Has COVID Caused a Rethinking of your Business Exit?
How do you sell a business in the midst of ongoing COVID?
There are many steps involved, but two important ones I would emphasize are business valuation and retirement liquidity.
Contrary to popular belief, business owners rarely know the sale value of their businesses, so the rest of their plan can be based on a false assumption.
Start by valuing the business.
Relatedly, there is the issue of whether your exit plan will have a “liquidity event.” If you sell the business, that helps convert illiquid business equity into retirement income.
If you’re passing the business to the kids or otherwise holding on to the business, you need to have some other source for retirement. Examples can include qualified retirement plans, deferred compensation, and consulting agreements.
What makes exit planning for you, the business owner, so complicated?
The likely challenge for you is that the business is your retirement plan, and it’s not easy converting business equity into retirement income.
If you sell to an outside buyer for a lump sum, you pay taxes upfront on the gain.
If, instead, you sell to a buyer for, say, a 10-year installment note, then your biggest retirement asset is a now a note from a buyer who you don’t control.
While it’s great to own a business, these are examples of the challenges faced in crafting an exit plan.
How has the Tax Cuts and Jobs Act of 2017 changed things?
The TCJA has caused many small business owners to consider retaining their businesses when they retire.
First, because of the 20% QBI [qualified business income] deduction that so many of them currently enjoy, they want to continue to reap the tax benefits associated with business ownership.
Second, since fewer of them are threatened with the prospect of an estate tax, they may hold onto the business in order to get a step-up in the business’s income tax basis for their heirs.
If this is your plan, this means you may have to start planning now to get the team in place so that you can run the company at arm’s length.
Has the COVID-19 pandemic had much of an effect?
Estate planning has taken on increased urgency.
Business owners are human, and many not only seen loved ones disrupted by COVID-19; they’ve also seen how lack of planning has made things worse.
Estate planners are swamped currently, not just because of their client’s tax issues, but also because of the demand for powers of attorney, wills and other estate planning docs, cleaned-up beneficiary designations, a plan for what happens if something goes wrong with their health, etc. When was the last time you updated your estate documents and your succession plan?
What kinds of products or arrangements are typically used to help business owner clients with business sale issues?
There has been an increased interest in products that facilitate future business sales. The sale of a business is a complicated process that we will reserve for other articles.
Examples of strategies to aid a transition or sale include life insurance to fund buy-sell agreements and key-person insurance to cover the loss of a rainmaker.
The combination of the pandemic and disrupted markets has caused business owners to pay more attention to business risk, and this includes the risks involved in having no exit plan. If you don’t have one, right now is a good time to start, for your own peace of mind and that of your family and employees.