THREE ELEPHANTS IN THE ROOM DURING AN OWNER’S EXIT

There are no guarantees in owning a business except for one: the owner will eventually exit their business, voluntarily or involuntarily. That is why planning for the owner and the business is critical.

This article presents three key considerations for owners as they plan for their exit. I call them the Three Elephants in the Room: taxes, succession and planning for what’s next.

Taxes

There are three parties involved in the sale of a business: the buyer, the seller and Uncle Sam. The effective tax rate in the sale of a business could range from 0 percent to over 60 percent, including corporate and personal federal and state taxes. That could mean the government would get more than the owner in the transaction.

Exit planning helps owners understand the various taxes associated with each type of transfer and make sound financial decisions to reduce their financial risk.

Tax treatments that are common in exits:

• Tax deferral.
• Capital gains (from 0-to-23.8 percent plus the state burden).
• Ordinary income tax treatment without payroll taxes (from 0-to-37 percent plus state taxes).
• Ordinary income tax treatment with payroll taxes (from 0-to-37 percent plus Social Security and Medicare taxes of 15.3 percent).
• Tax on pass-through corporate income. The tax rate for business income will be 29.6 percent versus the highest individual income tax rate of 37 percent.
• Tax on C Corp income (21 percent).

There are tax savings strategies and tools that owners can employ during their exit. This is particularly the case when it comes to internal sales—sales to family or managers.

Succession

Succession replaces the owner by moving chosen performers into a championship team, then into leadership, and owner. This requires time, training and stretching of the team members.

Successful succession is a critical aspect of an exit. If an owner can’t replace themselves, they will be stuck in the business without a buyer. To succeed, both the company and the owner must be ready for the transition. It is critical that the management team and future CEO are ready to move into their new roles, so the present owner can, over time, relinquish the day-to-day management, leadership and strategic role in the business.

A flexible plan may take several months to write and several years to execute. Depending on the readiness of a company’s management and the type of exit and current payout, a succession plan may last from three to 10 years.

On the other hand, if the business is systematized and has strong financials with mature management in place and the owner can take a four-week vacation, then the company could be sale ready in less than two years.

What’s next for the owner?

In addition to preparing the business for an exit, the owner must prepare themselves. They must be able to answer the question: what do I do next?

This process can be more challenging than anticipated. Exiting a business will have an emotional effect on a business owner. An owner who has been associated with their business for 20, 30 or even 40 or more years will undoubtedly have an emotional response when preparing for their exit.

The business is not just what an owner does; it becomes who they are. Owners have deep ties to their teammates, families, suppliers and the community. The owner must begin letting go emotionally and managerially during the exit and succession process. Spending less time in the office will allow the team to stretch and grow. This time away will allow the owner to travel and develop or continue other interests which will occupy their time in retirement.

Each exit is different and based on the owner’s short and long-term goals. Some owners want to stay attached with the business as a consultant or as chairman of the board. Others prefer separation. The key is to have a strategy to meet the desired outcome.