If the thought of disposing the business is on your mind, you are not alone. More than 51% of all business owners are over 50 years old and many are starting to develop their exit plans. While the methods have become far more sophisticated to dispose of a business, the considerations of the business owners have not, except in one significant way, which is to do much more tax planning.
The primary methods used to dispose of businesses have not changed even if the number of entities that may be involved in the disposal have increased than ever before.
The major methods are:
Selling of assets;
Dividing a business into parts;
Sale to an employee stock ownership plan (ESOP);
Selling the company stock (to family members and/or key employees and/or to competitors and/or to financial buyers);
Sale to grantor trust;
No matter which method(s) are used, the business owner must first engage in a review of goals to be achieved. Here are some questions to get you started:
Do I have family members who would like to take over the business? If so, do I sell/gift stock/assets or both?
If some family members do not wish to be involved, how do I treat them? Am I being fair or equitable?
Do I need to set up certain protections for grandchildren whose parents may not be involved in the business to make sure all of the grandchildren are treated equally?
If family members are not going to be involved, do I have certain key non-family employees who may wish to buy the business? Or should I try and sell to all non-family employees?
Do I have a spouse or significant other that I need to protect in their old age?
Are there other people or groups that I want to provide for in some way?
Once a business owner has a good handle on the answers to these questions, then sitting down with an experienced exit planner, attorney, or an accountant and laying out the goals will allow for a 1. full and frank discussion of the options to meet the goals 2. financial considerations involved in each one.
Too many business owners will engage in these discussions when the business is young and devise an estate plan which 5 or 20 years later maybe woefully inadequate to meet the goals. The rule of thumb for any business owner is that when you are meeting with your trusted legal and financial people for annual valuations because of buy-sell agreements that you may have in place, it is also a good time for the business owner to review and revise the existing goals. What made sense 5 or 20 years ago might not make sense today. It is worth a few extra minutes once a year to review your exit goals.
While business owners often fight the temptation to assess (and reassess) their goals thinking that whatever makes the most sense tax wise is the best way to go, in the long run keeping a good handle on the big picture will result in the best outcome for all concerned. Put a bit differently, do you really want to achieve a bad outcome such as treating one set of children or grandchildren better than the others to save a few tax dollars?
Let's examine the common disposition methods and discuss some of the tax implications to each.
Selling of assets results in capital gains on the appreciated value of any assets sold (but capital gains are so low that such should not be a reason not to sell). The upside of selling off assets is that you can sell off different assets to different buyers, thus maximizing your ability to find and sell to the top bidders available. For example, you can sell off your equipment to a competitor and your building to a commercial developer.
Dividing a business into parts can be a method that can achieve at least two different goals. One human goal is that if a business can logically be divided into different parts (i.e., either by different product/service lines or perhaps by geographic lines), a business owner can sell/give one part to one family member and other parts to others. The same idea can be used to sell to third parties as well, whether it is key employees, all employees, competitors, or financial buyers. Perhaps a competitor only does some of the types of work that you do, but not others, and thus is willing to buy part of your business but not all of it. Perhaps a financial buyer regards some part(s) of your business as lucrative and is willing to pay a premium for that portion but does not want all of your business. While there can be some complicated tax issues involved in allocating assets and properly determining the basis for each part, it is a process well worth considering if the price is right.
Sale to an employee stock ownership plan (ESOP) is an option that many business owners overlook. Why is this so overlooked? Because many attorneys and accountants feel the logistics in such a sale make it unworthy. Those who idly dismiss this option miss what could be an excellent option for the business owner. One advantage is that one's employees often are the very best market to try to sell to because they have the most desire to own a part of your business, presumably because they would not be your employees unless they thought highly of the operation. Employees often will pay a higher premium as well as seeing the potential for new products, services, or markets that have not been attempted to date. The same capital gains issues arise here as for other methods, but the extra premium which might get paid could be well worth it. The capital gains taxes can be spread out over time in that you could sell off perhaps 25% of your stock each year for four years and spread out the tax bite over four different tax years. Whether that is a good idea is a different question, but it is an option.
Selling of company stock (to family members and/or key employees and/or to competitors and/or to financial buyers). The tax implications identical in all of these scenarios are whatever your gain is will be taxed as a long-term capital gain at low tax rates. Thus, the question is not economic but human. What goals are you trying to accomplish? If family members are to be involved, then there are different questions than if they are not involved. You also can plan for family members by gifting of stock as well along the way; which brings into play other tax issues, namely that any family member will get your basis and will not get the automatic step-up on the basis which would otherwise occur if they inherited your stock at your death. On the other hand, paying any gift tax which might accrue along the way for gifts made in excess of the annual exclusion as well in excess of the lifetime limits might be cheaper than having your estate pay down the road. Your accountant is in the best position to discuss the numbers and potential tax implications. Ask for their ideas.
Sale to a grantor trust is another option that is not favored among attorneys and accountants but should be more fully considered. The usual advice is to gift the stock into a trust rather than sell the stock to a trust. The primary difference in the gift versus sell option is that a gift will also transfer the business owner's basis, and the trust then has that same basis. On the other hand, a sale will allow the trust to take on the sales price as the basis and not be penalized by the business owner's presumably much lower basis, which can be a major advantage for the trust if the stock might be sold in the short term especially. If the stock is going to be presumably held forever as the next generation takes hold, then a sale might be less useful because paying the fair market value might make it cost-prohibitive going forward. A sale would trigger the usual capital gains issues, but the tax implications of the gifting depend on the amounts involved. An accountant can run both scenarios for you.
Leaving business by will is always the fallback option if none of the other options have been utilized. The upside to leaving by will is that your heirs will get the value at the time of death as their basis going forward. The downside is that estate taxes may be due if the values are large enough. From a human side, leaving a business in a will can be a reasonable way of not making certain decisions as well. For example, a will can leave as much or as little to your children and grandchildren in different amounts or none at all. If you want to treat people differently, it is easier to do it in a will when you are not around for the fallout of your decisions.
Lastly, liquidation is always an option, even if not always the best option for many people. As one can imagine, a liquidation loses the value of the company as a going concern, but it also allows for a quick sale of assets as well. With depressed prices, it will certainly reduce the capital gains bite.
In the final analysis, disposing of one's business is a complex mix of both emotions and financial factors. How each business owner answers the personal questions and resolves the financial issues is deeply personal to each decision-maker. There is no one size fits all approach, and these decisions are best made when fully informed by planners, attorneys and accountants as to the financial and tax implications after the owner decide what personal goals are most important to him or her.