Transferring the Business to Children or
How do you successfully transfer your business to a child, key employee or co-owner? We feel the most successful method is to follow a recipe, which mixes, in equal measure, three key ingredients:
It should be obvious that a business cannot be successfully transferred unless the new ownership is capable, nor can we expect the transfer to be successful if the business itself lacks the ability to provide an ongoing stream of income with which to pay for the business acquisition. What may not be so obvious, however, is the corrosive affect of income taxation upon the sale of a business to "insiders" -- children, key employees, or co-owners. Let's look at two key facts.
First, your children or key employees may not have cash to buy you out. Therefore, any sale will take many years to complete¡Xa potentially risky prospect. Further, all of the cash used to purchase your ownership must come from one source: the future cash flow of the business after you have left it.
Second, without planning, the cash flow can be taxed twice. It is this double tax, (usually totaling more than 50 percent) that spells disaster for most internal transfers. Through effective tax planning, however, much of this tax burden can be legally avoided. Witness what Karl Clark did.
Karl Clark agreed to sell his company to a key employee, Sharon Smith, for $1 million. This value was based on the company's annual $250,000 cash flow, which Karl historically took in the form of salary. While Karl understood that Sharon could not pay $1 million (nor could she secure financing) he did think that she could buy out the company over a five or six year period, using the available cash flow of the company.
Karl's calculations were way off the mark. The time needed for a buy out was at least 10 years. But why were his calculations so off base? In a word, taxes -- actually in two words, double taxation. Without proper planning, this is what happens if Sharon buys the company (and what can happen to you when you attempt to sell your business to your children or employees):
Without proper tax planning, you too will pay an effective tax rate in excess of 50 percent on the company's available cash flow used to fund your buyout. This is likely to prevent, as it did for Karl and Sharon, a consummation of the sale of the business.
How might you avoid disaster and design your sale to minimize taxes and to maximize the opportunity for success?
Tax planning for the sale of your company to an insider takes time, it takes planning, it takes expertise, but it can save a tremendous amount of money. Take time now to begin the planning process:
Subsequent issues of The Exit Planning Navigator® discuss all aspects of Exit Planning.