We just closed on our home in Elmira this August after 18 years of ownership as Cyndee, my wife of 42 years, and I consolidate our summer life in Rhode Island and winter in Florida as we move deeper into retirement.
It was an emotional move leaving the many memories and our friends of 46 years. The decision came down to being close to our daughters and the entire family wanting to be near the ocean for vacations, holidays and an endless summer-beach lifestyle.
Before I go into the five issues of this article, let me share something about selling the house that would help owners selling their business.
Always Be ‘Show Ready’
During the process, there were elements of house selling that could help owners selling their roofing business. My wife always cleans the house and puts everything away before we leave home for a period of time saying, “Kevin, I always want to come home to a clean house.”
Our New York home was neither on the market nor did we have an agent. That didn’t happen until we got the call in Florida that a physician was moving into the area, saw our house and asked if it was for sale. We agreed to an agent’s one time showing, gave a price and had an agreement in less than two weeks.
The same can be said of a business. If you intend to sell, especially to a consolidator or competitor, have your books in shape and work on your first impression… by getting rid of any distractions. The first impression is critical.
My best advice to an owner who wants to sell to a competitor or consolidator is to find a professional mergers and acquisition adviser. One who understands the roofing industry. Then prepare the company for sale. This brings in multiple bidders in a competitive environment to drive the highest market price.
What most owners do not realize is that 70 percent of their wealth is trapped inside their private illiquid business and that fewer than 30 percent of private businesses will ever transfer or sell. As you will learn, selling a business is very different from selling a house.
Most business owners believe that exiting their business is a process that they can handle themselves, or ‘deal with’ when the time comes. They understand how to run a business but have never exited a business. This is a complicated process that requires specialized advice and a guide to coordinate all the moving parts that is much more complicated than selling a house.
Here are the five biggest differences between selling a business and selling a home – or, for that matter, how selling a business differs from the sale of virtually any other asset you’ll sell in your lifetime.
#1 – Valuation
Businesses have multiple values know as a ‘range of value’ and homes are based on the comparable sales of neighboring homes that resemble the house on the market. More importantly, the value of a home is not dependent upon who’s buying. In the world of residential real estate, all buyers are [essentially] equal; as they’re either qualified for financing or not.
In the world of business sales, the type of buyer that you are talking to is critically important. Different buyers bring different “valuations” to the business sale – some will pay more than others, and some will have to pay you out over time.
This is not the case with a home. But, in the sale of a business, value and the stream of payments varies from buyer to buyer. For example, a competitor will pay more for your business than an employee who needs to pay you from the operating cash flow.
In other words, the value of the business depends on to whom it is sold, i.e. an outside buyer, investor, employees, management or family.
#2 – Deal Structuring
When a homeowner sells they get paid the negotiated selling price at the ‘closing.’ In business exits, the amount of money received at closing often represents only a portion of the total proceeds that are part of a larger negotiated selling price. There is a general rule that smaller deals – less than $3 million - are subject to more structured payments, while larger deals get more cash at closing.
Deal structures could include deferred payments, contingent payments, non-compete payments, consulting agreements, escrow payments, and continued lease and property rental payments.
Complicating deal structuring even further is the fact that each of these payments are subject to different tax rates. Also, as a general rule, buyers prefer to purchase company assets, while sellers prefer to sell stock. Again, this varies significantly from the sale of a home.
#3 – Taxes
When you sell a home, there is generally one tax rate. When you exit a business, there are an endless number of potential tax outcomes for the transaction ranging from zero percent to more than 55 percent. The most easily-recognized tax rate is the rate applicable to the sale of stock - the capital gains tax rate. This rate applies to the gain - the amount of value exceeding the cost basis of the stock – that is realized in the sale of shares of the company.
Payments to an exiting business owner can be characterized as goodwill, personal goodwill, income. They also can fall into an Internal Revenue Code section deferring the taxation until a future date, such as IRC sec.1042 for (certain) sales of shares of a C Corporation to an Employee Stock Ownership Plan – ESOP.
A home sale does not afford the buyer and the seller options for reaching such characterizations, or tax deferments.
#4 – Transaction Types
The sale of a residential home includes all of the property and the structure(s) that are on that property.
Therefore, residential home sales are an ‘all or nothing’ deal.
Business exit strategies are limited only to one’s awareness and imagination. You can sell a portion or all of your company stock (or assets) as part of an exit. Many business owners do not know this. Once this concept is grasped, an owner’s primary motives for the exit may be more easily achieved.
In other words, different types of transactions are available to allow flexibility to the process of business owner exit strategies.
#5 – Service Providers
The sale of a residential home generally includes the services of a real estate broker. Their responsibility is to know local markets and attract buyers.
Alternatively, exiting a business includes the services of a professional who can: draft documents reflecting the agreement for the transfer of shares (or assets) of the privately-held company (an attorney); document any arrangements for future payments and security taken in lieu of payment at closing (again, an attorney); assess the taxes that must be paid as a result of the transaction (normally done in advance of a closing by an accountant); and understand the unique nature of your privately-held business (transactional intermediary).
A transactional intermediary should have experience:
- Presenting the business in a light most favorable to the exiting business owner.
- Locate potential buyers amongst a sea of investors.
- Collect, maintain, and enforce (if necessary) confidentiality agreements. You don’t ‘open house’ the sale of a privately-held business.
- Negotiate with potential buyers in a language that they understand, i.e. communicate the added value that your company affords the buyer in ROI.
- Coordinate all of the service providers required to close the deal.
In short, residential home sales are commonplace, whereas sales of privately held business require experience and a very delicate touch. It should be obvious that exiting a business is different than selling a home. Raising your awareness of the difficulties involved can mitigate many of the complexities of a business exit.
Time is your best friend with an exit. The sooner you begin planning positions the owner for success by dealing with building value in their company — reducing taxes, replacing income, tax efficiencies, and retirement planning so you don’t outlive your hard earned money.