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Making the Most of Your Business
Financial Planning
April 2006
Making the Most of Your Business
Many years ago, you started your business. You worked hard, made a name for yourself and your business and now itâs time to slow down. Perhaps you have children who are interested in following in your footsteps. Maybe they can help you ease out of the business and eventually take ownership. Perhaps there are a few key employees who have helped you along the way and itâs time for them to buy you out. The only thing you know for certain is that itâs time for you to have some fun, but whatâs the best way to do that?
The answer to the question is that there is no easy answer. In this monthâs general business article, we discussed a few ways you might go about determining a value for your business, but there are a few more considerations than just a few numbers. One very key component of any negotiation for the sale of a business is what the form of the sale will be. Will you be selling assets? Will the buyer take over any liabilities? If the company is a corporation, will you sell the stock instead of the assets? These are a few of the considerations this article will explore.
The first thing you should know is that the current form of your business will have a significant impact on your considerations. Since the sale of assets versus the sale of ownership percentages or shares makes little difference in partnerships and limited liability companies, letâs focus on corporations. A corporation that has been taxed as a C Corporation throughout its life is somewhat like a person. Itâs components like assets, especially fixed assets and intangible assets like goodwill, and liabilities can be about as hard to separate from the corporation as removing an internal organ. Both are generally very painful.
For the body, the pain is easily seen, but for the corporation things are a little trickier. The problem with depreciated assets like buildings and intangible assets like goodwill is that there is very little basis left by the time of sale, but the value of the assets can be significant. This will create a significant tax problem when it comes time to sell. For example say you started a business years ago with a $10,000 investment. Over the years, you built up a lot of goodwill and a reputation that allows you to make more than your competitors. Letâs say that intangible asset is worth $10 million and everything else in the company is pretty much worth itâs tax basis.
When you sell the assets of the company, you are going to have two levels of tax. First, the company will pay tax on the gain from selling its goodwill to the tune of 34% of $10 million. Now, you are left with $6.6 million to distribute to liquidate the company. So you liquidate the company and have a gain on liquidation of $6.59 million. You will pay a tax of $2.24 million on the capital gains. All of a sudden, you go from having $10 million to less than $5 million. Just think, if you had been able to just sell the stock, you would have $8.5 million left. What a difference it can make to sell the living organism instead of selling just the pieces!
If, then, you own a corporation, your path seems pretty clear; simply sell stock and you do far better than if you sell assets. If life were that simple, there would be less need for professionals like us to advise business owners like you, but itâs not that simple. The very thing that makes a stock sale attractive also makes a company worth less in the eyes of the buyer. When a buyer purchases assets, those assets can be recorded at their actual cost to the buyer. Assuming there is value to the corporation that exceeds the tax basis of the assets, a buyer will always want to purchase the assets. An asset purchase allows the buyer to record new tax bases of the assets and begin depreciating the assets at the higher bases. If there is goodwill involved, the goodwill can be expensed over a period of 15 years. This allows the buyer to recoup their investment a little quicker by reducing tax burden. This, in turn, increases the value of the assets to the buyer.
A second reason a buyer will want to purchase assets is to avoid taking over any hidden liabilities like lawsuits, employee and other claims. Simply purchasing stock puts the buyer in the same place you would be, while purchasing assets allows the buyer to purchase only certain parts of the business while leaving potentially negative attributes of the old corporation in the corporation itself.
Does all of this start to sound a bit complicated? It can be. If you are seriously looking at selling your business, donât forget the tax and business aspects of the sale. If the considerations are a bit overwhelming, donât worry, thatâs why we are here. Give us a call and let us help you negotiate the best possible deal you can get.
Have a terrific April.
The answer to the question is that there is no easy answer. In this monthâs general business article, we discussed a few ways you might go about determining a value for your business, but there are a few more considerations than just a few numbers. One very key component of any negotiation for the sale of a business is what the form of the sale will be. Will you be selling assets? Will the buyer take over any liabilities? If the company is a corporation, will you sell the stock instead of the assets? These are a few of the considerations this article will explore.
The first thing you should know is that the current form of your business will have a significant impact on your considerations. Since the sale of assets versus the sale of ownership percentages or shares makes little difference in partnerships and limited liability companies, letâs focus on corporations. A corporation that has been taxed as a C Corporation throughout its life is somewhat like a person. Itâs components like assets, especially fixed assets and intangible assets like goodwill, and liabilities can be about as hard to separate from the corporation as removing an internal organ. Both are generally very painful.
For the body, the pain is easily seen, but for the corporation things are a little trickier. The problem with depreciated assets like buildings and intangible assets like goodwill is that there is very little basis left by the time of sale, but the value of the assets can be significant. This will create a significant tax problem when it comes time to sell. For example say you started a business years ago with a $10,000 investment. Over the years, you built up a lot of goodwill and a reputation that allows you to make more than your competitors. Letâs say that intangible asset is worth $10 million and everything else in the company is pretty much worth itâs tax basis.
When you sell the assets of the company, you are going to have two levels of tax. First, the company will pay tax on the gain from selling its goodwill to the tune of 34% of $10 million. Now, you are left with $6.6 million to distribute to liquidate the company. So you liquidate the company and have a gain on liquidation of $6.59 million. You will pay a tax of $2.24 million on the capital gains. All of a sudden, you go from having $10 million to less than $5 million. Just think, if you had been able to just sell the stock, you would have $8.5 million left. What a difference it can make to sell the living organism instead of selling just the pieces!
If, then, you own a corporation, your path seems pretty clear; simply sell stock and you do far better than if you sell assets. If life were that simple, there would be less need for professionals like us to advise business owners like you, but itâs not that simple. The very thing that makes a stock sale attractive also makes a company worth less in the eyes of the buyer. When a buyer purchases assets, those assets can be recorded at their actual cost to the buyer. Assuming there is value to the corporation that exceeds the tax basis of the assets, a buyer will always want to purchase the assets. An asset purchase allows the buyer to record new tax bases of the assets and begin depreciating the assets at the higher bases. If there is goodwill involved, the goodwill can be expensed over a period of 15 years. This allows the buyer to recoup their investment a little quicker by reducing tax burden. This, in turn, increases the value of the assets to the buyer.
A second reason a buyer will want to purchase assets is to avoid taking over any hidden liabilities like lawsuits, employee and other claims. Simply purchasing stock puts the buyer in the same place you would be, while purchasing assets allows the buyer to purchase only certain parts of the business while leaving potentially negative attributes of the old corporation in the corporation itself.
Does all of this start to sound a bit complicated? It can be. If you are seriously looking at selling your business, donât forget the tax and business aspects of the sale. If the considerations are a bit overwhelming, donât worry, thatâs why we are here. Give us a call and let us help you negotiate the best possible deal you can get.
Have a terrific April.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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