The coronavirus pandemic and resulting economic trends have accelerated plans for many owners thinking of selling their business. With increasing mergers and acquisitions activity on the horizon, now is an excellent time for business-owning families to conduct personal planning ahead of a liquidity event.
Proper planning for the sale of your business can make the difference between “hitting your number” or a poorly funded or structured financial future. Getting it right involves two related pursuits: business readiness — aimed at achieving the best valuation and a smooth transaction — and owner readiness to maximize personal tax and estate planning opportunities.
With so much to think about during the sale, most owners focus their attention on the business to the detriment of their personal financial and estate plan and how it fits with the deal. It’s often late in the game when they start thinking about where the money will go on closing day, and to their deep regret, they discover many opportunities to maximize financial results and personal goals are no longer available. In some cases, the lost opportunities can cost hundreds of thousands of dollars in unnecessary taxes. In the worst case, a well-earned future could be put in jeopardy. The good news is with sufficient foresight, it’s easily avoidable.
When is the best time to address post-sale personal financial planning? It’s never too soon, but ideally your business and personal financial planning should start several years prior to beginning the sales process. In some cases, more than five years may be needed to maximize benefits depending on the type of company you have, its ownership structure, and your post-sale goals.
Know your financial independence number
Personal planning for the sale of your business starts with understanding what life will look like after the sale. What after-tax proceeds will you need to support your lifestyle and long-term goals? We call this the “financial independence number,” and it’s critical to know this before putting your company up for sale. It doesn’t matter what your company is worth if you don’t know what you need it to be worth to provide for your financial needs post-sale.
Finding your financial independence number starts with an up-to-date personal balance sheet. Much like a balance sheet for your business, it tallies up assets and liabilities and provides a snapshot of your finances. Your financial advisor can prepare a financial independence projection and then have a strategic conversation on achieving your specific business and personal goals post-sale, with this information in hand.
In some cases, your financial independence number may be in reach for a near-term sale. In others, it could be attainable after a few years of planning. If it turns out that the value of the business is substantially below your financial independence number, then you’ll know it may not be the best time to sell, or you’ll need a plan for additional income post-sale.
Wealth transfer and estate planning considerations
If the value of your business is well in excess of your financial independence number and it looks like the limits for the estate tax exemption will be exceeded, estate planning strategies can shift future upside from a sale outside of your estate. Planning opportunities may include selling or gifting part of the business-leveraging valuation discounts to an entity outside of your estate for the benefit of other family members. There are many options available to achieve this outcome, but one such vehicle is called a Spousal Lifetime Access Trust (SLAT). A SLAT may help realize estate tax savings while providing a useful “safety valve” for funds in the event of an unforeseeable financial need. This strategy can be helpful in situations where you’re approaching a sale of your business but aren’t completely confident about the likely sale price or your financial independence after the sale.
Again, many of the available planning opportunities are realized or lost as a transaction nears, so it’s critical to start early.
Tax strategies around charitable giving
If charitable giving will be in your plan, there are strategies to consider here as well. For example, in the year of the sale, your income will likely be higher than usual, and you may be able to maximize benefits from capital gains rates while using charitable deductions to offset the higher tax rate applicable to ordinary income. This requires running a multiyear tax projection to understand the most appropriate timing for making charitable contributions.
It’s also important to identify the right long-term structure for your charitable giving. While popular, in some situations, the compliance costs and administrative burden of a private foundation (PF) may make a donor-advised fund (DAF) more suitable. DAFs are considerably popular as of late, in part due to their ease of administration and relative privacy afforded when compared to PFs. If you can define your goals and intentions regarding a charitable giving plan, your advisory team can make a proper recommendation on the structure and timing of charitable gifts.
Qualified small business stock exclusion and stock options
Another presale opportunity called the small business stock gains exclusion may apply to your situation. This provision of the Internal Revenue Code allows exclusion of capital gains tax from the sale of certain qualifying C corporation stock. Similarly, if your company has an incentive stock plan for owners and staff, proper advance planning —including an early exercise of the options — can maximize the after-tax value of those options.
A regrettable scenario occurs when a company enters into a sales transaction before owners or staff have exercised their options. At closing, they’re faced with paying tax at ordinary income rates when they could have otherwise qualified for the lower long-term capital gain rate. Or better yet, with sufficient planning, they may have qualified for the qualified small business stock opportunity.
Preparing and selling the business
Once you know your financial independence number and have considered your estate and income tax strategies, it’s time to prepare the business for sale. Our business readiness experts will work with you to maximize your valuation and structure the transaction before going to market.
Post-sale financial planning
After the big day and the business is sold, you’ll be faced with the next big decision: what to do with all the cash. Thanks to good presale planning, you should already have in place a thoughtful cash management strategy to handle the proceeds upon receipt. The strategy provides optimal yield on your cash holdings and assurance of liquidity for the tax liability, all while providing breathing room prior to deploying longer-term funds. Planning beforehand facilitates greater confidence throughout the process — and less stress.
After going through the transaction and the pressures of the process, we typically find it’s helpful for clients to take time post-close to relax, discover their “new normal,” and thoughtfully lay out a long-term financial plan and investment strategy. A cash management strategy during this period can achieve a reasonable yield while not risking principal and provide time for reflection and development of a coordinated approach to deploying funds into the markets. This time can prove critical, as losing out on a few months of (potential) positive market performance won’t materially change your financial success, but rushing into poor financial decisions could.
Get started now
Planning early for the sale of your business doesn’t mean you need to make all the decisions about your financial future now. But you should consider the critical items that, if addressed early enough, will provide you a better opportunity to maximize the benefits from your years of hard work. You can use this checklist as a starting point for addressing the key questions:
- What’s your reason for selling? (Next chapter or venture? Strategic growth for the company?)
- What does your personal balance sheet look like?
- What’s your financial independence number?
- Do you know if you have excess capital relative to your financial independence which can be used for estate planning purposes?
- What are the implications to, and opportunities for, your estate plan?
- How and when will you educate your children about the family’s wealth?
- What are your goals for gifting to family or charity?
- How does the business sale impact current life insurance policies and buy-sell agreement?
- How will you strategically manage and deploy the liquid cash proceeds?
- What’s the financial condition of your company?
- Is all or most of your wealth tied up in the company, or do you have resources outside of it?
- Will you leave the company immediately after the sale or stay on as a consultant or employee?
- Are your current advisors able to assist with your personal planning and business readiness needs, guide you through the entire process, and provide wealth management advice after the sale?
A key factor to help manage the stress of selling a business is having a team of trusted advisors with expertise in wealth management, estate and charitable planning services, investment banking, and tax. We can help you create a timeline of what needs to be addressed, think through the personal impact, articulate the planning opportunities relevant to your situation, and explain how to synchronize them with your business planning. Ready to start? Give us a call.
