Plan for Post Tax Proceeds

This won’t come as a surprise, but nearly every business owner who is approaching a sale is focused on realizing the highest possible price. What may come as a surprise though, is that few are focused on the right number. The question “how much can I get for the company?” should always be followed by “after taxes.”

There are a number of issues that are going to alter your post tax proceeds (which is why we always recommend embarking on an Exit Planning Process).  With an appraisal in hand, working with a qualified tax advisor is a great way to really drill down on how a transaction might look for you and affect your retirement.

So, what kind of tax are we talking about?

Sale Structure: Stock or Asset Sale?

Probably the biggest thing that jumps off the page when considering transaction related taxes is the structure of a sale- specifically a stock or asset sale.  In a stock sale you are selling the whole company: assets, liabilities, the whole enchilada.  Tax on an stock sale is (principally) paid at the capital gains rate (currently 20%) on the amount over basis. This is pretty favorable.

In an asset sale you aren’t actually selling the company, rather you are selling the “pieces” of the balance sheet “a la carte”.  You might sell all assets and all liabilities, but depending on your negotiations you might just be selling goodwill and fixed assets (thus retaining cash, AR, AP, liabilities, etc).  The tax implications on an asset sale are a bit more complicated.  Goodwill is taxed at capital gains (20%), but generally speaking the other assets are taxed at ordinary income (think about 40% all in).

So right off the bat it’s apparent that, generally speaking, a stock sale will result in higher post-tax proceeds than an asset sale. The catch? Getting a buyer to agree to a stock sale can be very difficult.

Installment Sale

Not all deals are structured “cash at close.”  In fact, studies show that the vast majority are not all cash deals. One such structure is an installment sale which spreads the purchase out over a number of periods (you guessed it – in installments). This structure has tax implications as sale proceeds are realized over a multitude of periods. So this is another situation in which your tax advisor can run some scenarios to help you understand post-tax proceeds.

Company Structure

This is a big one that you can’t really address in the short term. Are you a S-corp or LLC (i.e. a “pass thru entity”)? If so, go ahead and skip this section. C-corp? You might want to buckle in for a few years. You’re probably well aware that C-corps face an issue of double taxation. If you sell the corporation as a stock sale all is well – you’re in cap gains territory. But remember how we mentioned that most smaller deals aren’t stock sales? An asset deal for a C-corp is killer: since you are selling assets, the corporation pays taxes on proceeds as ordinary income, then YOU pay taxes on your income. Ouch.

Suggestions? Convert to a pass through. Note that this where my “couple of years” comment comes from. A C-corp conversion takes 5 years to “season.” You can still sell after the conversion, but you wind up paying taxes on “built in gains.”

Bottom line? If you are a C, you need to really rationalize why you need to be a C. If you don’t have a good reason then it’s probably time to start thinking conversion.

Takeaways

We just scratched the surface here. Tax planning is complex – yet “post tax proceeds” is the number you need to focus on. Get yourself into an exit planning process, understand valuation, and then get to work on the tax component. Don’t get caught off guard a few weeks from closing.