Do your business owner clients have an exit strategy? Do they intend to sell the business to a relative, key employee(s) or an unrelated third party?
It’s well documented that an effective succession strategy is a challenge. Your clients’ objective may be to secure a market value sales price, continuation of the business’ success for the buyers and employees, perpetuity of the business’ culture and values, or some combination thereof.
Typically, the primary challenge that owners face is receiving fair market value for their closely held business. A prospective third-party buyer realizes the talents and relationships that represent the goodwill value are tied to the owner. Without an employment contract to retain the owner, the value is reduced and the seller may want to avoid an employment contract.
An alternative is to sell the business to a key employee or employees. This approach provides a readily identified buyer whose expertise and familiarity with the business enhance the business’ chance for ongoing success. The outgoing owner may have interest in that ongoing success financially and psychologically. The problem with a sale to key employees is that they rarely have capital for a down payment, much less purchase of a business.
Another challenge is tax risk. The seller will be subject to capital gains tax, and perhaps ordinary income tax, on sales proceeds. The buyer is purchasing the business with after-tax dollars and, therefore, is paying an increased cost.
Default risk presents yet another challenge. If the buyer is making installment payments, those sales proceeds may ultimately depend on the ongoing success of the business.
The shared tax & equity partnership (STEP) may be an attractive exit strategy for addressing the aforementioned challenges. STEP would provide the following advantages:
? a mechanism to share opportunity, equity, and responsibility with top key employees without sharing ownership in the core company;
? a current year income tax deduction to the company;
? tax-favorable sale proceeds to the selling owner when he/she is ready to exit;