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.

Who Doesn’t Love a Discount?

Who Doesn’t Love A Discount?

If given the option to pay full price or receive a discount, it’s safe to say the majority of individuals would prefer a discount, regardless of what they’re purchasing. Why would this be any different when it comes to your business?

When valuing a minority interest in a business (an ownership interest of 50% or less), it’s typical of buyers in the marketplace or a valuation analyst to apply minority discounts, which are more technically known as a discount for lack of control (DLOC) and a discount for lack of marketability (DLOM).

We know what you’re thinking: what are these discounts and why do they matter? Here’s a look at each type:

A DLOC is an amount or percentage deducted from the operating value of an entity to reflect the absence of some or all of the powers of control. When someone holds a minority interest in a business, they lack the ability to:

  • Implement business and operational characteristics;
  • Appoint and remove management;
  • Control the timing and amount of distributions;
  • Put the entity’s assets to their highest and best use.

In other words, the person buying into the business is receiving a discount because they are not receiving the full benefits of control.

A DLOM is an amount or percentage deducted from the operating value of an entity to reflect illiquidity (inability to quickly convert to cash) in privately-held entities when compared to public companies. In the valuation world, we refer to liquidity as “cash in three days”, which is expected when selling publicly-traded stock. However, when it comes to selling private companies, it takes much longer than three days to receive cash, which is why a DLOM is appropriate.

Discounts are extremely important to understand when negotiating transactions with investors. Investors’ primary way to receive a return on their investment is through distributions, which are primarily dependent upon the company’s financial stability, and diversification among the services and/or products and geography of the business.

Going back to the concept of “cash in three days”, investors will also look at the obstacles they could encounter if they decide to sell their interest in the future, which could potentially be affected by the company’s transfer restrictions and redemption policy. Therefore, appropriately discounting a minority interest is important as it could potentially make or break a deal.

Of course there are some risks that should be considered on the sell-side of a transaction. The amount of time it takes to complete a transaction, accounting and administrative fees incurred and the probability that the actual sales price could be much less than the asking price are some sneaky issues worth keeping an eye on.

Not only are discounts important to consider when searching for outside investors, but they are also a strategic tool that can be helpful when exiting a business. In fact, if you’re planning to sell your business, there’s a good chance you might encounter these discounts. It’s important to understand them so you know what price you can realistically expect from the sale of your business.

It goes without saying that buyers appreciate discounts to the share price, but sellers may not. After all, everyone wants to get top dollar for their business. Buy-sell agreements are commonly used to allow a company or its shareholders to purchase the interest of a shareholder who decides to withdraw from the company for a specific price or by using a set formula to determine a price. However, instead of preparing for a smooth exit, many buy-sell agreements tend to cause more issues as the use of a set price or a formula may not consider the current economic and financial condition of the company, which could lead to legal (and expensive) issues.

An effective buy-sell agreement should include an explanation of relevant discounts and the requirement for an appraisal from a certified appraiser to determine the current fair market value of the company. A well written buy-sell agreement will help minimize misunderstandings and disagreements, ensure proper discounts are appropriately applied to the company value and make for a smoother transaction among all parties involved.

Buy-sell agreements and all pieces of the puzzle can be difficult to put together. Luckily, our business valuation team is trained and ready to help you conduct a successful business transaction. If you need help, just ask!

 

State and local tax issues when buying or selling a business

You’ve always dreamed of owning a business. Now you’ve found the perfect one to purchase. You ask all the questions you can think of, come to an agreement on price and now you’re ready to go, right?

One major thing that sometimes gets overlooked is something called “successor liability.” This is the idea that when you buy a business, or the assets of a business, you generally also inherit all the liabilities associated with that business or the assets.

Some of these liabilities are pretty easy to figure out, but others may be hidden and difficult to know about or quantify. For instance, you can be audited for periods before your ownership and you can be assessed for sales or other taxes owed by the last owner.

Don’t believe us? Here are some common examples of successor liability discovered after the purchase of a business:

So what are some issues that could create tax exposures for you and your new company?

  • Company had the duty to file but failed to do so
  • The return was filed, but tax was not remitted
  • Company failed to pay use tax
  • Company did not have all the correct exemption certificates
  • Local taxes were ignored

So what can you do to reduce your risk when purchasing a business? Perform the proper due diligence. Due diligence can take a number of different forms, but generally includes reviews of the following:

  • Is the seller filing in the states where it has a duty to?
  • Are the returns accurately and timely?
  • Are taxability decisions correct?
  • Is the proper tax rate being applied?
  • Are exemption certificates accurate and up-to-date?
  • Has the seller been audited or received inquiries from any state?

Hiring a professional to assist you with a due diligence study can help you properly assess the potential liabilities and arrive at a more informed decision. Plus, it will hopefully save you some headaches later on.

But due diligence doesn’t just apply to buying a business. Let’s say you’ve finally made it to retirement and want to sell your business. Performing a due diligence study can help you be sure you have handled all these tax issues correctly and nothing will pop up unexpectedly that may scare away a potential buyer.

No matter what side you’re on, a little additional work upfront could potentially prevent some difficult, timely and expensive mistakes later.

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.

Successful Succession: Starting Early

You may have just gotten started or are barely getting going. So why would you need to think about a succession plan early on?

Succession planning is the process of identifying and developing people inside your organization to fill key leadership and ownership positions. It’s also commonly known as transition planning, as you’re looking at how you’ll transition the business to the next leader(s).

Succession planning is important to the sustainability of your business. According to Harvard Business Review, “some 70% of family-owned businesses fail or are sold before the second generation gets a chance to take over.”

For many small businesses, leadership has been in place for a number of years, and with that comes a substantial amount of knowledge that could potentially leave your organization. Further, without a solid plan in place, until the very end, you’re leaving your business’ future to chance.

So how do you get started?

Come up with a plan. Start with the owner, which may very well be you. Talk through what you want your company’s end game to look like. Do you want to sell out for the highest price? Do you want to reward employee loyalty and hand over the company to one of your hard working professionals? Do you want to keep it in the family? And then there’s the question of timing … how soon do you want any, or all, of this to happen?

Then, look at your leadership goals. Where is there talent in your organization? Is there a particular group or individual that has the support of others? Will this succession change your organizational structure? Who do you want to incentivize to stay long term?

Also, remember talent might not present itself in picture perfect form. So do you have a diamond in the rough that will take some mentoring and coaching, but in the end will be a truly great leader for your organization?

Hint: You also need to be thinking about employee retention here. You don’t want to put a lot of time and effort into someone who ends up leaving before the transition. So make sure you think through an employee retention strategy.

Throughout this entire process, make sure you are COMMUNICATING. Ensure you have buy-in from any and all stakeholders in your organization. This will include investors and key personnel.

Make a date with your business advisor. It’s important to ensure you have a plan in place that serves the culture, mission, vision and people of your organization. But it’s also vital to have outside help.

You’ll need a full cast of business advisors to ensure your succession plan is successfully in place. These characters will include:

  • Attorney to help you walk through buy/sell agreements and transaction documents.
  • Financial Advisor to help you determine that your ownership lifestyle is met, as well as help you raise funds for your buy/sell agreement.
  • Tax Professionals to help you understand the tax implications of transitioning your business.
  • Appraiser in order to help you value the business for transition, gifting or sale.
  • Estate planner, who will help you see past the sale of your business and into retirement.

Be strategic. It’s important to be strategic as you prepare your succession plan and not just look at the current state of your operation. Succession planning should focus on growth, retention of talent and improve processes.

And one final thought … if all of this seems like a lot of work, that’s because it is. So don’t start at the end. Start early so you’re prepared to go forward with the end in mind.

 

YOUR END GAME: The Importance of Sales Tax

One thing we find is that businesses are really excited to start. You have great ideas and you’re ready to make your dream a reality and introduce a product that will change the world … or at least the way we’ve always done something.

What few businesses add to their mounting to do lists when they start is to think about how they’ll END. Your end game is critically important to consider at the beginning because it helps you chart your course.

Here are a few questions you should be asking right from the beginning:

  • What is your business goal?
  • How do you plan to grow your business?
  • What happens when it comes time for you to exit your business? Who takes over?
  • How do YOU want to exit your business?
    • Merger?
    • Acquisition?
    • Sale?
    • Retirement?

These are just the beginning of numerous questions you can ask. And these don’t take into account a critical component to your end game: SALES TAX. Yes, the current sales tax laws at the time of a buy/sell transaction have an implication on your business. And for you serial entrepreneurs out there, it also has an impact on businesses you buy.

Buyers need to be alert to unpaid or unknown taxes in advance. Otherwise you may be in for a world of hurt when you acquire hidden liabilities. Sellers have to demonstrate you have addressed things like sales and use tax, nexus and payroll tax … to name a few. The way these items are handled can impact the purchase price and what can be done to successfully close the deal.

Now before you freak out, RELAX. We can help. Join us as we discuss how sales tax laws play into business transactions and things you should watch for. You can find us in Mankato on August 2, Sioux Falls on August 3 and Fargo on August 4. We’ll even give you lunch.

P.S. Check out these different considerations when talking about Your End Game. Just make sure you start talking about it early.

 

 

The Importance of Valuation

Do you know how valuable your company is? No, we’re not talking about how much you think it’s worth. We’re talking about an independent appraisal of the worth of your company and how much it would potentially sell for. Welcome to the world of business valuation.

Why does this matter?
Now you may be thinking, I just got going in this. I’m not ready to sell my business so a valuation isn’t important to me. Well, we respectfully disagree and we’ll tell you why.

For one thing, it’s beneficial to have a qualified appraisal of the Company’s stock to provide stockholders with an estimate of their shares and their investment in the Company.

Further, a valuation is important for any stage business because it prepares you for a transaction triggering event, even when you don’t see one in your near future. Plus, you know what they say about best laid plans …

What do we mean by transaction triggering events? Here are just a few ideas:
• Shareholder/employee quits
• Shareholder/employee is fired
• Shareholder retires
• Shareholder wishes to sell stock
• Shareholder becomes disabled
• Shareholder death
• Shareholder divorce
• Company bankruptcy

When these types of things happen, they can cause a shift in your business and its future. It’s amazing how quickly your plans for your business may change when affected by these types of events. That’s why we recommend you consider including a well-defined valuation process in your buy-sell agreement.

Fine, tell me more about this valuation business.
One way to go about this is to choose a single appraiser now (not when the transaction triggering events have already occurred). Then have the appraiser conduct annual or periodic valuations of your business. This enables all shareholders to know and understand the value of your business throughout its lifecycle.

Why choose an appraiser early on? Well …

  • Selected appraiser will maintain independence with respect to the process and render future valuations consistent with terms of agreement and with prior reports.
  • Appraiser valuation process is known by all parties at the outset.
  • All parties know what will happen when a trigger event occurs, rather than scrambling to put together a game plan.
  • Because the appraiser must interpret the ‘words on the pages’ in conducting the initial appraisal, any issue regarding lack of clarity or terms would be resolved. Subsequent appraisals, either annually or at trigger events should be less time consuming and expensive than other alternatives.
  • Parties should gain confidence in the process.
  • Parties will always know the current value for the buy-sell agreement (this is helpful for planning all-around).
  • Appraisers’ knowledge of the company and its industry will grow over time.
  • This process creates a means of maintaining pricing for other transaction, enhancing “the market” for company shares.

Why do I have a feeling there’s more …
Because there is. Other things you should probably be consider but haven’t probably thought about include:

  • How are shares of your company purchased or funded? Where will the money come from?
  • Who buys the shares? Other shareholders? The company? A combination?
  • The Company has a number of life insurance policies. Is the insurance adequate?
  • Are there other financial resources available to buy the shares?
  • What are the terms of the transaction? (down payment, interest rate, security, etc.)
  • Are there any restrictions on share payments under the company’s loan agreements?

As you can see, there are a number of potential issues that could result in your buy-sell agreement being a “ticking time bomb.” So it’s important to discuss these issues early and often with your shareholders and your business advisors.