If you’re a business owner, your days are largely consumed with giving your enterprise its best chance at success: From identifying and capitalizing on growth opportunities to wrangling challenges and threats of all sizes.
What usually falls off the radar? Planning for the future.
More specifically, figuring out what you need to net from the ultimate sale of your business to ensure the following years are fulfilling.
To be fair, it’s not generally an issue of neglect, but one of pressing matters. When the business is rolling, it takes all of your time and energy. But at some point, a financial plan becomes essential as it provides a framework for what you’d like to achieve in your life — and how the sale of your business can help you get there.
Consider the founder of a contracting business who wanted to sell out to the company’s key employees, a group that included his son. Mike Benedict, head of BOK Financial business transition services group, said that when many of the key employees discovered they would still be working with the son, they left the company, and the son eventually left as well. Absent the critical personnel, the company’s value plummeted, and the owner received a fraction of its previous value.
Yet, because the owner had developed a financial plan years earlier and stuck to it, he had enough assets outside of the business to shrug off the resulting lower sale price, Benedict said.
Similarly, when another of Benedict’s clients who had been saving for years decided to sell his business valued at $3 million to his two daughters, his personal finances allowed him to creatively structure the deal. Thanks to his plan-driven foresight, he knew he only needed to extract $1 million from the business to fund the retirement he envisioned, so a strategy involving seller-financed notes and gifted shares made everybody happy.
“I need to know the client’s number — how much after-tax value I need to extract out of the business for them to be financially independent,” Benedict said. “I can do the best job in the world of getting a business ready to go to market and sell it at a very fair price for that business, but if that very fair price is not enough to fund their living expenses, then that’s a disaster.
“They won’t get another chance to sell the business again.”
Foundational questions set the tone
Many see the planning process as a series of tactics, but much like a company’s strategy is built on thoughtful insights, a business owner’s financial plan is constructed around his or her goals and ambitions.
Pat Staudt, market executive with Bank of Texas Private Wealth, fleshes out such considerations in conversations with owners that delve into family priorities, philanthropic thinking and perspectives on a desired legacy. He also explores the owner’s preferences for the business’ future, including whether he or she wants to:
- Pass ownership to family members
- Sell to employees or a third party
- Stay involved in the business following the sale
“We always ask ‘what keeps you up at night?’ and we frequently hear fears of not providing for a spouse or paying for kids’ education if they pass away, as well as not being able to live the life they thought they’d be able to live in retirement” Staudt said. “Without planning, the business owner doesn’t know what they need, and if they haven’t done it, they might find themselves stuck.”
Ultimately, the planning process explores the costs associated with the owner’s personal goals and leads to a target number.
“If the process results in a number that’s way more than the business is ever going to provide, then expectations need to be reset,” said Kimberly Bridges, director of financial planning at BOK Financial. “Usually the highest dollar value comes from a third-party sale, but if the owner wants what’s best for the customers, employees and family, a third-party sale may not be the right answer.”
Benedict calls the disconnect between the target number and the likely after-tax sales proceeds from a business sale the “wealth gap” and said that owners typically manage to resolve up to a 20% variation by adjusting their retirement expectations. If the gap runs 40% or higher, he said owners frequently pull back from putting the company on the market to address both sides of the equation.
By putting a plan in place far in advance of an expected exit, an owner can also plot out a more gradual payoff, Benedict said, using measures such as stock sales or a deferred compensation plan.
Bridges added that the long-range approach also allows business owners to diversify their personal balance sheets and mitigate risk. It’s not uncommon for business owners to have nearly all of their assets — in terms of both their financial capital and human capital — tied up in the business.
“When your balance sheet is concentrated in this fashion, your risk exposure is amplified because if something happens to you or the business, it can impact not only the current business and household cash flows, but potential future cash flows if the value of the business declines,” she said. “Premature death or disability present a real risk if don’t have proper protections in place.
“If you never create a plan, you may never see that risk exposure.”
Allowing for the necessary evil: taxes
An extended timeframe also allows for tax-efficient maneuvers, Bridges said.
“Taxes are a fact of life that you’re going to have to deal with if your business is a success,” she said. “If you wait to plan for that, you may miss opportunities to take advantage of gift and estate planning strategies that allow you to transfer ownership to family and others in the most tax-advantaged manner.”
For example, by gifting shares to family members long in advance of a sale, you may be able to take advantage of lower valuations while spreading the capital gains burden that results from the sale.
Benedict added that he’s seen many business owners tripped up by tax matters when they sell as some of the proceeds may be treated as ordinary income — not as capital gains — and double-taxation issues are common.
“An early estimate of tax liabilities is critical in determining what the proceeds of a sale may look like,” he said. “With enough time, however, proper tax planning and elections can be beneficial, which is why a CPA experienced in transactions should be part of the long-term financial planning effort.”
Within the same tax year as the sale transaction, Bridges said that establishing a charitable trust or donor advised fund can also reduce a seller’s tax obligation. Especially if appreciated stock is transferred to the philanthropic vehicle just before the sale. But these should only be used if there is charitable intent.
Trusts are legal structures that can streamline the distribution of your estate upon your death while shielding beneficiaries.
“Trusts are especially important for anyone who has an estate that’s not easily transferable through account beneficiary designations or joint titling,” Bridges said. “A trust allows the individual to define exactly how the property and assets are to be handled and keeps the estate out of probate court.”
When settled outside of probate court, an estate avoids additional administrative fees, resolves creditor issues rapidly and keeps the details out of the public record — an important consideration given the amount of money that can be passed along.
“Plus, as it looks like the estate tax landscape could change dramatically in the near future, trusts will likely grow in importance,” said Benedict, who explained that structures such as grantor retained annuity trusts can be effective at passing company-related wealth to heirs tax-free.
Overcoming inertia invaluable
While a financial plan may be on your long to-do list, it’s possible you’re waiting for the optimal moment to tackle it, given the multiple directions your life — and the business you own — are pulling you at any given moment.
That’s fair, especially considering that you’ll need to invest time and energy in thinking through your goals and developing and revising the plan. And it could have some expenses related to the legal, tax and accounting expertise a comprehensive plan will require.
But, given the variables and unknowns that abound in your professional and personal life, meeting with a team of professionals and putting together such a plan sooner rather than later should rank fairly high on your priority list.
“Of course, it depends on the person, but during the pandemic, we saw a lot more concern in the moment — people were made more aware by what they were going through,” Staudt said. “Simply put, there are those moments where we have no control and we want to have a plan in place.”
Learn more about our financial planning and business transition services.