What most sheet metal owners do not realize is that 70 percent of their wealth is trapped inside their private, illiquid business and that fewer than 30 percent of them will ever transfer or sell. The challenge is to have a plan to beat these odds and sell to an outsider, investor, employees, management or family. Selling a business is very different from selling a house.
Most HVAC business owners believe that exiting their business is a process that they can handle themselves or deal with when the time comes. They understand how to run a business but have never exited a business. This is a complicated process that requires specialized advice and a guide to coordinate all the moving parts.
This article will explain the differences between selling a sheet metal business and selling a home — or, for that matter, how selling a business differs from the sale of virtually any other asset that you will sell in your lifetime.
Businesses have multiple values known as a “range of value,” and homes are based on the comparable sales method for neighboring homes that resemble the house being sold. More importantly, the value of a home is not dependent upon who is the buyer. In the world of residential real estate, all buyers are (essentially) equal; they are either qualified for financing or they are not.
In the world of business sales, the type of buyer that you are talking to is critically important. Different buyers bring different “valuations” to the business sale — some will pay more than others, and some will have to pay you out over time. This is not the case in the sale of a home.
In the sale of a business, value and the stream of payments varies from buyer to buyer (for example, a competitor will pay more for your business than an employee who needs to pay you from cash flow from the business).
In other words, the value of the business depends on to whom it is sold: outside buyer, investor, employees, management or family.
When homeowners sell their home, they are paid the negotiated selling price at the closing. In business exits, the amount of money received at closing oftentimes represents only a portion of the total proceeds that are part of a larger negotiated selling price. There is a general rule that smaller deals — less than $3 million — are subject to more “structuring” of payments while larger deals get more “cash at closing.”
Included in the deal structuring are deferred payments, contingent payments, non-compete payments, consulting agreements, escrow payments, and continued lease and property rental payments.
Complicating deal structuring even further is the fact that each of these payments is subject to its own different tax rate. Also, as a general rule, buyers prefer to purchase assets of a company while sellers prefer to sell stock. Again, this varies significantly from the sale of a home.
When you sell a home, there is — generally — one tax rate. When you exit a business, there are an endless number of potential tax outcomes for the transaction ranging from 0 percent to more than 55 percent. The most easily recognized tax rate is the rate applicable to the sale of stock — the capital gains tax rate. This rate applies to the “gain” — the amount of value exceeding the cost basis of the stock — that is realized in the sale of company shares.
Payments to an exiting business owner can be characterized as goodwill, personal goodwill or income, or, alternatively, they can fall into an Internal Revenue Code section deferring the taxation until a future date, such as IRC section No. 1042 for (certain) sales of shares of a C-class corporation to an employee stock ownership plan.
The sale of a residential home does not afford the buyer and the seller options for reaching such characterizations or deferments of the taxes.
The sale of a residential home includes all of the property and the structures that are on that property. Therefore, residential home sales are an all-or-nothing deal.
Business exit strategies are limited only to one’s awareness and imagination. You can sell a portion or all of your company stock (or assets) as part of an exit, a fact that many business owners do not know. Once this concept is grasped, an owner’s primary motives for the exit may be more easily achieved.
In other words, different types of transactions are available to allow flexibility to the process of business-owner exit strategies.
The sale of a residential home generally includes the services of a real estate broker. A broker’s responsibility is to know local markets and to attract buyers to the property.
Alternatively, exiting a business includes the services of a professional who can draft documents reflecting the agreement for the transfer of shares (or assets) of the privately held company (usually an attorney), document any arrangements for future payments and security that is taken in lieu of payment at the closing (again, an attorney), assess the taxes that must be paid as a result of the transaction (normally done in advance of a closing by an accountant), and understand the unique nature of your privately held business (a transactional intermediary).
A transactional intermediary should be able to:
• Present the business in a light most favorable to the exiting business owner
• Locate potential buyers among a sea of investors
• Collect, maintain and enforce (if necessary) confidentiality agreements — you don’t “open house” the sale of a privately held business.
• Negotiate with potential buyers in a language that they understand, i.e., communicate the added value that your company affords the buyer from a return on investment perspective.
• Coordinate all of the service providers that are required to close on the deal.
Raising your awareness of the difficulties involved can mitigate many of the complexities of a business exit.
Residential home sales are commonplace, while sales of privately held businesses require experience and a very delicate touch. In a business sale, the owner will need specialized advice from their accountant, valuator, business attorney, tax attorney, estate planner, insurance agent, investment adviser and others. The role of an independent exit planner is to coordinate all of this isolated information together into a blueprint/plan and then have the specialized adviser implement and improve the final design. This puts the owner in control besides saving a lot of time and money.
Time is your best friend with an exit. The sooner you begin planning, the better positioned you will be for success in building value in your company, reducing taxes, replacing income, retirement planning, and not outliving your money.
Kevin Kennedy is the founder and CEO of Beacon Exit Planning LLC, a managing partner in Beacon Merger & Acquisitions Advisors LLC, a national speaker and author on exit planning and succession for private businesses. He provides plans and strategies to guide private owners with succession and exiting their businesses. For more information, visit www.beaconexitplanning.com or email KJKennedy@BeaconExitPlanning.com.
The information is not intended to be legal, accounting, insurance or tax advice.