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Northwestern Mutual Guest Column — Key Considerations for Selling Your Business

When it comes to your business, understanding how much it is worth can be challenging and involves answering many different questions. Do you plan on selling your business any time soon? If so, who are you planning on selling it to? Whether it’s an employee, family member or strategic buyer, with 2023 right around the corner, now is the time to consider developing a financial preparedness plan for business succession planning.

READ — Exit Planning: New Study Shows Most Colorado Business Owners Are Not Ready to Sell Their Businesses

Value Your Business

The day-to-day challenges of running a business often impede our ability to understand its value and formulate a game plan around getting the outcome we desire. Not only do I encounter this with clients as a wealth management advisor for the Colorado Northwestern Mutual office, but as a business owner myself looking to sell down the road, I have a front-row seat to the same set of challenges.

Rather than basing how much your business is worth on a recent sale of a similar enterprise, or performing a Google search of earnings before interest, taxes, depreciation and amortization (EBITDA) multiples in your industry, consider scheduling an independent valuation with a professional to help you understand where value is attributed. It can be both surprising and enlightening to find out what the outside market values most, or least, about your business.

Once you have a valuation, you have a benchmark to drive and clearly understand future growth, and can spend time performing in those areas that enhance value. Furthermore, when the valuation is updated each year, you receive quantifiable feedback about the changes you are making in the business.

Develop a Financial Plan

Selling your business at the price you desired and finding out later you must unexpectedly return to work due to the market environment, taxes or unforeseen health changes is not ideal.

“Reverse engineering” what your future lifestyle and estate plan requires is the first step, and you can achieve this by working with a certified professional to create a comprehensive financial plan. Some of the considerations for a successful financial plan include:

1. Tax implications

This should address current tax issues, tax that is related to the business sale and tax implications during retirement and upon passing.

2. Asset management

Do not mistake an investment portfolio for a financial plan. How your assets are allocated now, how they will be allocated post-sale, where assets are located (taxable or non-taxable account) and what performance is needed to allow your plan to work are all common themes surrounding asset management.

3. Risk management

In the event of a disability or premature death, where will the money come from to execute on your buy-sell agreement with your partners? Was your life insurance structured as an asset or established for a finite period of time to cover death? Do you have a plan for long-term care during retirement? Protecting your current ability to run the business along with weighing your future desires are all important considerations.

READ — How to Avoid Risk While Running your Business

4. Estate planning

When the financial plan reveals that you will be unable to spend all of your wealth, would it make sense to gift shares of the company to children or future grandchildren before the explosive growth of the share value? There is so much to address on this front that having a plan that works in concert with an estate attorney is essential.

Tax Considerations

Is your business structure today the most tax-efficient for current income and a future exit? Do you have a business structure that will award you the best tax outcome when you plan on eventually selling your business?

In addition to engaging your planner, consider hiring a law firm with knowledge of the tax and estate planning front to work alongside your CPA to determine the best strategy.

Build a Team Around You

In addition to building a management team to help run your business, you should also invest in a comprehensive financial planning team. Now is the time to take a fresh look at what advisors are on your team, who is needed and who needs to be replaced.

In addition to a CPA, a valuation expert and an attorney who can bring business organization, estate planning and tax knowledge to the table, a CERTIFIED FINANCIAL PLANNER™ professional or CFP® will make sure the outcome you desire is never out of focus when tax strategy, business organization, estate planning and differences in opinion surface.

Exiting the business that you started and/or ran for years is complex and emotional. The earlier you begin the methodical process of building a trusted team around you and creating a financial plan, the higher likelihood of receiving the true value of what your hard work has built.

Royce ZimmermanRoyce Zimmerman is the wealth management advisor for Northwestern Mutual.

Exit Planning: New Study Shows Most Colorado Business Owners Are Not Ready to Sell Their Businesses

The Exit Planning Institute (EPI) recently conducted research to better understand the exit readiness of Colorado business owners and to see how prepared Colorado business owners are for an eventual sale. What we found was interesting and insightful, and underscores both the uniqueness of this region and the growing and evolving discipline of exit planning.

The Colorado State of Owner Readiness Report features survey results from over 400 business owners in Colorado. Survey results showed 95% of Colorado owners felt that having a transition strategy is important for both their future and the future of their business. Yet, 48% of owners stated they had no written personal financial plan and 65% indicated they had no formal or written transition plans.

Despite understanding that having a succession plan is critical to both business success and their own future, the survey results highlighted many reasons business owners had not started exit planning. The most common reason was owners were too busy growing their business to focus on exit planning. In addition, nearly 10% of owners did not have a transition strategy in place because they did not understand how to start the process. In fact, the survey found that 68% of business owners in Colorado are unfamiliar with their exit options.

READ — Creating a Small Business that Thrives

The impact of ill-prepared owners in a transition can be both economic and social. Applying these survey results across all Colorado businesses, we can project that more than half of all privately held companies will look to transition within the next 5 years, equating to approximately $1.7 billion in value. Without a proper exit plan, some of these business owners will not be able to find a buyer for their business, and of the ones that do, many may not maximize the outcome or end up regretting their exit from their business.

The first step to an effective exit strategy begins with understanding the value of your company. Nearly 71% of those surveyed indicated they had not completed a formal valuation or had no clear understanding of their company’s value at all. In addition to understanding value, exit planning integrates business planning with personal planning so business owners can prepare for a fulfilling and significant exit from their business.

If Colorado business owners want to rapidly grow the value of their company while creating significant wealth for themselves and their families, they must get educated on the exit process, create a formal transition plan, and concentrate on understanding and accelerating the value of their business. Our findings show that Colorado business owners are already aware of the importance of exit planning, but with the help of qualified professionals, these business owners can ensure their transition plan sets both their business and their future up for success. The good news is Colorado is home to numerous exit planning professionals. These professionals include Certified Exit Planning Advisors (CEPAs) in the Rocky Mountain Chapter of the Exit Planning Institute.

The full results of the Colorado survey can be found in The 2022 Colorado State of Owner Readiness Report.

 

 

2019 Headshot1 Snider Scott 500x532Scott Snider is the president of Exit Planning Institute and a nationally recognized industry leader, growth specialist, and lifetime entrepreneur.

The 4-step process to selling your business

If you’ve decided it’s time to sell your business, it’s imperative that you take your time and do things right.

Skipping steps in the process or hurrying over paperwork assuming that everything will be fine could land you in legal hot water and owe you money.

Here are the four steps in the process of selling your business that you should follow for a successful transaction so that you can avoid the most common mistakes and disputes.  

Have Your Business Professionally Valued 

You want to get a fair market price for your business. You or the buyer may think you know its value, but frequently, both the buyer and the seller are a long way off.

Hiring a local business appraiser to perform a valuation of your business is essential to ensuring you are getting paid what it’s worth.

The appraiser’s job is to conduct a thorough investigation of the business’s financial assets and debts and draft a report detailing its value. This objective appraisal can help you and the buyer get on the same page about a fair price.  

It’s essential to take this step at the beginning of the process so that the parties know the baseline value of your business from the start. It also gives you time to fix any areas of concern identified by the appraiser, such as broken equipment. 

Sign a Letter of Intent 

A Letter of Intent (LOI) explains that you intend to sell your business and that the buyer intends to purchase it from you. It summarizes the terms that you and the buyer agree on before the parties spend real money and time on third party advisors, due diligence, digging into the details, and negotiating the final deal terms and agreement.

An LOI isn’t a binding contract; however, it both establishes each party’s seriousness concerning the transaction and makes sure the parties are actually on the same page about the outline of the deal. 

The LOI doesn’t guarantee a sale, but it is a significant step forward. Your LOI must be transparent and include any significant necessary terms.

Ensuring this will help focus both parties’, limit surprises and disputes that will derail the deal, and keep the parties accountable through the process, all from the beginning of the transaction. 

Enlisting the help of a seasoned business attorney can make the LOI clearer to each party. 

Focus on Due Diligence 

Next, you will be asked to, and may need to, share financial, operational, and every other kind document with the prospective buyer to prove that the business is not only in in good financial standing, but is everything it is represented to be, according to the buyer’s own independent analysis. 

In addition to interviews and tours of facilities, you will need to collect and provide many documents such as tax returns, bank statements, registrations, manuals, customer files, Operating Agreements or Bylaws, licensing and zoning information, and agreements with other parties such as vendors or employees. This complex process can sometimes take months. 

Negotiate a Purchase Agreement  

The purchase agreement should then be discussed and negotiated. This agreement is a formal legal contract that spells out the terms of the transaction. 

The agreement is the final, comprehensive, detailed form of the LOI, and even more than the LOI, the purchase agreement must be clear, explicit, and define critical terms. 

The buyer and seller can sign this agreement at closing or weeks in advance with multiple contingencies or conditions that must be done before the closing takes place.

Once the closing is complete, where the buyer transfers payment and the seller gives possession of the ownership interests or business assets, the business officially belongs to the new owner. 

Avoiding Frequent Transactional Disputes 

Unfortunately, when selling a business, some sellers encounter transactional disputes. Although this part is not an official step in the process, it’s something that sellers and buyers should be considering throughout the entire process. 

Examples of common transactional disputes when selling or buying a business are: 

  • Working capital disputes: Typically, sellers keep all cash on hand for the business’s working capital needs making it necessary to establish the target amount of money between the buyer and seller.  Practically every private company transaction should involve a specific method to develop a working capital requirement. This isn’t something that should kill a deal. Both parties should be able to reach a reasonable agreement considering all the various factors. 
  • Conflicts over earnout calculations: Earnout mechanisms are essentially agreements that are completed after closing to keep sellers engaged or to shift the risk of post-closing risks. They are often complex and can create additional disputes between business buyers and sellers. There may be conflicts over the earnout period, the control of the business post-acquisition, or how the calculations should be done.
  • Missing or vague language in purchase-and-sale agreements: As previously stated, ensuring clear language and even defining essential terms with the LOI and purchase agreement is imperative to a smooth transaction. When terms or definitions are ambiguous or missing, problems are more likely to arise.
  • The valuations of COVID-19 affected companies: These valuations can cause inherent disputes in a post-COVID-19 world. The professional business valuation should include the impacts that the pandemic has had or could have on the business, both positive and negative.  

All business sellers and buyers can significantly reduce the risk of disputes by being forthright with information and demanding that all agreements be clear and on paper.

 The best way to ensure this is to hire a well-versed business attorney who can help with every step of the sales process. 

They are familiar with all the information that must be disclosed, the issues that need to be addressed, and are experienced in drafting clear agreements that both the seller and buyer can easily understand.  

Risk allocation and the sale of your business

The prospect of increased capital gain taxes has the attention of those considering the sale of their companies. But as of this writing, the proposal in the House Ways and Means Committee requires a business be subject to a binding contract to sell on September 13 to avoid the additional 5% tax.  

So, while it might be too late to do anything about that, it is never too late to focus on other ways business sellers can protect their purchase price. I want to focus on just one—risk allocation—and it’s a big one. 

Risk allocation makes up the bulk of any contract for the sale of a privately-held business, yet most sellers come to the sale process with no appreciation for the issues or the complexities involved.

Buried after mind-numbing pages of “warranties and representations”–promises and assurances the owner makes about the business–are a couple pages of indemnifications.

These indemnifications can go on for years and put the entire purchase price and more at risk. Yes, if you are not careful, you could sell a company for $1 million and then be sued for $5 million. 

The knee-jerk reaction is to say you’ll only sell your company “as is.” That is certainly one risk allocation strategy—the buyer takes all risks—but it will have a huge impact on the price the buyer is willing to pay. There’s a balancing act that goes on between price and risk, so it pays to sell subject to understandable and commercially reasonable risks, so be prepared for what’s involved.   

Those pages of warranties and representations? Be ready to spend hours creating “disclosure schedules” that respond to the contract’s requirements or provide information to keep you from being in breach. 

Sellers are often exasperated by the process of creating these disclosures, especially since they likely already spent hours responding to the buyer’s due diligence requests.  

Keep in mind that your responses to buyer’s due diligence will not likely not be considered in a lawsuit for indemnification—only information in your disclosure schedules will be relevant. 

As for indemnification, there are several opportunities to pare back broad exposures without adversely impacting your purchase price. Time limits are a starting place—how long after closing can a buyer make a claim. Periods of one to two years are much better than no time limits.  

Indemnification caps—your maximum exposure—are another consideration. Caps are often expressed as a percentage of purchase price. For larger private companies, a cap of 10-20% is reasonable; caps tend to increase, however, as companies get smaller, though a cap of 50-100% of the sales price is preferable to no cap.   

Indemnification “baskets” or deductibles should also be negotiated. These provisions are agreements by the buyer not to sue for indemnification until claims exceed some threshold. These are essentially an acknowledgment that “stuff” happens in any business and it is reasonable to accept a modest amount of it—often one percent or less.

Not quite “as is,” but when combined with good disclosure schedules and well negotiated indemnification provisions, they help a seller keep as much of that well-earned purchase price as possible.

Jimthomas13386final Jim Thomas is a business lawyer and director at Minor & Brown, PC with years of corporate and M&A experience in Greater Denver. Most of Jim’s clients are privately-held companies and individuals who look to him as a long-term, trusted advisor, helping with business issues and purchase and sales transactions all over the U.S. He enjoys working in varied industries, representing a wide variety of businesses from formation through exit and succession strategies, and whenever complex issues arise in the business life cycle. He can be reached at [email protected] or 303-376-6026.

(Sponsored content for this article provided by MB Law)

Selling your business in 2021? There’s still time to save estate taxes

Tax Law Changes on the Horizon

Odds seem increasingly likely that Congress will succeed, using the budget reconciliation process, in passing a tax bill between October 1 and the end of the year.

Income and capital gains tax rate increases are anticipated, along with a reduction in the estate tax exemption amount from the current $11.7 million to possibly $5.0 million or even $3.5 million per person.

If you’re a business owner, current market optimism, coupled with looming tax law changes, present a unique climate of urgency in deciding whether to sell your business. 

Fortunately, closing a sale  before year-end  is still feasible. Good businesses brought to market now may sell more quickly and at higher than normal multiples because of historically low interest rates, readily available debt financing, and high levels of “cash on the sidelines” to invest—all of which are driving buyer interest. 

Tax changes alone shouldn’t dictate your decision to sell. That said, specific proposals under President Biden’s American Families Plan are impacting exit planning. Most salient include the proposal to nearly double the top long-term capital gains tax rate to 39.6% (43.4% if you include the net investment income tax), and taxing the appreciated value of unsold assets at the owner’s death. Long-embraced strategies for tax planning efficiencies are being upended by these proposals. 

Consider, for example, a business owner planning to make a bequest of family business interests to his or her children at death. The owner could see that bequest treated as if it were a sale for income tax purposes, taxable at the 43.4% capital gains rate (subject to certain exemptions and payment deferrals); in effect, the owner could see a loss of the basis step-up tax benefit for gifts from holding those assets until death. Moreover, this tax would be independent of the gift and estate tax, currently assessed at 40% on amounts gifted or transferred at death in excess of $11.7 million per person.  An increased estate tax rate and a lower exemption amount under the Biden plan would exacerbate the tax hit. 

Often you as an owner don’t have the luxury of scripting the precise timing and path between formation and exit.  If external forces (e.g., market conditions or tax law changes) are driving the sale of your business before year-end, there’s still time for effective estate planning measures. 

3 Proactive Steps You Can Take To Mitigate Estate Taxes: 

1. Put governing documents in order

Be sure your Operating Agreement, Voting Agreements, Shareholders’ Rights Agreements, Buy-Sell Agreements, and the like are current and complete, and consistent with your overall estate and business succession plan. Consider whether any provisions are stale and in need of an update (such as a valuation formula in a buy-sell agreement). Confirm all necessary signatures are on file and ownership information is up-to-date. Because time kills deals, eliminating potential hiccups in the due diligence phase is even more critical now if you’re seeking to close before year-end and mitigate the impact of higher taxes. 

2. Leverage Generational Gifting

If the sale of your business will create a taxable estate, there is powerful leverage pre-sale to gift and sell interests in your business, prior to a market value being set by an outside buyer. You can take advantage of lack of marketability and lack of control discounts for minority, non-voting interests ranging from 25-35% or more, depending on the circumstances.

Ideally, you should complete any gifting of business interests long before signing the Letter of Intent with the buyer. The IRS has taken the unofficial position that the execution of an LOI sets a price.

Pre-LOI, you can maximize lifetime gifting planning by removing business interests from your estate at the discounted value. Any increase in value at the time of sale, along with future appreciation on the business interests, would occur outside of your estate. 

If you simply don’t have time to focus on estate planning before signing the LOI, all is not lost. You may still be eligible for discounts “before the deal is done” based on uncertainties inherent in any deal. 

Discounts for the time value of money held in escrow, probabilities of hitting earnout targets, and risk arbitrage regarding whether a deal will happen at all provide a basis for taking discounts on pre-sale gifts of business interests, potentially in a range of 12-13%.  

3. Leverage Charitable Gifting

If you’re charitably inclined, charitable gifting pre- sale can help you achieve your goals and at the same time yield tax efficient results. For highly appreciated assets, pre-sale is a perfect time to consider a contribution to a charitable remainder trust (CRT).  You can gift an interest in your business to a charity and retain an interest in a periodic payment (such as an annuity) for a specified term.

At the end of the term the remaining assets would pass to the charity.  Tax benefits are three-fold: [1] there would be no gift tax on the gift to the charity; [2] as a tax-exempt entity the charity would pay no income tax on the sale of the interests (notwithstanding the gain on the appreciation of the company’s assets at the time of sale), and [3] you as the business owner would receive an income tax deduction for the value of the assets given to charity in the year of transfer.

IRS Section 7520 interest rates, used to calculate the annuity amount that is paid to the owner, remain low, making this a good time to consider a CRT. 

If your goal is to close on the sale of your business before year-end, it’s not too late to implement certain business succession and estate planning techniques. Acting now could have a meaningful impact. 

Photo Maribeth Younger Maribeth Younger, Counsel, Williams Weese Pepple & Ferguson.