Buying or Selling a Business?
Factors in Setting a Price Business mergers, takeovers, and buyouts are still occurring at a phenomenal rate in the US. Savvy business owners are reaping top dollar as payment for their sweat equity in their companies. If you were to place your business on the market would you readily know its worth? Surprisingly, very few business owners do.
What’s it Worth to You?
Malcolm Forbes once said, “People overvalue what they are not and undervalue what they are.” The same can be said of determining the value of a business. Setting the price (and getting a good one) is often the most important aspect of the transaction. Some business owners base their companies’ worth on their years of “sweat equity.” However, that doesn’t have anything to do with market value. To learn the true value of your business, you need a more scientific approach, starting with a valuation method. The most common methods are:
1. Comparables—Value is determined by the ratio of sales price/earnings of recently sold companies (similar in nature to your own) multiplied either by your earnings, or by your revenues.
2. Discounted cash flow— Value is determined by your company’s projected cash flows discounted back to the present at a rate that incorporates risk. Other factors come into play as well, such as company size, industry, customer base, growth potential, competitive positioning, product mix, technological capabilities, and management talent. It’s also important to realize that a company’s value is different to different buyers. Some buyers identify synergies and are willing to pay a premium; others try to prey upon naïve sellers who don’t know their own company’s value.
So, how do you become more knowledgeable about your company’s worth? Retain the services of a professional valuator—someone who understands the buyers in your market, who is objective and has years of appraisal experience.
Taxes Play a Big Part
In all the excitement of buying or selling a business, it may be hard to concentrate on taxes, but they affect the real price of the business. And, being unprepared can cause a serious blow to your economic expectations. The question is: Do you know the real price of your business? Components that make up the real price include:
• The type and quality of the consideration.
• The timing of the payments.
• The tax effect of the transaction. These components overlap, with the type and quality of the consideration and the timing of payments having a huge impact on the overall tax effect of the transaction. To determine the real price of your business, you will need to compare the tax effect of various reporting alternatives and a range of prices. Intangible assets, such as goodwill and intellectual property rights, both inside the business and outside the business (if any), will need to be identified. You should also consider other interrelated agreements, such as employment, consulting, or noncompete. Don’t start negotiating until you know what you really have and what your possible options are.
Taxable or Not?
The majority of businesses are sold in taxable transactions. Nontaxable transactions include mergers and situations where the seller takes as consideration buyer stock or qualifying property in an exchange. Although the general tax-planning rule is to avoid or postpone tax, there are some advantages of a taxable sale: • When the seller gets cash, concerns about the quality of buyer stock or the limitations inherent in selling buyer stock are nonexistent.
- The buyer doesn’t have to contend with the seller as a shareholder and the buyer can get a steppedup basis in the assets.
- The parties also don’t have to worry about the technical requirements of a tax-free or taxdeferred transaction. A taxable sale can be structured as either an asset sale or a stock sale. In general, the seller wants a stock sale and the buyer wants an asset sale. See the chart on page four for a comparison of these two alternatives.
Timing of Payments
Sales are often structured as installment sales (where the payments are extended over a number of years) because the buyer doesn’t have enough cash on hand. Installment sales are also useful since many small businesses are sold with an “earn-out” provision, where the buyer pays a contingent amount over a number of years, based on the business’ performance. Use of the installment method for tax purposes is advantageous for the buyer as it helps match the recognition of gain to when cash is actually received.
If you sold a business in an installment sale but were unable to treat it as such for income tax purposes, you need to amend your prior tax return to use the installment method. However, many business owners that sold businesses during Buying or Selling a Business? Factors in Setting a Price (continued from page two) the repeal period probably weren’t able to structure their sales as installment sales. As a result, they may have had to sell their businesses at much lower prices. While they may be able to go back and restructure their sale agreements, most will probably never recover their losses.
If you’re considering the big move, call your tax professional. Someone specializing in business valuations can help you determine the true value of your business, and work with your attorney and tax advisor in reviewing the sale documents for accounting and tax purposes.
Recruiting: Staying One Step Ahead of the Competition
Whether you have a small, family-owned business or a large corporation, attracting and retaining the right employees is becoming more and more challenging. Today, it is quite common for several businesses to compete for the services of skilled and talented individuals in the same manner they would compete for a customer’s business. So, how can your business set itself apart from the others and attract key individuals?
In addition to salary, most potential employees have a certain level of expectation concerning benefits. When evaluating each prospective employer, they probably will first look at what core benefits each employer has to offer. The following benefits may be among their primary considerations:
Qualified Retirement Plan.
The number of employer-sponsored retirement plans has increased dramatically over the years. With a general shift away from defined benefit plans toward defined contribution plans, the 401(k) plan has gained popularity. Today, prospective employees often expect, at a minimum, that a plan will be available to them. Plans, such as the 401(k), can be made more attractive with employermatching contributions.
The amount of vacation time available is always an important consideration for prospective employees when looking at an overall benefits package. In fact, many individuals place great value on the amount of free time available to them, even if they fail to use it all on an annual basis.
With escalating health care costs, health insurance is one of the more desired employee benefits. Although group health insurance is a fairly common benefit, there are particular details and costs associated with each respective plan that may sway a prospective employee.
Changes in demographics within the workplace have resulted in the employee’s need for greater flexibility. Dual-income families, single parents, and a host of technological changes will certainly continue to alter the face of business today and in the years to come. Therefore, it is important for businesses to recognize this trend and make slight modifications to policies and procedures when necessary.
The work atmosphere of a potential place of employment may also be a key factor in an individual’s decision- making process. Prospective employees often consider such factors as stress level, the communication channels between employees, and the delineation of duties.
For executive-level employees, there are a variety of additional benefits that can set one employer apart from another. However, in many cases, Internal Revenue Service (IRS) anti-discrimination rules may require providing these benefits to all existing employees. Fortunately, there are some benefits that allow employers to be more selective.
Executive Bonus Plan
This benefit allows the employer to pay a selected employee a compensation bonus that is used by the employee to pay the premium on a life insurance policy. The employee owns the policy and the bonus amount can be a deductible business expense for the employer.
A growing concern for many individuals is how to maintain their financial and personal well-being in the event of a debilitating accident or illness. Since group disability plans may offer only minimal amounts of coverage, individual disability insurance paid by the employer is becoming a much soughtafter benefit by prospective employees.
Voluntary Benefit Plan
Such a plan offers a menu of benefit options (e.g., dental insurance, disability insurance, etc.,) to employees in addition to existing core benefits. Employees then pay (usually through payroll deductions) for whichever benefits meet their respective needs. Because voluntary benefit plans are offered in a group setting, costs are generally more affordable than if the employee were to purchase similar benefits individually. These plans can also be set up on a pre-tax basis, resulting in tax savings for employer and employee.
Business owners are quickly realizing that a competitive salary alone is no longer the only factor that today’s highly skilled employees seek. Just as you shop for the “right” employees, they shop for the “right” employer. They look for the best combination of salary and benefits—the one most appropriate for their situation. Therefore, employers need to offer a creative benefits package that sets them apart from the competition.
Asset vs. Stock Sale
- Potential double taxation resulting in less net, after-tax proceeds.
- Potential ordinary income, recapture, or higher tax rates on some assets.
- Business can generally sell without minority shareholder consent.
- Can avoid (not acquire) unwanted assets and liabilities.
- Assets have basis equal to fair market value paid.
• One level of taxation.
• Capital gain treatment.
• Minority shareholders may not want
• Takes over all assets and liabilities of
corporation at purchase.
• Assumes exposure to potential
• May have minority shareholder issues.
• Assets have carryover basis (tax basis
Determining the Real Value of a Bonus
Did you know that the actual value of a bonus, in the form of a fringe benefit, is reduced when an employee is required to pay income taxes on the benefit? Because of this taxation factor, many companies pay the fringe benefit (the bonus), plus additional money to pay the income tax on the benefit. This is commonly referred to as a “double bonus.”
For example, a corporation purchases a cash value life insurance policy on the life of one of its key executives or owners. The insur- Determining the Real Value of a Bonus ance premium is $6,500, which the corporation will bonus to the employee. If the employee’s combined federal and state income tax rate is 41% (35% federal and 6% state), the tax on the $6,500 would be $2,665, leaving only $3,835 with which to pay the life insurance premium.
How much more will the corporation need to provide to allow the employee to pay both the life insurance premium and the tax on the premium? The amount can be calculated by dividing the $6,500 by 1 minus .41 (the employee’s tax rate), in this case dividing $6,500 by 0.59 for a total of $11,016.95. The company should bonus this amount to the employee, who would then be left with $6,500 after taxes to pay the insurance premium.
The information contained here is not written as or intended to be tax or legal advice. The information provided here may not be relied on for purposes of avoiding any federal tax penalties. You should seek tax or legal advice from an independent tax or legal advisor