Building Exit Readiness: Are Your Truly Prepared to Sell?

As business owners look toward retirement, we often hear them say something like this: “This business is my retirement.” Without a doubt, most small business owners have invested not only their money, but also their blood, sweat, and tears into building a successful company, and even though they know, deep down, that it’s time to step back from day-to-day management, it can be tough to think about walking away from something they’ve built.

But for many business owners, the emotional challenges aren’t the only problem. Because they are counting on converting the value of their business into the funding source for a secure retirement, they face a number of financial questions, as well. Further, it’s often the case that simply selling a business to the highest bidder can have unexpected and unpleasant consequences, both for the seller and for the business itself. As we’ve written previously, business owners need to leverage the value of what they’ve built to provide for future financial security, but depending on the particular needs of the owner and the business, that process can take several different forms.

Selling Your Business: Setting Goals

As small business owners look toward retiring and dialing back or terminating their involvement with the business, they may have several different goals in mind. Especially if the company is a family-run enterprise, they may be thinking of transitioning leadership and/or ownership over to a younger family member. Some may be intending to hand the reins to a trusted employee. Others may be shopping for a qualified buyer who can keep the business running, while still others may intend to simply liquidate the business and use the proceeds to fund their retirement and other desirable financial goals. Each of these outcomes has different requirements and different implications, both for the seller and for the business and its stakeholders.

In addition, the owner may have a variety of needs to be met by the sale of the enterprise. These may include the need to enhance the value of the business once the owner steps back from day-to-day involvement, minimizing tax liabilities resulting from the sale, or diversifying personal wealth away from the business. (This last deserves special consideration, since 70–90% of small business owners have the majority of their personal net worth tied up in their companies.) Good exit planning takes all of these factors into consideration.

How do I know if my business is ready to sell?

No matter whether you plan to sell to a third party or manage an internal transaction, there are some steps you need to take at least five years (and maybe longer) in advance of the planned sale date to ensure that your business is ready for sale.

1. Up-to-date valuation.

No matter who you plan to hand the keys to, the new owner or manager will want to know exactly what the business is worth. Depending on the buyer, you may need to hire an independent appraisal (an internal buyer who is already familiar with the business may not require this).

2. Transparent financials.

You will want to be able to document stable (and preferably growing) revenue, and most buyers will focus on earnings before interest, taxes, depreciation, and amortization (EBITDA). Your books should clearly separate the business’s assets, liabilities, expenses, and cash flow from your personal financials, and most buyers will want to see several years’ worth of consistently profitable operations.

3. Leadership delegation.

Certainly, many small businesses are deeply integrated with the personality, reputation, and connections of the founder. But if you want to sell the business as a going concern, prospective buyers (especially external parties) will want to see that the business can run efficiently without you. And if an internal succession is planned, you need a long “runway” to prepare the future leader for a seamless transition of responsibility.

Asset sale or stock sale?

You will also want to think about the form the sale of your business should take. There are two main forms the transaction can take, and they are central to the tax planning on the sale of a business.

1. Asset sale.

In this scenario, the buyer purchases specific assets and liabilities, and the legal entity and any unspecified risks remain with the seller. Some buyers prefer this, because they can avoid taking on hidden environmental or legal risks and also receive a stepped-up basis for the assets. Future depreciation or amortization can then allow them to save on taxes over time. On the other hand, this option may be less desirable for the seller, especially if the business is organized as a C corporation (which can result in double taxation, as the business pays taxes on the gains from the sale, and the owner pays again when the proceeds are distributed; proceeds from certain assets like inventory and accounts receivable are generally taxed at a less favorable ordinary income rate).

2. Stock sale.

A stock sale transaction transfers ownership of the entire entity, including all assets and liabilities. While a stock sale is often the simplest route, buyers may not prefer this option, since it makes them liable for all obligations of the business, including any undisclosed liabilities that may later come to light. However, sellers may benefit from a stock sale by the ability to pay taxes at capital gains rates, which are generally lower than the marginal rate on ordinary income.

How do I plan for life after selling my business?

Finally, let’s talk about the emotional side of selling a business. Here, too, much depends on the specifics of the situation and the nature of the owner’s current and desired involvement. Some owners are ready to sign the papers, cash the check, and embark on a lower-stress retirement lifestyle. Others (and this may be especially true for those who are transitioning the business to a younger family member or trusted employee) may wish to stay involved on a part-time or consulting basis to support the new owner’s changeover to full responsibility. Whether your aims are one of these or something in between, it’s important, as a part of the selling process, to set goals and timelines for your own conversion from full-time business operator to “former owner” status.

You need to think about what is most important to you: your goals, core values, and priorities. How will this new phase of life support those? Are there important objectives you’ve been putting off until you have “more time”? If so, how do those aims rank on your list of priorities for your “second act”? The most critical thing here is to ensure that you are able to separate your identity and self-worth from the business. After all, it defined much of your life for many years; make sure you know what you plan to put in its place.

In all of this, your Aspen advisor can be a valuable support and guide. We work closely with clients who are selling their businesses to help them design the financial structures and do the emotional preparation needed for a successful transaction and transition. If you are considering the sale of your business, we can walk with you through the process; just let us know when you’re ready to talk.