By: BT Team | 01/23/25
You’ve started and grown your business, despite all the hurdles you had to overcome. It may be difficult to think about a time when you will transition out of that business; however, succession planning should start at least five years before you want to leave your company. If you put off your exit strategy until you’re ready to get out, you may seriously limit your options, including who you can sell to, the value you will receive and how successful the transition is. You can also expect that your succession plan will need to be adapted because of circumstances that are beyond your control, such as health problems, life changes, key employee departures, market conditions and interest in your company by intended successors. In the meantime, there are tax minimization moves you can make.
The following six options are what you’ll typically find available when you’re ready to transition away from your business.
You’ve built a legacy, and now you’re ready to pass it on to a younger sibling or the next generation of your family. This is often an entrepreneur’s dream, providing for his or her family for generations into the future. However, it may not be your kids’ dream, and they could have no interest in taking the business over. Though you have the option of providing them with the business as a gift, doing so does not deliver many or perhaps any proceeds to you at the time, which can limit your retirement income if you haven’t made other arrangements.
Another option is selling your company to a key employee who is already experienced with your business. This is an attractive option if you have good relationships with key employees and want to maintain the current culture. However, many employees will have limits to their financial resources or may not have the business acumen to be a good entrepreneur. You’ll spend time training the employee and may have to finance the deal personally or through your business due to difficulty with bank financing. Is this risk one you’re willing to take on?
Although selling to an outside party can provide you with a great value, the opportunities to do so may be limited, especially in industries that are not seeing rapid growth. It can be difficult to vet the potential buyer(s), so you will likely need an investment banker. Settling for only one buyer in the process limits your sales options.
While merging with a competitor or selling to a private equity group can also provide a good price, you’ll need to market your company to potential buyers that want your territory, key employees, customer relationships, technology or other assets.
To get a fair price while keeping your business going as-is, an ESOP can facilitate your transition, but there can be issues with acquiring debt financing. For an ESOP, the outgoing owner(s) is not always willing to give a personal guarantee, though it is frequently required by some banks. Assuming an ESOP can be facilitated, is your management team ready to run the company?
While this is often the easiest way to get out of a business, it also provides the lowest value for the owner. This involves selling off equipment, assets and real estate; collecting your receivables; and paying off any liabilities.
When considering an ownership transition, understanding the tax implications of each strategy is essential. Each model—whether it involves an internal ownership transition, a sale to a competitor, or establishing an ESOP—carries unique tax considerations that can impact the financial outcome for the seller and the business.
For instance, sales to a third party, such as a competitor or private equity firm, are often structured as asset sales, which may be taxed at both ordinary income and capital gains rates.
An Employee Stock Ownership Plan (ESOP) allows business owners to sell all or part of the company to employees, with opportunities to defer capital gains taxes, especially when transitioning to a C Corporation. Additionally, S Corporations owned by ESOPs can avoid federal taxes on the ESOP-owned portion of the business. However, ESOPs can be costly to implement, with initial costs exceeding $100,000 and annual maintenance ranging between $20,000 and $50,000.
Worker-owned cooperatives (Co-ops) provide a cost-effective alternative to ESOPs, allowing sellers to defer capital gains taxes while enabling employees to gain ownership and share in profits. Co-ops also offer flexibility in setting ownership criteria and maintaining a management team focused on growth.
By consulting with tax professionals and succession planning experts, business owners can tailor their business ownership transition plan to minimize tax burdens and maximize value.
Preparing your business for a smooth transition is as important as selecting the right ownership transition models. This preparation involves more than just financial considerations—it requires addressing operational, cultural, and leadership factors.
For an internal ownership transition, such as transferring ownership to a family member or key employee, it’s critical to establish a multi-year plan for transitioning roles, responsibilities, and relationships. Without this structured approach, the risk of failure increases significantly.
In external transfers, particularly when selling to competitors or financial buyers, conducting thorough due diligence is key. Ensuring a cultural fit and aligning on long-term goals can prevent disruptions that might otherwise lead to employee turnover or operational instability.
Additionally, implementing strategies to enhance profitability and operational efficiency can make the business more attractive to potential buyers and ensure a smoother transition.
There are many factors to consider when determining which transition option is best for you. Our experienced team of business advisors is here to create a solid plan for the succession of your business, while considering current and future tax minimization plans. For more information, please contact Gina Miller or Brett Dixon by calling 770.396.2200.
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