Untying a business and its owner is a monumental undertaking with many decisions. The spotlight falls naturally to the business sale, but it’s often the management, family and owner transition that takes the most attention.
Frank Goins, a wealth advisor with SunTrust Private Wealth Management, challenges owners considering a sale, “What do you plan on doing tomorrow? What outlet do you anticipate having for your drive, creativity, wisdom, knowledge and experience?” Without a confident answer to these questions, a business owner is not ready to sell.
Step 1: Getting started
Transition planning starts with priorities. Jason Sykes, client advisor with SunTrust Private Wealth Management, finds many business owners prioritize family dynamics and other non-financial factors over tax and financial implications. Some business owners have a non-negotiable view of the outcome they want. Sykes points out that flexibility and a willingness to explore alternatives will yield superior results.
The first step in any transition planning is a realistic business valuation. Understanding the true value of the business may have a dramatic impact on the owner's transition plans, particularly if the exiting owner is relying heavily on funds extracted from the business. Some owners, particularly if they are planning to pass the business on to a family member, underestimate the importance of obtaining a realistic valuation of their business.
Preparing the business for sale and for the highest valuation means demonstrating that the business can operate independent of the owner’s management, sales or operations contributions. Further, tuning the business to operate at peak efficiency increases income and may boost the valuation.
Step 2: Sorting out family transitions
“Time is an ally when passing a family business onto the next generation,” Goins says. Early planning gives owners more time to break the bonds that tie them to their business. It may also allow for better tax planning. Time also allows family members to consider whether to continue with the business.
“Time is an ally when passing a family business onto the next generation.” Frank Goins, Wealth Advisor, SunTrust Private Wealth Management
Parents should have open, honest conversations with their children early in the planning process. “It may be that Mom and Dad are saying, ‘We want to pass this down to you,’ and the kids finally have enough courage to say, ‘This isn’t my dream. It’s not what I want to do. I think we probably ought to sell rather than you pass it down to me,’” Sykes says.
As difficult as that prospect may be for some parents, it may ultimately prove the best outcome for both the family and the business. “I had a knowledgeable matriarch tell me that you can always leave someone your money, but you can never leave them your passion,” Goins says. Without passion as a motivator, both the new owner and the business are likely to underperform.
More time with the children testing the waters as business operators means more time to evaluate their business acumen. Goins advises, “Owners learn by failing along the way, and when members of the next generation come along, they’ve got to have an opportunity to fall down and skin their knees along the way to ensure they are ready to be effective owners.”
Step 3: Dig into the numbers
Deliberate planning means better sales decisions. Owners sometimes focus solely on the gross sales price, but different structures or transaction types may mean vastly different net cash amounts.
The deal structure is as important as the economics. “We always want owners to consider selling their shares of stock in the company versus their assets,” Goins says. “That’s better for income taxes, and it also helps in the long term where, if they sell their stock, they may limit future litigation risk.”
“Estate and gift taxes, as well as income taxes, figure prominently in transition planning”, says Goins. Changes in these taxes are likely to affect how business owners reach their objectives. While Federal estate tax exemption changes could minimize the estate’s tax burden and offer additional planning avenues, varying state tax estate exemptions may complicate it.
Owners should keep an eye on the state income tax codes since they can change with the political winds. Planning that considers different future tax scenarios is critical. “Some of the [planning] objectives would not change based on a tax change,” Goins explains. “But the method would most likely change.”
Step 4: Plan for life after the business
Once a business owner hands over management to a new owner and begins devoting energy to new endeavors, financial questions remain. Many owners have all their wealth invested in their business and relinquishing control over income generation does not come easily. “As owners of the business, they feel like they are in control of their income, whether they really are or not,” says Sykes. When it comes time to invest in other financial instruments, they feel less certain. “That’s a big psychological jump,” Sykes says. “Owners may actually be taking less risk by diversifying their wealth, but psychologically, this is a real barrier.”
“As owners of the business, they feel like they are in control of their income, whether they really are or not……Owners may actually be taking less risk by diversifying their wealth, but psychologically, this is a real barrier.” Jason Sykes, Client Advisor, SunTrust Private Wealth Management
Transition planning is a team effort. Goins and Sykes recommend looking for advisors with expertise in tax, law and finance, and within finance, expertise in mergers, acquisition and personal finance.
When seeking advice, Sykes says candor should be top of the list. Owners need advisors who are straightforward, even if their advice is difficult and unwelcome. The cost of a deferential advisor is high.