Selling a business for a profit of $200 million sounds like a problem that many people would like to have. After all, an influx of cash can be a wonderful thing. But handling the sale of a business requires a team of advisors and careful planning, or else that boon can quickly go bust.
“Entrepreneurs are often property rich and cash poor because they've invested in their business," said Alma Banuelos, head of Trust & Estate Services for City National Bank. “When they net a profit of $200 million from the sale of their business, they need to be ready with a plan to preserve that capital by minimizing their tax liability and structuring accounts to provide for their future plans."
While selling a business should be a carefully planned transition, it is unfortunately common for entrepreneurs to sell first and manage the money later, said Paul DeLauro, Manager Wealth Planning for City National Bank.
“Ideally, we work with business owners for years before the sale, but when people come to us after a sale we explain the importance of having a team of advisors to be successful in preserving and protecting their assets," said DeLauro. “We aid in gathering their attorney, accountant, asset manager, wealth planner and insurance expert to coordinate their financial plan."
Many owners discover when their sale is imminent that they could have saved on taxes if they had structured the transaction a different way, said Gaye Chun, a senior wealth planner with City National Bank.
“It's so important to examine all your options before a sale," Chun said.
A major transition such as selling a business requires an intertwined life plan and financial plan.
“Business owners need to recognize that the sale of their business will have an impact on their family and their lifestyle," said Banuelos. “Now that they're free from running the business, they need to decide what they want to do next. Is there a passion they want to pursue outside of the business? Do they want to go back to school or start a new business? Do they want to spend time on philanthropic causes or traveling?"
Each decision has an impact on their financial plan, along with their age, their family and their other assets.
“People who sell their business when they're in their 60's or 70's often have a tremendous sense of loss around what they've built," said DeLauro. “They need to figure out how to replace the adrenaline of being an entrepreneur. One of the first things I talk about with business owners getting ready to sell is what they want to do next and how they'll use the capital from the sale."
Mapping out cash flow and deciding when and how to gift money to family members and to charities should all be part of the post-sale discussion.
If a business has already been sold, Banuelos said, the short-term plan should be to immediately establish a living trust to protect the assets of the sale.
“If the seller already has a living trust in place, they can adjust the trust to accommodate the influx of cash," she said. “If a seller passed away before a trust was established, there would be no way to avoid probate."
Another option is to place some of the assets from the sale into a donor- advised fund, a charitable trust or a family foundation, said Shilpa Mirchandani, a senior wealth planner with City National Bank.
“The biggest issue for someone who hasn't planned in advance of a sale is tax mitigation," said Mirchandani. “It's important to meet as soon as possible with a wealth planner and an investment advisor to develop a plan."
Sellers who plan to invest in a new business need to develop a strategy to minimize their taxes while protecting and growing their assets for their next endeavor, said Chun.
If the sale is confirmed but has yet to be finalized, it may be possible to structure the deal by gifting part of the business to minimize the tax burden.
Pre-planning a sale affords business owners the opportunity to make sure the transaction is tax-efficient, said Chun.
“You want to make sure you've arranged the sale to minimize your risk of not seeing the full payment for the business," said Chun. “You can also secure your investment options ahead of time so you have a plan for your immediate post-sale needs."
A common practice for many business owners is to dissolve their business rather than sell it, said DeLauro. Others gift a business to their heirs. Any decision should be carefully planned in advance of a sale.
“Entrepreneurs often want to sell their business to insiders to keep the company alive but that takes a lot of planning to determine who will run it," said DeLauro. “Business owners sometimes think selling to a third party is the best answer if they want a life after the business sells, such sales can be complicated with an additional layer of liability. That's why it's so important to immediately protect as much of the assets from the sale as possible."
Structuring a sale with all cash upfront is often ideal, but some sellers agree to a payout over time, said Chun.
“If you get the money upfront and the business goes bankrupt the next day, you don't need to worry," she said. “If you're getting a payout, you have an interest in making sure the business continues to thrive."
How much someone garners from the sale of their business depends in part on who they sell it to, said Chun. Owners who sell to family members or to their employees are likely to get less than if they sold to a third party, but there is a potential tax benefit to the sellers if they choose an employee stock ownership plan (ESOP).
“One client I worked with sold a $70 million business to his employees through an ESOP and retained a five-year consulting position so he could guide them through the transition," Mirchandani said. “Some owners stay on the board of directors so they know what's happening to the business they built."
Business owners need to consider their goals if they plan to sell their business, such as creating an income stream or increasing their charitable giving, or both.
“One technique is to gift the business to a charitable remainder trust, a tax-exempt entity, so there are no tax consequences from the sale," Mirchandani said. “This can be structured to create an income stream to the grantor during the trust term, with the remainder going to a charitable beneficiary."
“I recently met with a CEO, who was a 50% owner in a business started by his father," said Mirchandani. “The CEO's brother owned the remaining 50%. Other than the CEO's oldest son, who had no ownership in the business, there were no other family members who worked in the business as employees. The CEO wanted to retire in the next few years, and sell 40% of his share of the business to his brother, while keeping 10% for his son. We discussed the importance of maintaining harmony between his son and his brother who will continue to work together, as well as the overall viability of the business. It's imperative to have a family governance structure and business succession plan to ensure that all family members and key stakeholders are on the same page."
Businesses sometimes have a buy-sell agreement that stipulates how and when a partner's or shareholder's ownership interest may be transferred in the event of departure or death, said Mirchandani.
“Buy-sell agreements must be reviewed every few years to make sure they are aligned with the owners' goals and are adequately funded, usually with an insurance policy," said Mirchandani. “The terms of the buy-sell agreement may determine a method for valuing the business and dictate whether the payout is an installment or a lump sum."
Pre-sale and post-sale planning are essential for business owners to ensure the safety of their post-transaction lifestyles, said Chun.
“Talking to a team of financial advisors before selling a business can result in a smoother process that maximizes the profit and protects the proceeds for the owner and the owner's family," said Banuelos.
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