The Elephants in the Room: Three Issues Every Exit Plan Must Address

Shutterstock image of stacked elephants The Elephants in the Room: Three Issues Every Exit Plan Must Address

There are no guarantees in business except for one: you will eventually exit your business, voluntarily or involuntarily. As the average owner has over 70 percent of their wealth trapped inside their illiquid business, developing an exit plan for the owner and the business is critical.

Taxes

There are three parties in the sale of a business: the buyer, the seller and Uncle Sam. Each path has a different value, tax ramifications and compromises.

Most conventional plans do not have a focused strategy to reduce the most expensive pain: the tax burden. The value and tax liabilities vary greatly depending on the type of exit an owner pursues. The effective tax rate in the sale of a business could range from zero to more than 60 percent with corporate, personal, federal and state taxes. That could mean the government would get more than the owner in the transaction. Ouch!

Exit planning helps owners visualize the various taxes associated with each type of transfer and make sound financial decisions to reduce their financial risk.

Tax treatments that are common in exits include the following:

  • Tax deferral, capital gains treatment: 0–23.8 percent plus the state burden
  • Ordinary income tax treatment without payroll taxes: 0–37 percent plus the state
  • Ordinary income tax treatment with payroll taxes: 0–37 percent plus social security and Medicare taxes of 15.3 percent
  • Tax on pass-through corporate income: The tax rate for business income will be 29.6 percent versus the highest individual income tax rate of 37 percent.
  • Tax on C corporation income: 21 percent

The good news is there are tremendous tax savings strategies and tools, especially for internal sales to your family, managers and employees that can save the company, buyers and sellers money. And remember, the company cash flow pays for everything.

Succession

Succession plans replace the owner by moving the chosen performers into a championship team, then into leadership and a process to replace the CEO/owner. This requires time, training and stretching of the team members.

Successful succession is a critical aspect of an exit. If the owner cannot find a replacement, they will be stuck in their business without a buyer.

Both the company and the owner must be ready for a successful transition. It is critical that the management team and future CEO are ready to move into their new roles, so the present owner can, over time, relinquish the day-to-day management, leadership and strategic role in the business.

A flexible plan may take months to write and years to execute. Depending on the readiness of a company’s management and the type of exit and current payout, a succession plan may last from three to 10 years.

On the other hand, if the business is systematized and has strong financials with mature management in place and the owner can take a four-week vacation, then the company could be sale-ready in less than two years.

Which comes first, the exit or succession plan? Ideally, begin with an exit plan 15 years from your retirement date to implement strategies that give you a clear vision of your financial future outside the business. Once you have financial clarity for your own retirement, you can then focus on succession, becoming less of a manager and more of a coach/mentor.

What do I do next?

This can be an unexpectedly hard question. Exiting a business will have an emotional effect on a business owner, especially an owner who has been associated with their business for 20, 30 or even 40 or more years. A business is not just what we do; it becomes who we are. Owners have deep ties to their teammates, families, customers, suppliers and the community.

The owner must begin letting go emotionally and managerially during the exit and succession process. Spending less time in the office will allow the team to stretch and grow and allow the owner to travel and develop or continue other interests that will occupy their time in retirement.

Each exit is different and based on the owner’s short and long-term goals. Some owners want to stay attached with the business as a consultant or the chairman of the board, while others prefer separation. The key is to have a strategy to meet your desired outcome.

Going into the exit process with the awareness of the three elephants will help you face the challenge you are about to encounter. First, you need clarity of your financial future with an exit plan, then you are liberated to move into the succession and planning your retirement.

Start early, as time is your best friend.

About the Author

Kevin Kennedy

Freelance Writer

Kevin Kennedy is the founder and CEO of Beacon Exit Planning, LLC ("America's Exit Planner"), and a managing partner in Beacon Merger & Acquisitions Advisors, LLC. He is a nationally recognized speaker, author and a thought leader on exit planning...

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