The Two Exit Planning Killers: Time and Tax (Part 1)
By Gary Smith
In a prior blog on exit planning processes, strategies, and outcomes, one option was to “Give/Sell it to the people.” This is when you, the owner, decide you want to transfer the business to key employees as part of your exit plan.
Time and taxes are the two leading causes of death for this plan. In today’s blog, we will address the time issue, followed by a subsequent blog regarding tax implications.
Time Travel Only Works One Way
When you want to transition a business to key employees, family members, or both, it is ideal to have at least three to five years to implement the plan. There are two main reasons for that.
First, you’re going to make mistakes. The person you thought was the right person might not be the right person, or they may leave. As a result, you may need to change people and roles based on their skills and strengths. You may also need to change your business model.
Second, this process takes time and focus that many business owners don’t have much of in a short period. While you may only need to spend 48 hours on the project, it may take a year or more to find those 48 hours.
Remember, every day you spend in your business puts you another day closer to your exit. Also, your exit has already been planned. State and federal law will decide what happens to your business if you don’t do anything. The fate of your family, your employees, and your business is in your hands.
Big Thought of the Blog
Don’t limit yourself by thinking the only available options are those plans that you have heard about. The financial benefits of ownership, management of the business, and ultimate control of who manages the company are different and should be treated differently. What plan you implement should be the result of what you want to do, and you shouldn’t try to fit what you want into a certain box based on the rules of that box.
Where You Start
Before we get to the tax killer, and to keep in line with our Big Thought, you’ll have to answer some questions about your exit that will drive your time and taxes.
- Should a key employee pay for the employee’s initial ownership?
- Does it matter if the employee must pay income tax if you discount the price on (or give) ownership? Do you want to help the employee with paying that tax?
- If you could be paid full, fair market value for your ownership and walk away tomorrow, would you? (Seriously, would you leave your business and employees in someone else’s hands tomorrow?) If not, how long do you want to be able to stay involved in the company at a minimum? (How long will any successful transition take?)
- If the business’ cash flow is the source of all payments for your ownership, how would you structure payments? For example, if you start with $0 of compensation for you and the future owners of your business, how should cash be divided? Should everyone get base compensation of $x with all cash above that amount funding your exit? Should the key employee get some payment as an owner or some incentive payments before the cash goes to fund your exit?
- Should you agree that you won’t terminate the key employee’s employment without cause to provide the employee some job security?
- Should the employee have the option to force you out by paying you the total amount you are owed for your exit at some point?
- Do you want to set a “purchase price” for your ownership at the beginning of the plan, or should the business’ future value impact what you get paid (increase or decrease)?
Engaging an attorney to walk you through these questions and avoid these and other exit plan killers is a wise choice. Don’t leave your options to chance. Venn Law Group can help you understand the answers and advise you about your options. We can also help you make any needed changes. Contact us today to learn more.
Gary W. Smith is an attorney at Venn Law Group with more than 25 years of experience providing legal counsel and innovative solutions to business owners and management teams. His areas of focus include mergers and acquisitions, succession and exit planning, securities and capital structures, business structures, and tax. He excels at navigating the legal complexities of diverse industries ranging from professional services and IT infrastructure to manufacturing and real estate.
Gary W. Smith is an attorney at Venn Law Group with more than 25 years of experience providing legal counsel and innovative solutions to business owners and management teams. His areas of focus include mergers and acquisitions, succession and exit planning, securities and capital structures, business structures, and tax. He excels at navigating the legal complexities of diverse industries ranging from professional services and IT infrastructure to manufacturing and real estate.