KANSAS CITY, MO — Determining a leadership exit plan for an organization, whether it’s through retirement, sale, merger or acquisition, can be one of the most difficult decisions a company will make. There are many aspects to consider, including business continuity; transition plans; the wellbeing of the employees, customers and vendors; and the overall financial impact.
The departure of a top executive will have a significant impact on the enterprise, and the exit strategy is an important process. It requires patience because it can eat away at time, finances and, to an extent, sanity.
The first step is familiarizing the leadership team with how the process will look.
Whether planning for a sale or retirement, the next business or individual doesn’t necessarily need to be identified immediately, but the leadership team should think about what traits the successor or next owner should have and weigh them against the goals and aspirations of the organization.
Similar to selling a home, the buyer or successor should be able to see themselves leading the company or visualize the company as part of a larger organization. Updating processes and writing down specific business protocols will help the successor easily pick up where the predecessor left off. In the case of an acquisition, it will help the buyer more easily fold the business and operations into its own.
When selling the business, a valuation is a critical component to help determine the appropriate price and reveal — and tackle — any obstacles that might jeopardize the sale. The business valuation can be done in early stages of an exit strategy to allow the opportunity to address any potential issues that would come up for a potential buyer.
The three most common business valuation methods are income, cost and market.
With the income approach, future financial metrics are converted into present values to determine what future cash flow is worth today. The cost, or asset, approach determines how much it would cost to recreate the business from the ground up. Lastly, the market approach bases the value of the business off similar sales transactions. Looking to the market is a reliable way to estimate what sales price will be acceptable to interested buyers.
There are also several tax implications that will vary depending on the specific exit strategy a business chooses to pursue.
A business sale or liquidation can be structured in one of two ways: a stock sale or an asset sale. For a C or S corporation, the exit plan should be structured as a stock sale. A capital gain or loss will be seen on the sale of ownership shares. If the assets of the business are sold, the sale price will be allocated to each asset, and gains and losses will be calculated separately.
The holding period and character of the gains will be determined by how the assets are used in the business.
For a company with an employee stock ownership plan (ESOP), the exit strategy will look a little bit different. C corporation owners have the option of deferring their gains by reinvesting their proceeds in securities of other domestic companies. This can allow owners to defer taxes for years or even decades, and if those replacement shares are held until death, the gains will be permanently excluded.
Owners of ESOP companies — both C and S corporations — will have the option to sell their shares back to the company over several years, enabling them to gradually exit the business. This will not eliminate capital gains taxes, but it will spread out the gain recognition.
Owners of family businesses often want to transfer ownership to the next generation. The first option is to transfer ownership shares while the owner is still alive. In this case, it will be necessary to file a gift tax return. Some business owners draft their wills so business interests are transferred to their heirs when they die. If the business and other assets in the estate exceed the gift/estate tax exemption, the estate will owe taxes on that transfer.
Another option is to transfer ownership over time. To reduce reliance on the gift and estate tax exemption, business interests can be transferred into a trust. There are many trusts that can hold business interests, so it’s important to talk with a business advisor to select the one that’s right for the business and its long-term goals.
There are countless ways to exit a business, and each method produces different outcomes, both strategically and financially, all with their own tax considerations. By identifying the right exit strategy early and relying on resources such as a valuation consultant, lawyer, broker and business advisor, the process can run more smoothly for all parties involved.
This story is from the April | Q2 2023 issue of Commercial Baking. Read the full story in the digital edition.
