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.

Exit Planning: Estate Planning

As a reminder, this blog series is based on The Seven Step Exit Planning Process created by the Business Enterprise Institute (BEI).

After several blog posts, we’ve reached the final post in our exit planning blog series. So, what does the final component of the exit planning process have in store for you? Personal wealth and estate planning!

As a note, just because this is the last step in the process, it doesn’t mean this shouldn’t be considered when you’re actually out of the business. In fact, the earlier business owners start this step, the more benefits they may receive.

It’s no surprise that the IRS lays claim to a business owner’s wealth, especially when it comes to estates. However, there are other beneficiaries a business owner might want this wealth to go to. As a business owner, you will want to have a wealth transfer method that will pass on the wealth with minimal interruption from that pesky IRS.

So, how do you go about keeping the IRS interruptions to a minimum? According to the BEI, focusing on the following three issues can help ensure success in the wealth preservation planning process.

  1. Money for Yourself – To make decisions regarding how much money should be left (to children, charities, etc.), you must first decide how much wealth you want to keep for yourself after exiting the business. This can be determined by looking at the objectives and goals you set in the beginning of your exit planning process.
  2. Money for Kids – The idea of leaving money to children after the sale of the business is a common, but sometimes difficult one. It’s often hard to decide, given the success of the business, how much is too much or too little to leave to children. It’s important to remember that children usually do not receive the full amount up front. Rather, it is transferred through trusts or over time.
  3. Minimize Tax Impact – With tax outcomes always fluctuating due to governmental policies and procedures, it’s hard to make a solid plan and know exactly how much money will be left untouched. To try to keep the amount of money taxed to a minimum, business owners (and their advisors) must be proactive.

A few other pointers for estate planning…

  • Estate Planning Preferences –Having your preferences documented can make the estate distribution process go a lot smoother. Consider including how you want personal property distributed, any personal representatives you may have, donations to charities, how the estate will be distributed, trust designs and power of attorney, to name a few.
  • Personal Lifetime Wealth Management – Understanding the decisions and actions that must take place to manage your personal wealth is crucial in making sure you obtain the highest amount upon leaving the business. It is important to consider spending strategies, estimated income and retirement, investment strategies and possible insurance strategies.
  • Wealth and Estate to Family – More than likely, you have decided to leave some part of the estate to family members, be it your children, spouse or both. Things to consider for your family include insurance proceeds, timing of income stream, transfer of assets and estate allocation preferences.
  • Protection of Personal Assets – Protecting your personal assets can enhance security of your assets against any claims against your company. Such assets to be considered may be loans to the company, collateral, ownership and rights and lifetime transfers.

Personal wealth and estate planning can help ensure you have a solid exit plan in place that is ready for whatever life may throw at you next.

In closing, we want to remind you that exit planning is a crucial step to ensure your business continues on long after it has left your hands. If done correctly, having a solid exit plan in place can help business owners be sure their dreams and goals are reached.

Exit Planning: Continuity

As a reminder, this blog series is based on The Seven Step Exit Planning Process created by the Business Enterprise Institute (BEI).

Throughout the course of this blog series, we’ve covered some important exit planning steps, such as business valuation and setting exit objectives. However, situations arise that we aren’t able to plan for.

So how do you prepare your exit plan? One word … continuity.

Business continuity planning, in its most basic sense, prepares the business owner and all related parties for unforeseen circumstances impacting the business. Events such as death of an owner or a disability are often covered in continuity planning. Continuity planning communicates the owner’s wishes regarding the continuity of the business in writing. You should also ensure it includes both short term and long term plans.

Here are a few questions to consider when starting to think about continuity planning:

  • Do you have a plan for your business if the unexpected were to happen to you?
  • Who can operate and control your business and financials if you’re gone?
  • Do your employees, specifically senior management employees, know of your plans?

While you might think it’s slightly morbid to think about, remember how important this is. Take a moment to think through these questions and then begin to draft your continuity plan based on the answers.

Here are BEI’s top five recommendations for content in a continuity plan:

  1. Extra Pay for the Extra Mile| The stay bonus plan emphasizes how critical it is for certain employees to remain with the business after your departure. Start with figuring out which employees these are and how much they’ll make for sticking around. From there, a bonus amount can be determined. The stay bonus gives these awesome employees an incentive to stick around with the business rather than jumping ship…but with a great business like yours, they’ll probably want to stay no matter what.
  2. Handing Off the Baton|This recommendation covers the terms of ownership transfer when the time comes. It allows remaining employees and/or co-owners to make the right move when transferring ownership. In other words, it makes sure all your hard work is being handled correctly. It may also include exceptions to the terms, such as transfers to family or other employees of the company in the event of an unexpected death or disability.
  3. Where’d the Money Go?| This recommendation covers what steps need to be taken in the event financial resources are no longer available to support the business. In this part of the plan, it is common to summarize the financial support of the company, such as leases, loans and lines of credits. The financials of your business can also include possible solutions in the event commonly used financial resources are no longer available.
  4. Back to the Basics| The continuity instructions cover the basic aspects of the plan on a written or electronic instruction form the owner can complete, sign and store with all other important personal planning documents. It is important to frequently review this to ensure everything is updated to match any recent changes. The instructions should include the desired future of the company which covers sale and transfer of the business. Not sure on who you want your business to go to? Check out these blogs for guidance on making this choice. In addition to who the business will be sold to, the instructions may also contain the desired price for the business, including a general price range and an absolute minimum sale price. Important information is often found in the instructions, such as important dates and deadlines and other information not easily obtained. Think of this as a game plan with all the directions clearly explained.
  5. Salary Summary| The last recommendation summarizes the plans to pay salary or compensation to the owner and the value that can be expected on departure for the business. This can include events that would trigger such payments, payment amounts and termination of payments.

Although there may be other important information to consider depending on your own unique business, these five recommendations are a good starting point for business continuity planning.

Just like all other aspects of life, change is constant and it impacts us and our business whether we are ready or not. Continuity planning helps you be prepared for these changes so your business can continue to be successful after your departure.

 

Exit Planning: Increasing Value

As a reminder, this blog series is based on The Seven Step Exit Planning Process created by the Business Enterprise Institute (BEI).

Today we continue our journey through the exit planning process. Our last blog discussed the importance and method of finding out the value of your business, and today we will build off that concept with step three: increasing the value of your business.

After completing your business valuation, you may have found your business is not worth as much as you hoped. Because of this, selling your business will not generate enough money for you to live comfortably the way you were hoping. Another problem you could be facing is a lack of interested buyers, which could be due to the fact your business doesn’t pose much value to them.

So, how do you solve these problems? The answer lies within value drivers, which do exactly what the name suggests – they drive up value!

It would be a mistake to assume every business, no matter the type, could increase its value by utilizing every value driver possible. After all, each business has characteristics that make it unique. However, there are seven value drivers, according to the BEI, that are common to all industries and can be tailored to match each unique business.

Management Team – One of the most important aspects of any business is its employees. When you think of a management team, you should be thinking of those employees responsible for decision making, monitoring and setting objectives and motivating employees.

So how can this team be a value driver? It’s likely the team members have a variety of talents and skills that have helped the business become what it is today, and have a proven track record of success. Potential buyers are looking for a management team with staying power; in other words, they want these talented individuals to stick with the company to help ensure success. It is also common to assume if a management team can stay in place, the company then has the ability to keep and maintain customer relationships, which keeps the company’s reputation intact. The stronger the management team, the higher the offer from the buyer is likely to be.

Operating Systems – In addition to a great management team, buyers are also interested in what systems and policies are in place to continuously generate revenue from an already established, yet still growing customer base. These systems include, but are not limited to, procedures used to generate revenue and maintain expenses, customer relationship management programs (CRM) and means of distribution. Having these systems properly established and documented show the buyer the business can continue to be profitable after sale. Think from the buyer’s perspective; as a buyer, you want to be sure the business will grow and continue forward with new ownership and that it will not fall apart when the previous owner exits.

Customer Base – We’ve touched on the customer base in the previous points, but this value driver deserves its own emphasis. Buyers are looking for a business that has an established customer base that won’t be going anywhere soon. According to the BEI, it is a great practice to have a diverse customer base in which no single client accounts for more than 10% of total sales. This adds protection if a customer(s) is lost. When buyers are willing to shell out large amounts of money, they want to make sure they are getting what they’re paying for.

Facility Appearance – Although not a huge factor for most businesses, it is still important to keep in mind some buyers are very, shall we say, picky? Some buyers have a tendency to be more reserved with their spending if the physical appearance of the business or its equipment isn’t very appealing to the eye. A clean and organized office promotes the idea that the business is also well organized. Superficial improvements, both interior and exterior, can improve the marketability of your business.

Growth Strategy – It is important to have a realistic growth strategy in place. By realistic, we mean a growth strategy that fits your business, not an elaborate plan that is not attainable. Keep your growth strategy ambitious, but also attainable. This strategy can show potential buyers specific reasons why cash flow and the business will continue to grow after it has been purchased. The growth strategy should be based on factors such as market plans, industry dynamics and demand based on demographics, to name a few. The growth strategy helps the buyer understand your business, and where it will go in the future.

Financial Controls – Financial goals are not only an important part of how a business is managed; they also help to safeguard a company’s assets and support any claims of the company’s profitability. A buyer will not spend a large amount of money on a company without first knowing what the company’s cash flow has looked like; they need to have confidence in the company. Giving buyers confidence can lead to a much higher valued sale.

Cash Flow – To piggy back off the last driver, not only do we want financial controls in place, but we want to make sure the cash flow is All of the value drivers in some shape or form contribute to a stable and predictable cash flow, so it is important to focus on all of the value drivers to operate their business more efficiently. Buyers look for companies with a solid cash flow they can increase after purchasing, and are willing to pay top dollar for these companies.

What a buyer decides to pay for your business is dependent on many factors. However, to increase that number and get top dollar for your company, it will be beneficial to follow these seven value drivers down the road of exit planning success. Following these seven value drivers can lead to a competitive advantage over other businesses that will give your business the upper hand when it comes time for buyers to decide which business they would like to purchase.

 

Exit Planning: Business Valuation

As a reminder, these seven steps are based off of BEI’s Seven Step Exit Planning Process

Welcome back to our series on exit planning. In our last blog, we talked about the goals and objectives needed to create a successful exit plan. One of those goals was knowing how much money would be needed from the sale of the business to maintain your current lifestyle. That brings us to the topic of this blog: business valuation.

We get it, you’re probably wondering why you need to do this now or how this applies to you. Even if you are not planning to leave the business for quite some time, or think you know what your business is worth, business valuation is an important and crucial step to ensure you have a solid exit plan in place.

Okay, let’s get down to the nitty gritty. For most business owners, their business is their most valuable asset. Sure, you might have real estate, property or stocks, but the main source of income is the business. When you sell the business, you need to know if the cash flow from the sale will be enough to sustain your lifestyle desires. So, how does this business valuation thing work?

First, it is important to note there are two types of valuations that can be done, based on how far away you are from your exit date.

  1. Thorough Valuation – If you are ready to leave the business now, it is important to have this type of valuation completed. This will establish whether your company can be sold today at its appraised value. Often times, business owners think their business is worth more or less than it actually is. This valuation ensures a correct estimate is in place.
  2. Calculation of Value – This type of valuation is usually completed annually for those who plan to leave the business, but not for quite some time. This gives more of an approximation of the value, rather than a definitive answer. It helps to determine if the business is on track.

By now, you should be able to determine which type of valuation best suits your needs. However, you’re probably still wondering why you should be doing this. After all, it is your business and you know more about it than anyone else.

Here are some of the top reasons why you should have a business valuation.

  • Determine Worth – When business owners are ready to sell, they want to receive the full and fair value from their ownership interest. But how do they know exactly what this price should be? Often times, following casual estimates and rules of thumb does not take into account location, reputation, technology and other important factors that impact the business’ worth. A business valuation, on the other hand, does consider everything. Think: would a buyer purchase a business without knowing how much to pay for it? Probably not, and you as a business owner also need to know how much it is worth in order to determine an asking price.
  • Accuracy – After determining what your business is worth, you then have a comparison factor. Once you know how much the business is worth, you can then compare that with your lifestyle desires after the sale, and accurately predict if the business sale will be enough to sustain the lifestyle, or if changes will need to be made to get to this level (our next blog focuses on the idea of increasing value).
  • All Factors Considered – Along with including factors such as technology, reputation, etc., the valuation takes into account many different scenarios and options to ensure everyone involved will get the best bang for their buck. This takes into consideration the idea that the value of the business is actually relative and not fixed, meaning it can vary based on many factors. A valuation will take into account the different buying scenarios, such as selling to a third party or selling to an insider. With the value fluctuating, having a valuation done periodically will help keep the value up to date so you have the best idea of just how much you will get from the sale.
  • Motivation – Finding out what your business is worth through a valuation can be a great form of motivation for all parties involved, but especially management and employees. Once insiders know where the business is standing and what potential it has for growth, they can often be motivated to work harder to reach these goals. A common way for this motivation to occur is through incentive programs, especially those that link the size of the incentives to the growth in the value of the business.
  • What is Fair – If you are selling a business, do you really believe interested buyers will just take your word for it and accept whatever price you say? Probably not. A business valuation can help determine the fair market value of your business, which can then help you develop a fair asking price that doesn’t offend anyone in the process.

So there you have it. A business valuation is absolutely necessary, no matter what stage of the business you are in. It is recommended to start early in case the value needs to be raised, but no matter when you decide to act, the business valuation should never be ignored.

 

Exit Planning: An Introduction

Chances are, as a business owner, you have heard of exit planning. But have you ever sat down and considered it in all its glory? Exit planning is a crucial step to any business, no matter what stage. In fact, the earlier you consider it, the more time you have to create an effective exit strategy that will ensure your business stays successful even after you are no longer in the driver’s seat.

Did you know that exit planning and succession planning often get confused? While the two sound similar and have some common themes, they are actually different.

  • Succession Planning – Focuses on identifying successors within a business and preparing them to replace the existing business leaders; Focuses on transfer of leadership from one generation to the next
  • Exit Planning – Analyzes all of the factors that impact a business owner, including current and future planning; Identifies strategies and steps that are most likely to allow the business owner to reach their goals

In this next series of blogs, we will be discussing a framework for exit planning and what you, as a business owner, need to know to keep your business running smoothly after you exit.

The steps we’ll be discussing are based on BEI’s Seven Step Exit Planning Process. They include:

  • Identifying Owner’s Objectives & Goals. This step will focus on identifying primary planning objectives, such as desired business departure date, who you want to leave the business to and more.
  • Quantifying Business and Personal Financial Resources. In this step, we will talk about valuation and cash flow. This will include asking yourself how much you know about the worth of your business, and how much it is expected to bring in future cash flows.
  • Business Value Enhancement. In order to make the business more appealing to your ownership interest, you must know how to increase value.
  • Ownership Transfer to Third Parties. To make sure that a smart transfer is made to a third party, this step will ensure you know how to sell to a third party in a way that will maximize your cash while minimizing your tax liability.
  • Ownership Transfer to Insiders. If you are considering transferring the business to someone on the inside, such as family, this step will be of high importance to you. This step can also help you decide whether an inside or third party transfer is right for you.
  • Continuity Planning. This step will help you ensure you have all the necessary precautions taken to be sure your business continues on if you don’t.
  • Personal Wealth and Estate Planning. It is imperative to have a plan in place to provide for you and your family post-business sale. This step will help make sure you are on the right track for financial security.

Prepare to join us over the course of these next seven blogs to learn a framework on successful exit planning and how it can benefit you and your business now, as well as in the future.

 

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.