Starting a business
Starting a new business is an exciting time but there’s a lot to think about. We’ve broken down the basics that explain how to start a small business.
After years of hard work and dedication, you’ll inevitably get to the point where you choose to transition your business. Though it can be challenging to let the business go, it should be viewed as a mark of success. You've grown your business to the point where you can take move onto the next chapter. This is a huge accomplishment!
Even if it will be a few years before you move forward, it’s in your best interest to start planning sooner than later. Following are the key considerations when putting together your succession plan:
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Before you can put your plan in motion, you’ll want to outline what you want to achieve and when. Ideally, you should start planning three-five years before you want to transition or sell your business. Preparing in advance has the added benefit to position you to respond to an opportunistic situation, like and unsolicited offer.
As you think it through consider:
“You want enough time to reduce or eliminate risks that might reduce the value of the business,” says Tom Smith, senior vice president and managing director of Business Owner Advisory Services from U.S. Bank Wealth Management. “A major risk for the buyer is the imminent departure of a business owner who is still the key employee of the firm.” That situation could negatively impact the company’s value in the market.
Smith recommends that in most cases where the sale is tied to retirement, the owner plans to remain with the business for some time to help the new owners make a smooth transition. “Buyers may be more attracted if the previous owner agrees to remain actively involved for two-to-three years to help facilitate a smooth transition,” he says. An alternative is to have a qualified replacement designated before new ownership takes control.
You know the saying, know your worth? It applies in business too. You’ve poured your heart and soul into your business but your passion isn’t enough to determine what your business is worth in dollars.
A lot of financial and legal details go into transitioning a business, not to mention emotions! Because of this, you’ll want to work with experts who will ensure you cross all the t’s, dot all the i’s and can help you get the most out of the transition.That team typically includes tax, legal, accounting and wealth management advisors.
A business owner advisory team can help you evaluate options and choose the one that’s right for you. They can help you:
Deciding whether you want to sell or transition your business will guide your succession planning efforts. Here are the options and what to consider for each path.
When thinking about selling on the open market, consider what you’d like to accomplish from the sale. Owners who want to maximize the value for their business are likely headed toward a competitive auction to find a buyer who offers the best price and terms. In that instance, the universe of potential buyers may be quite broad.But if you have certain criteria, such as finding a buyer who will keep the business functioning so employees can keep their jobs, then the pool of prospects gets narrower. The focus turns to finding a good cultural fit.
Typically, indications of interest from potential buyers are solicited and initial bids are provided. These tend to be ballpark estimates that don’t necessarily resemble the final agreed-upon sales price. After you determine which offer looks most appealing, the next step is to obtain a letter of intent. “While generally not legally binding,” says Smith “the parties are agreeing on a roadmap to a definitive, binding agreement.” Even at this point, there may be another four months or more left in the process, assuming all goes well.
Some potential buyers may want to dig more deeply into the company’s financial and legal records and even go so far as to talk to some of the company’s customers. Buyers often have an accounting firm conduct a “quality of earnings” analysis to verify that the numbers being reported are accurate. After all of this is completed, final negotiations can get underway.
In some cases, the potential buyers of your in the business may come from the inside. If there are partners in the ownership, one partner seeking to sell may try to come to an agreement with other partners in executing a sale.
“The big question when selling to a partner is to what extent the partners are on the same page,” says Smith. He has seen situations where partners who mostly agree on how to operate a business have significant differences when it comes to terms of a sale. Good communication that leads to alignment on priorities is important to help facilitate a smooth transition.
Some business owners want to create an opportunity for employee ownership of the firm as part of their business exit strategy. One alternative is an Employee Stock Option (ESOP), which is a trust and is incorporated into a retirement plan for an organization. It offers tax advantages for the seller and for the ESOP as ultimate owner of the company.
Employees who participate in an ESOP will be vested in the plan after a specific number of years, which encourages them to remain with the business over the long run. A business loan can be a great vehicle for a partner to buy your business, too.
The time it takes to sell your business can be significant. Preparing the business for a sale can take a year or longer. The sale process itself can take up to another six months or more.
Some business owners wish to pass down their business to their children, other family members or even gift it to employees who will continue their legacy. This option typically is considered if the recipient plays a key role in the business. You’ll need to decide if any money will change hands or if you will pass the business and all of its assets to your successor. Both situations can have financial implications for both you and the individual or individuals taking over your business.
If you plan to transition your business to a younger generation, the key is to start the process early – ideally several years before you plan to step back from your business. This will allow you to identify the best potential successors and prepare them for their new roles. Here are the key considerations in preparing your succession plan:
Identify successors: Look for family members or employees who have the skills, experience, and motivation to take over the business. Consider their strengths, weaknesses, and interests, and involve them in the decision-making process.
Develop a plan: Create a detailed plan that outlines the steps you'll take to transition the business. This plan should include a timeline, financial projections, and contingency plans for unexpected events. If you foresee a need for funds, business lending could be an option to consider.
Communicate openly: Communication is critical during a business transition. Be honest with your potential successors about your expectations and plans and encourage them to share their concerns and ideas. Keep all stakeholders, including employees and customers, informed about the transition. Consider when to involve certain parties in your financial considerations. Introduce them to your banker so you can have a transition conversation. Also, lending can be a helpful vehicle if money will change hands.
Train and mentor your successors: Provide your successors with the training and mentoring they need to succeed in their roles. This may include on-the-job training, formal education, or mentoring from outside experts.
Develop a transition team: Create a team of advisors, including lawyers, accountants, and financial advisors, to help you with the transition process.
There’s a song about knowing when to walk away. Maybe this resonates with you. Just because you’re ready to hang up your hat doesn’t mean you have to transition your business to someone else. You can simply turn out the lights and close the door. Well, there’s a bit more to it than that. Here’s what you need to think about:
While this is a must for any business, having excellent books including historical performance, expenses, revenue projections and cash flow is even more important if you’re planning to hand your business off to someone else.
It’s important to have accurate and up-to-date financial data ready to show potential buyers as part of your business exit strategy. It might take one to two months to pull together all the information they expect to see. It includes:
If your business has one, the support of a strong controller or chief financial officer can be instrumental at a time like this. Smith also recommends an outside, independent accounting firm review the numbers to validate the information you’re providing to potential buyers.
As we all know, things don’t always go according to plan. Sometimes a sale falls through or a medical situation emerges. When creating your succession plan, be sure to have a Plan B, Plan C and maybe even a Plan D.
The irony of selling your business is that when it occurs, often later in your career, it will require a significant commitment of time and effort on your part. “It can be a full-time job on top of your already demanding work,” says Smith. Before you start, be sure of your own commitment to see the process through on your terms.
Also make certain you can devote time to the steps that are required to achieve your objectives in selling the business. It can be beneficial to work with an advisor who can help oversee the process, work on identifying and contacting potential buyers and help guide you through the various and often complicated steps.
It bears repeating that the sale process itself will likely take six months or more. Depending on the makeup of your business, it may require that you stay involved for a period of time before you fully separate yourself from service.
Key takeaways
Starting a new business is an exciting time but there’s a lot to think about. We’ve broken down the basics that explain how to start a small business.
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After you have completed the important tasks of determining the value of your business and preparing your business is for sale (I.e., making sure financials are in order, made necessary repairs or upgrades, etc.), you will need to create a marketing plan so that people know your business is for sale.
Your marketing plan could include advertising in trade publications, listing your business on online marketplaces or business broker websites, or contacting other business owners in your industry. Don’t forget to notify your personal network that your business is for sale.
Once you have interested buyers it’s a good idea to screen them to determine if they are qualified to purchase your business. This could include asking for financial statements, credit reports, or business plans. When you’ve identified a qualified buyer, you'll need to negotiate the terms of the sale and finalize the transaction. Consider hiring an attorney or business broker to help you with the legal and financial aspects of the sale.
Selling a business can take time, and you may need to be patient in finding the right buyer. Be prepared to answer questions and provide information to potential buyers, and make sure you are comfortable with the terms of the sale before finalizing the deal.
The exact tax consequences of selling your business will depend on various factors such as your legal structure, sale price, and assets sold.
Here are some of the most common tax implications to consider when selling a business:
1. Capital gains tax: If you’re the sole proprietor of your business, any gain from the sale will generally be subject to capital gains tax. The amount of tax owed will depend on the length of time you were in business, the cost basis of the business, and the applicable tax rates.
2. Depreciation recapture: If your business has assets that have been depreciated over time, the sale may trigger a recapture of that depreciation. This means that you may need to pay taxes on the portion of the sale price that represents the amount of depreciation that you previously claimed.
3. State taxes: In addition to federal taxes, the sale of a business may also trigger state taxes, which can vary depending on the state in which the business is located.
4. Structuring the sale: Depending on how your sale is structured, the tax consequences can vary. For example, if the sale is structured as an asset sale, the tax consequences may be different than if it is structured as a stock sale.
U.S. Bank does not offer tax advice. It's important to consult a tax professional to understand the specific tax implications of selling your business and to help you structure the sale in a way that’s in your best interest. Looking for more information on tax considerations when selling your business? Read our in-depth article.