and your company? Here are a few pros and cons to consider for each:

strategicfinancial