Exit Planning

Tax Planning for Exit Strategies

There is no doubt that exit planning and its execution are complex and challenging. The exit planning is critical and can save the seller a significant amount of funds. With a fifteen-month plan to exit your business with the proper planning and execution – the seller should be able to add another 30% to his / her net proceeds. This is possible because it:

  • Provides you with the time to properly “clean-up” the balance sheet;

  • Eliminates unnecessary costs. Remember that each dollar you save or add will within the next 18 months generate a significant result. For example, if the company has a valuation multiple of 6, then every dollar improvement in EBITDA generates you, the owner, 6 dollars. This is not a bad ROI. The general pitfall is there are “too many sacred cows”;

  • Allows the inventory to be optimized;

  • Assures you have the right team. Too many low / middle market companies do not have the bench strength once the owner leaves. Or even worse, the bench strength comes from family members. Develop a team knowing the short-term and long-term strategy and share the upside opportunity with them. If done properly, these key individuals will generate their savings several fold in comparison to the costs;

  • Incentivizes all the key players to ensure everyone is on the same page; and

  • Gives you time to meet with your tax advisor very early in the process to ensure you minimize your tax exposures and / or obligations. Ensure that your tax advisor is an expert in the M&A phases of business. This is a very complex set of transactions – this is not the time to have an inexperienced player. After all – this business sale may be the most important financial transaction in your life.

From a tax perspective, you, the owner, should have a solution to the following tax issues:

  • What Type of Entity Do You Use to Conduct Your Business?

  • Is a Tax-Free Deal Possible?

  • Are You Selling Assets or Stock?

  • Allocation of Purchase Price is Critical.

  • Other Payments to Sellers; Personal Goodwill.

  • Installment Sales (Seller Financing) and Escrows.

  • Earnout/Contingent Payments.

  • Outstanding Stock Options.

  • State and Local Tax Issues.

  • Pre-Sale Estate Planning.

Unrealistic Valuations

Warren Buffett said it best: “Price is what you pay, value is what you get.”

One of the biggest struggles with selling in the lower to middle market is business valuation expectations. The top reason for deals not closing in 2022 was due to a valuation gap in pricing.

Of those transactions that didn’t close due to a valuation gap in pricing, approximately 69% had a valuation gap in pricing between 11% and 30%. Sellers almost always feel their business is worth far more than what the market will bear. Here are a few basic reasons explaining this valuation gap:

  • The owner is valuing assets, not cash flows. Investors are not concerned as to what you paid for your assets. A buyer is focused on the cash that the business can generate and its risks. This is especially true with service and technology companies.

  • Too often, the owner is not optimizing their value/opportunities due to lack of preparation. A small investment in preparing for the transaction can more than pay for itself if properly executed.

  • Owner’s attachment to the Company. If the Company has paid your salary, the children’s tuition, etc., you place more value on the enterprise and may not appreciate the risks associated with the business from an outsider’s perspective.

  • Valuations based on the rare astronomical business successes. Examples include Instagram, Facebook and Apple - these entities are so far outside the realm of th norm that any meaningful comparison is ludicrous.

  • Private Equity Firms and the relatively low cost of capital have generated an unprecedented frenzy over competing for the companies with an EBIDTA greater than $5 million.

  • The owner is equating the valuation based on wants/needs, not on a fair market value.

Before deciding to sell your business, hire an independent, accredited business valuator to provide you with a reality check as well as means of improving the future price.