Before selling your small business, consider these estate planning tips for business owners.
The sale of a business can be a rewarding yet complex financial event. For many owners, it represents a significant transition—out of your business and into retirement. And for those who haven’t saved for retirement elsewhere, the sale of your business can be critical to securing a healthy retirement. The stakes couldn’t be higher.
That’s why it’s crucial as a business owner to identify opportunities and minimize risks when selling your small business. In this article, we’re sharing five estate planning tips for business owners to consider before exiting your small business.
Like estate planning, succession planning outlines what would happen if you were gone. Indeed, a succession plan can be critical to the continued success of your small business. Yet most small business owners don’t have one. Unfortunately, this can leave you unprepared for your upcoming transition.
And while estate planning and succession planning have many similarities, they are also distinctly different.
For example, instead of deciding where your property would go, your succession plan centers on business continuity. In other words—“Succession planning is the strategy and process of transitioning key leadership roles in an organization to an employee or vetted outsider.”
And when it comes to our estate planning tips for business owners, a solid succession plan can be essential for several reasons. For example:
It shows potential buyers that your business can continue without you.
First, having a succession plan for your business should inspire confidence in potential buyers. It shows that while you may be important to the success of your business, it can continue without you. This offers buyers the peace of mind that they can successfully transition you out of the business and continue operating profitably.
It can facilitate the smooth transfer of ownership.
Second, by developing a succession plan, you can facilitate the smooth transfer of ownership.
Ultimately, a succession plan will highlight the key steps, people, and decisions that need to be made as you transition out and someone else transitions in. You can think of it as a blueprint or map to guide the new owner to continued success.
Next, proper tax planning is key when preparing to sell your small business. Simply put, selling your business means income, and income means taxes. But, depending on how you structure the sale, you could significantly reduce your tax liability.
The mechanics of tax planning can be complex. You may want to consider speaking with a financial planner like Oak Capital Advisors or a tax expert to discuss your situation in detail. In the meantime, here are some additional estate planning tips for business owners to consider:
First, different assets will be taxed at different rates.
While you will likely sell your small business as a single asset, from a tax perspective, it’s not so simple. Instead, your business is made up of many different assets. Each of those assets is treated as being sold separately to determine the individual gains and losses.
From inventory to goodwill, each aspect of your business can be taxed at a different rate. For example, when selling your business, the inventory gains or losses are taxed as ordinary income, with rates as high as 37%. But, the sale of capital assets results in a capital gain or loss, with long-term rates ranging from zero to 20%.
So, it’s essential to understand the different assets in your business and the tax rates you can expect.
Second, there’s some flexibility in how you assign the purchase price.
This is where the opportunity exists.
When selling your business, there’s flexibility in how you assign the purchase price. So, sellers have a strong incentive to allocate as much of the purchase price as possible to capital assets, creating favorable long-term capital gains treatment.
But unfortunately, this often runs counter to the interests of the buyer, who may prefer to assign more of the purchase price to other types of assets. So, when negotiating the sale of your business, it’s essential to understand where to push and where to offer concessions, all while minimizing your tax liability.
And, it’s important to note that the IRS has specific guidelines owners must follow when assigning the purchase price. Be sure to consult a tax professional to advise on your unique situation.
Third, installment sales can help spread out tax liabilities.
Lastly, consider the benefits of an installment sale when selling your business.
An installment sale spreads the payment across multiple years rather than receiving payment all at once. This offers sellers the benefit of avoiding a high-income year, often resulting in lower marginal tax rates over time. On the other hand, this may also expose sellers to the risk that the buyer defaults on the agreement.
Third on our list of estate planning tips for business owners is to consider setting up one or more trusts. Indeed, trusts can be a valuable estate planning tool for small business owners preparing to sell.
First, you can use a trust to protect proceeds after the sale of a small business. By establishing a trust, owners can transfer the proceeds from the sale and appoint beneficiaries of the trust. This can be a great way to ensure your loved ones are taken care of after you’re gone while also avoiding the costly probate process.
In addition, there are different business trusts to consider, from grantor trusts to simple or complex trusts—each with its unique benefits and use-cases.
A buy-sell agreement is a legally binding agreement that seeks to ensure business continuity in case of a change of ownership.
For example, a buy-sell agreement between partners could establish that if one partner were to pass away, the other would buy the remainder of the deceased partner’s interest. This could be critical to maintaining the business continuity while providing a lump sum to the deceased partner’s family.
When selling your business, a buy-sell agreement can also be critical because it forces you to establish the fair value of your ownership stake and outline an exit plan for partners—both of which can be helpful during the sale of your small business.
Lastly, one of the most important estate planning tips for business owners is to prepare for unexpected setbacks.
Selling your small business can take time, and during that time, it’s critical to manage your risks. And one of the most significant risks that small businesses face is the loss of key personnel, either from death or disability. And considering that nearly 50% of all individuals 35 or younger will fall victim to disability for 90 days or longer before age 65, the risks may be higher than you realize.
By adequately insuring key personnel like yourself, other owners, top executives, or managers, you can limit some of the downside risks in your business.
At a high level, by purchasing life insurance for key persons, your business would receive a lump-sum death benefit if a key person were to pass away. In addition, disability insurance would provide a stream of cash payments if a key person were to become disabled. This can provide your business with some extra capital during the event of a death or disability.
Ultimately, the sale of your small business may be one of the most significant financial transactions of your life. Therefore, it’s critical to understand the complexities of using estate planning strategies to limit your risk and capture potential upside.
Keep in mind that this is not a comprehensive list of estate planning tips for business owners. However, these strategies may help you when developing your exit plan. They may also prompt you to look into other strategies and best practices before selling your small business.
Remember, we’re here to help.
Oak Capital Advisors specializes in retirement planning for small business owners. If we can help you evaluate your retirement readiness and set you on a path to financial freedom, please start here. We’d love to hear from you.