Wednesday, April 13, 2011

Transferring a Business to Children or Employees

How do you successfully transfer your business to a child, key employee or co-owner? The most successful method is to follow a recipe that mixes, in equal measure, three key ingredients:

• One part: the ability, experience and dedication of the prospective new owners;
• One part: a company with strong, consistent cash flow and little debt; and
• One part: a transaction designed to prevent income taxes from eroding the cash flow available to you, the seller.

It should be obvious that a business cannot be successfully transferred unless the new ownership is capable. Furthermore, we cannot expect the transfer to be successful if the business itself lacks the ability to provide an ongoing stream of income with which to pay for the business acquisition. What may not be so obvious; however, is the corrosive effect of income taxation upon the transfer of a business to "insiders" — children, key employees or co-owners. Let's look at two key facts associated with transferring business to an insider.

First, your children or key employees may not have cash to buy you out. Therefore, any sale may take many years to complete — a potentially risky prospect. Further, all of the cash used to purchase your ownership may come from one source: the future cash flow of the business after you have
left it.

Second, without planning, the cash flow can be taxed twice. It is this double tax, (sometimes totaling more than 50 percent) that can spell disaster for many internal transfers. Through effective tax planning, however, much of this tax burden can be legally avoided.

How might you design your sale to lower taxes and maximize the opportunity for success?

1. You should have a plan that yields you a greater after-tax amount for the sale of your company. Since the cash flow of the company may increase, the key is to provide Uncle Sam a smaller slice of the available cash flow.
2. Use an experienced advisory team who understands the importance of tax sensitivity to both seller and buyer in order to make more money available to you.
3. In addition, you and your advisors should use a modest, but defensible valuation for the company. Because a lower value is used for the purchase price, the size of the tax bite is correspondingly reduced. The difference between what you will receive from the sale of your business, at a lower price, and what you want to be paid to you after you leave the business is "made good" through a number of different techniques to extract cash from the company after you leave it.

Thought for the Week

"A corporation's primary goal is to make money.  Government's

primary role is to take a big chunk of that money and give it to others."

~ Larry Ellison