Selling Your Business Tax Implications And Business Valuation
Selling your business is a complex venture, and many business owners are not aware of the potential tax consequences.
If you’re thinking about selling your business, the first step is to consult a your trusted certified public accountant. You will need to make sure your financials in order, obtain an accurate business valuation to determine how much your business is worth and develop a tax planning strategy to minimize capital gains and other taxes to maximize your profits from the sale.
You can sell your business internally to someone inside the company: management, employees, or family members. In general, internal transfers provide a sale at a lower gross price but can produce a greater net sale price due to tax and fee minimization and have a chance of maintaining an existing company culture.
Many business owners have no idea what their business is worth. Some may underestimate whereas others overestimate. Sometimes significantly. Obtaining a third-party business valuation in Missouri allows business owners to set a price that is realistic for potential buyers while achieving maximum value.
A third-party sale to someone outside the company can be advantageous to business owners who want financial security from their exits. Third-party sales tend to have the highest ceiling for potential payment among all exit paths, especially if a strategic buyer is the purchaser.
The fundamental advantage of a third-party sale is that business owners receive the bulk of the purchase price at closing, rather than over the course of several years and a third-party sale’s deal structure is usually more straightforward than other transfer methods, provided business owners and their financial advisors commit to proper pre-sale planning.
But a business owner needs to remember that in a sale to a third party, owners lose control of their companies at closing. The culture of their business is likely to change and if they do not receive the entire purchase price in cash at closing, they significantly increase their risk of receiving the balance in the form of earn-outs or a secured promissory note that they hold for the balance of the purchase price. This means that the price they get is subject to future company performance after the sale.
The importance of preparing your business financials before listing your business for sale cannot be overstated. Potential buyers will scrutinize every aspect of your business. Not being able to quickly produce financial statements, balance sheets, profit and loss statements, tax returns, equipment lists, product inventories, and property appraisals and lease agreements may lead to loss of the sale.
Tax Consequences of Selling
As a business owner you probably think of your business as a single entity that will be sold as a lump sum. The IRS however, views a business as a collection of assets. Profit from the sale of these assets may be subject to short and long-term capital gains tax, depreciation recapture of real property, and federal and state income taxes.
For IRS purposes, each asset sold must be classified as capital assets, depreciable property used in the business, real property used in the business, goodwill, or property held for sale to customers, such as inventory or stock in trade. Assets are considered tangible (real estate, machinery, and inventory) or intangible (goodwill or trade name). The gain (or loss) on each asset sold is figured separately.
Third-party sales can create severe tax consequences for the unprepared business owner. For example, many owners start their companies as C corporations and never convert them to S corporations. In these cases, owners of C corporations who sell their ownership shares can be taxed twice on the final sale price (one tax at the corporate level and a second tax at the personal level). The combined tax rate can exceed 50%.
If you are thinking about possibly selling your business, you need to start considering these implications long before you put your business on the market. Please contact our business valuation professionals in our office for further guidance.
