My E-Myth- Refer a Friend
- What is the E-Myth?
- Print Page
- Type Size: A A
Exit Strategy - Don't Tax Your Family
An exit strategy is a plan to extricate oneself from the current situation. In a business context, exit strategy most often means how best to either sell or close the business. A good exit strategy should anticipate economic trends, bring you closer to realizing financial goals, ease your transition out and make it easier for new owners to take control.
There are also important tax considerations of which to be aware should you be planning to sell your business to your children.
The Flood
You are probably aware of the large number of baby boomers set to retire in the next few years. A logical result is an associated increase in the number of businesses for sale, as boomers liquidate their businesses for retirement assets.
Web searches with terms like "boomers selling their business" generate hundreds of results, as these events are clearly on the radar of mergers and acquisitions firms and financial advisors. PriceWaterhouseCoopers found that half of US business owners plan to sell within 10 years, and another source expects 40% of family-owned US businesses to sell in the next five years.
Be Prepared
One of Benjamin Franklin's many pithy comments was "By failing to prepare you are preparing to fail." This is true regarding your exit strategy. At a minimum you should have an exit strategy in place before the market floods with businesses for sale. And if you're already planning to sell, you may want to beat the rush.
Timing the sale of your business in the public market may prove analogous to the selling of stock, i.e., when will it be most valuable? Factors favorable to sellers include times of economic expansion, low capital gains tax rates and low interest rates.
If you cannot hand-pick your buyer, be wary. In your career as a business owner, you are likely to sell just one business, while active corporate buyers will work multiple deals every year. Consider that
- Active buyers have the advantage in business valuation and negotiation
- Business-valuation-by-owner is often low, typically minimizing profits for taxes' sake
- Business owners are often impatient to sell
A vital negotiating point will be the strength of your documented business systems and financial statements. Turnkey systems add to a business' value and ease the assumption of control by new owners. In this area particularly, an E-Myth'd business will be more valuable than a similar business without well-documented systems.
Don't Tax Your Family
Many boomers will be selling their business to their children. Without planning for this transition, a seller risks imposing three distinct taxes on their family. With proper forethought, you should be able to smooth the hand-off to the kids, and keep associated taxes to a minimum. Let's say you're selling your plumbing company to your daughter.
Plan A
She's going to pay you market value for the business, plus interest amortized over 10 years.
- First, you receive regular payment for your equity, but the interest charged is taxable, and any profit you make on the stock value is subject to capital gains tax.
- Second, she can't deduct the cost of the stock from her income. She works to earn the cash, pays taxes on that income and pays you from her net income.
- Finally, when you die, any residual after-tax profit you realized will be subject to estate taxes.
Plan B
A smarter way to sell a family business to a child is to first establish the business as an 'S Corporation'. With this status, your daughter can deduct the interest paid to you. Moreover, she can withdraw corporate profits (with no dividend tax) to pay for company stock. The estate tax still applies, but keeping in mind the inevitability of death and taxes, we believe one should enjoy life while one is able.
The key is to plan in advance for a successful exit.