Many business people who are exceedingly successful in their respective industries do not have a comprehensive understanding as to the value of their business, and especially how much money will be available for their retirement. Although many business owners might have a general idea of what the value of their business might be, they do not know the true business value or the net profit of the sale of their business, after all of the necessary calculations, deductions and assessments, including loan pre-payment penalties that can be significant.
When trying to estimate the value of their business, some business owners use values based on things like a percentage of dollars of sales, a specific multiple of EBIDTA (earnings before interest depreciation taxes and amortization), on net worth, or on recent sales of similar businesses. Regardless of the business owner’s approach, that number will not reflect the amount left after paying income taxes on the sale.
We recently had a client (we will call them “XYZ” store) with a successful retail business, having annual sales of approximately $14 million, come in to tell us that they were offered $10 million to sell their business. When we sat down with the client and computed the gain on the sale and the amount of money needed to pay off the liabilities, including the bank debt, the client was left with just under $1 million for the two partners who owned the business – that is hardly enough for both to retire on.
The tax bite is especially large today. Many business owners have taken significant deductions for bonus depreciation in the last few years. *Bonus depreciation allowed business owners who purchased new equipment, and other qualifying items, to deduct either 50% or 100% of the cost in the year of purchase. Although this benefit allowed the business owner to reduce current tax expenses, it has significantly increased the amount of taxes due on the business sale.
We advised XYZ to sell some of their recently-purchased stores. The newer stores were not performing as well as other stores which XYZ had owned for a long time and this had a significantly negative impact on cash flows. Since the equipment and improvements in these stores were used, they did not qualify for the bonus depreciation. As a result, there was a lesser gain on sale. In advising the client to dispose of these stores first, we helped XYZ eliminate the taxes due on the sale, yet retain the ability to pay off the bank debt and payables for these stores –– thus increasing the client’s cash flow.
We also had a client with a mini warehouse business for which they received a purchase offer based on an 8% cap rate, which seemed significant in today’s market. When we computed the tax bite, based on a 5% tax free return, they were left with a yield that would have produced less than 50% of the cash flow they were receiving today. Unless they were able to do a tax free exchange, we advised them not to sell based on the initial offer.
Today, there is a vast number of private equity firms looking to acquire profitable businesses. These firms have considerable expertise and access to substantial capital. In today’s constrained lending environment, business owners are not always able to get the financing they need to grow their business. As an exit strategy, some savvy business owners are bringing in a private equity partner to help them build their business. By considering this type of exit strategy, the business owner could sell an initial percentage of their business today, say 25%, and after a few years of successful growth, be able to sell the remainder of the business for two or three times its present worth. In this case, choosing the right private equity partner becomes essential to your success. (Read “Identifying the Right Private Equity Partner for Your Business” featured in NJBIZ on June 1, 2015 and reprinted at http:// www.citrincooperman.com/News-Events/Insights/Articles/Identifying-the- Right-Private-Equity-Partner-for-Y/225_CCCornerNJBIZJuly2015.aspx
However you consider the value of your business and how you plan to sell it, before you enter retirement, get the value of your business and how you plan to sell it, before you enter retirement, get the right answers and find a knowledgeable professional to guide you through the process. right answers and find a knowledgeable professional to guide you through the process.