The Time To Start Planning Is Now
Those are the words of wisdom from John Edson, CPA, CMA, CVA, of Blanski Peter Kronlage & Zoch, PA, Golden Valley, MN. Edson is an accountant who spends a lot of his time in the construction industry, providing such businesses with accounting, auditing, tax, and business valuation services.
Edson spoke at one of the breakout sessions that took place at the recent Contractors 2000 Super Meeting XXI. Even though the topic was a bit morose, he held the attention of all the contractors in the room as he presented his seminar, “Building Value in Your Business: Strategies for the Owner of a Closely Held Business.”
WAYS TO LEAVEYou may think your business is valuable, but what is it worth to someone who might consider buying it? Edson recalls a client who, with his brother, owned a large and profitable construction firm in Colorado. But when the two brothers decided they wanted to get out of the business, they found that no one else wanted to buy it. They ended up liquidating all their assets for pennies on the dollar at auction.
No one wanted to buy them out because without the two brothers, the business had no value. The two brothers never trained anyone else in the company on how to run the business; the two brothers were necessary to keep the business going, and they didn’t want to stay.
This is a prime example of why contractors, in particular, should plan their exit. This gives them an opportunity to build value into their businesses.
“At some point, every owner leaves his or her business, voluntarily or otherwise,” says Edson. “At that time, every owner wants to receive the maximum amount of money in order to accomplish personal, financial, and estate-planning goals.”
Edson notes that there are four basic ways to leave your business:
1. The most preferable way for most contractors is to transfer ownership to their children. Provided you get along with your children, it’s a good way for you to remain active in the business and train them properly. You are also in control of your departure date. And, this scenario also allows the transfer of wealth to the next generation, minimizing taxes.
The taxes are minimized, because it may be possible to “gift” the business to your children in order to avoid estate tax.
Edson stresses that it may be most beneficial to be set up as an “S” corporation rather than a “C” corporation. As a “C” corporation, profits on the business will be taxed twice when sold. That’s not the case with an “S” corporation.
Note: If you’re currently a “C” corporation and change to an “S” corporation, you must wait 10 years before taking advantage of the reduced taxes as an “S” corporation.
2. Another way to leave your business is to sell it to other owners or employees. There will still be taxes to be paid in this scenario, but they can be minimized. You, the owner, benefit because you can structure the deal ahead of time to suit your needs and objectives. You can also maintain control during the buyout and prequalify buyers through on-the-job training.
3. You can sell your business to a third party. This is advantageous because you get the cash, and you can then treat all your children equally in the estate settlement. Unfortunately, you may get zapped with taxes.
If you’re considering this route, you will need to provide the buyer with estimates of future earnings — buyers aren’t necessarily as concerned with historical data. In addition, buyers will be looking for the unique items that make your business valuable, including employees, customer base/market share, name recognition, company earnings, assets, structure, maintenance agreements, etc.
4. The final way to leave your business is through liquidation. “This is the least-desirable method,” says Edson. “And it’s not as simple as it seems, because you still have to organize the auction.” The primary reason for liquidation is that a business lacks sufficient income-producing capacity to interest a buyer.
HOW TO LEAVETo plan your exit, Edson suggests the following seven steps.
1. Set exit objectives. Who do you want to transfer the business to? How much longer do you want to work in the business? What is the annual after-tax income that you want to collect during retirement?
2. Determine the value/price of your company. Basically, what do you think your business is worth? It’s much more complicated than simply taking your assets and
subtracting liabilities. You need to consider future earnings, rates of return, risk premiums, etc. (Consultants can help you with this process, Edson notes.)
3. Increase your business value. What are your company’s strengths and weaknesses? Set out on a path to increase value by creating a succession plan, thoroughly develop internal systems, diversify the customer base (focus business), modernize your facility, and create a seven-year exit plan.
4. Convert your business value to cash. This is done by cleaning up your company’s books, performing an audit, and analyzing performance. Only then is it worthwhile to start identifying potential buyers. (Again, a consultant can help determine the cash value of a business.)
5. Transfer the business. The four ways to transfer were explained earlier.
6. Create contingency planning for the business. Come up with an alternate route in case you’re disabled or die prematurely.
7. Perform estate planning. This includes all the planning you must do to minimize tax burdens on your estate.
The bottom line, says Edson, is that you should build as much value as possible into your business, as soon as possible. “You need to build value in order to withstand changes that are out of your control.”
Publication date: 04/15/2002