You start your business with dreams of making millions. At selling time, you want to keep as many of those after tax dollars as you can in exchange for your blood, sweat and tears. Advance planning can make a big difference in the amount you pocket after the sale.
Consider this: Under prevailing tax rates, Owner A sells a business for $1 million in cash and receives $800,000 in after tax proceeds while Owner B sells a business for $1 million in cash and keeps $500,000 (or less!) in after-tax proceeds. The difference in the cash you keep has everything to do with the form of ownership, the nature of the transaction and the tax structuring.
In discussing the inevitability of changes in the ownership of privately owned companies, let's look at one market area. San Diego County is home to approximately 145,000 privately owned businesses that cover a wide range of industries including manufacturing, retail, distribution, professional services and just about everything in between. These businesses range in size from one owner with no employees to those with hundreds of employees. Most are quite profitable and have been growing in conjunction with San Diego County’s population and economic growth for many years. As a certainty over the years, 100% of these businesses will experience a change of ownership. In some cases, this change will be involuntary and take the form of a bankruptcy or closure. However, in the vast majority of cases, it will result in the owners receiving significant amounts of money as they transfer the earning power and goodwill of their businesses to others.
Because there is not a centralized database that tracks all forms of transfers of business ownership interests, the annual rate of transitions of ownership can only be estimated. However, from prior research on the topic, and from 25+ years of experience in providing representation to those who sell their privately owned businesses, I estimate that between 6% and 7% of all privately owned businesses change ownership during a given year. This means that the average period of ownership is approximately 13 years. The vast majority of these transitions will involve the sale and transfer of all prior ownership to new ownership.
In most cases, the owners will have spent years running their businesses on a day-to-day basis to generate both personal income and profits. Yet surprisingly, few business owners will have assembled the necessary plans for when they elect to sell, or know how to be positioned to maximize their after tax dollars when it comes time to transition the ownership of their businesses.
Though an exit strategy should ideally be part of an original business plan, it is never too late to become informed about all aspects of how to unlock the hidden value of your business and convert it to cash when the time comes to sell. In the above $1 million illustration of the sale of a business, the tax savings are obvious but what is not obvious is a true understanding of getting a buyer to pay you what your business is really worth. The process of profitably transitioning business ownership involves a series of steps that include the following:
