If you own a small business, it’s never too early to start thinking about succession planning. Establishing a plan long before you intend to sell can increase your chances of a favorable outcome down the road.

The following steps can help you identify special factors to consider. We also outline several planning goals and illustrate how a deal’s structure can directly impact the eventual outcome of your transaction.

Step 1: Establish your goals.

Business owners often have several goals when selling their business. In cases with multiple owners, these goals may be aligned but often are not. For example, one owner may prefer an outright sale to a third party, while another might prefer an internal sale. In another scenario, one owner may want to retire from the business completely, while the other prefers to stay involved in some capacity following the sale.

Maximizing net proceeds (and the tax treatment on a future sale) is always a hot-button issue for sellers, and it’s common for buyers and sellers to have a completely different set of objectives when structuring a deal. This issue is particularly difficult to manage when a possible sale involves an internal buyer or another related party. Therefore, it is extremely important to discuss your goals with your partners to identify any inconsistencies you may have on an individual level. The earlier you start these discussions, the more time you’ll have to lay a proper foundation for a successful business succession plan. Some common goals for a transition plan might include:

  • Providing some flexibility in winding down your involvement in the business. Good outcomes are generally not achieved when a vacuum is created by the sudden departure of the original owners, particularly if these owners play an important role in running the business.
  • Planning for continuity of management with adequate training and experience.
  • Maximizing the potential of an up-front payout from the sale of the business.
  • Creating a future stream of income from the sale proceeds to replace the owner’s salary and/or bonuses. This is a common goal when the owner’s business interest represents the vast majority of the owner’s wealth.
  • Minimizing the potential tax liability that can arise from the sale of a business for the seller and their family (capital gains, income, estate, gift, and generation skipping). For example, a stock sale will likely lead to a long-term capital gain (LTCG) tax treatment, whereas an asset deal may result in a situation where a significant portion of sales proceeds are taxed as ordinary income.
  • Rewarding key employees who have helped grow the business.
  • Finding a good cultural fit with a buyer to maintain the seller’s legacy within the company and the community.

Step 2: Establish a valuation methodology and/or obtain an appraisal of the business.

Depending on the type of business (personal services, manufacturing, retail sales, etc.), many different methodologies can be used to establish a reasonable value. A few examples include the net income approach (multiple of EBITDA), the discounted cash flow method, market based comparisons, and net asset value method. It’s also a good idea to consider industry “rules of thumb” to help affirm the final valuation. Of course, any valuation may be adjusted up or down based on what a buyer is willing to pay. The tax treatment of the sale for the buyers and the sellers may impact the final price.

You can enhance the value of your business with good planning. Sellers should always look at any proposed transaction from the buyer’s perspective because there is only one chance to “get it right” with a win-win result. For example, all of the following factors may impact the value of your business:

  • Will a proper management and control structure be in place following the transaction? Is governance an issue if the sale is to insiders or family members?
  • Has “business risk” been minimized? Will clients or customers stay with the company after the sale? Is the revenue stream too heavily dependent on a handful of large customers? Can anything be done to mitigate these risks?
  • Is a business continuity plan in place? How about cyber security and privacy policies? Do you need to obtain insurance policies for any parties to the transaction?
  • Is the business brand transferrable to the new owners or is it heavily dependent on the seller’s participation in the business? What can be done to transfer any proprietary knowledge or skill to the new owners?

Step 3: Come up with a structure for the sale that makes the most sense given your goals and the needs or concerns of the buyers.

For example, a business can be sold using many different techniques including:

  • Stock (or membership unit) sale versus an asset sale.
  • Using seller financing, third-party debt including small business administration (SBA) solutions, installment sales, or straight-up cash deals.
  • Using consulting agreements and non-qualified deferred compensation plans.
  • Long-term leases or management agreements.
  • Hybrid or combination deals including a mix of solutions, executing Grantor Trusts, making an IRC 338(h)(10) Election, utilizing a dividend payment plan, ESOP financing, or using private annuity contracts.
  • Are there any step-up considerations if the business is transferred via inheritance?

Make sure your documents are in place

Even if a sale isn’t imminent, you should make sure a preliminary transition plan is in place. Keep certain documents up to date such as shareholder’s agreements, operating agreements, employment agreements, and non-compete agreements. It is always a good idea to keep your corporate records up to date, including tax filings, minute books, policy and procedure manuals, HR files, and state registrations. If your business has a “buy-in” policy, is it consistent with the exit strategy already in place or being contemplated in the future?

Defining goals, determining a value, and establishing the type and structure of any proposed sale only scratches the surface in creating a sound business succession plan. We encourage you to have regular discussions with your business partners and financial advisors to lay the groundwork for a potential sale years before the actual event.

Author Christopher R. Plagge Tax Growth Leader

Chris has been involved in the tax and financial services industry since 1983. He earned a bachelor of science degree in accounting from Elmhurst College and has a membership interest in Savant.

About Savant Wealth Management

Savant Wealth Management is a leading independent, nationally recognized, fee-only firm serving clients for over 30 years. As a trusted advisor, Savant Wealth Management offers investment management, financial planning, retirement plan and family office services to financially established individuals and institutions. Savant also offers corporate accounting, tax preparation, payroll and consulting through its affiliate, Savant Tax & Consulting.

©2023 Savant Capital, LLC dba Savant Wealth Management. All rights reserved.

Savant Wealth Management (“Savant”) is an SEC registered investment adviser headquartered in Rockford, Illinois. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments and/or investment strategies recommended and/or undertaken by Savant, or any non-investment related services, will be profitable, equal any historical performance levels, be suitable for your portfolio or individual situation, or prove successful. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. The scope of the services to be provided depends upon the needs of the client and the terms of the engagement. Please see our Important Disclosures.