Many baby boomer roofing contractors intuitively understand they need to plan for the exit but are consumed with the day-to-day grind and procrastinate.
At the same time, the owner knows that they’ll eventually exit their business, voluntarily or involuntarily. That’s why planning for the owner and the business is critical.
Some owners probably have some future planning done, like a buy-sell or their will, but it’s uncoordinated for the complicated exit. Simply put — they’re STUCK.
They’re not alone. According to the U.S. Small Business Administration, about 40 percent of American businesses face the transfer of ownership issue at any given time. The primary cause for failure is the lack of planning.
Facing this exit challenge is crucial since the average owner has over 70 percent of their wealth trapped inside their illiquid business. This short article will help what I call the “Three Elephants in the Room:” taxes, succession and what to do next?
There are three parties in the sale of a business: The buyer; the seller; and Uncle Sam.
Each exit path has a different value, tax ramifications and compromises. Most conventional plans do not have a focused strategy to reduce the most expensive pain — the tax burden.
The value and tax liabilities vary greatly depending on the type of exit an owner pursues. The effective tax rate in the sale of a business could range from 0 to over 60 percent — that includes corporate, personal federal and state taxes.
That could mean the government would get more than the owner in the transaction. Ouch!
Exit planning helps owners visualize the various taxes associated with each type of transfer and make sound financial decisions to reduce their financial risk.
Tax treatments exposure that are common in exits:
- Tax deferral.
- Capital gains treatment. From 0-23.8 percent plus the state burden.
- Ordinary income tax treatment without payroll taxes. From 0-37 percent, plus the state.
- Ordinary income tax treatment with payroll taxes. 0-37 percent plus social security and Medicare taxes of 15.3 percent.
- Tax on pass-through corporate income. The tax rate for business income will be 29.6 percent versus the highest individual income tax rate of 37 percent.
- Tax on C corporation income — roughly 21 percent.
The good news is there are tremendous tax savings strategies and tools especially for internal sales (the most common in construction) to your family, managers and employees that can save the company, buyers and sellers a lot of money. And remember, the company cash flow pays for everything.
Succession replaces the owner by moving the chosen performers into a championship team, then into leadership and a process to replace the CEO/owner. This requires time, training and stretching of the team members.
Successful succession is a critical aspect of an exit. If you cannot replace yourself, you’ll be stuck in your business without a buyer.
To succeed in this challenging succession process, both the company and the owner must be ready for a successful transition. It’s critical that the management team and future CEO are ready to move into their new roles, so the present owner can, over time, relinquish the day-to-day management, leadership and strategic role in the business.
A flexible plan may take several months to write and several years to execute. Depending on the readiness of a company’s management and the type of exit and current payout, a succession plan may last from three to 10 years.
On the other hand, if the business is systematized and has strong financials with mature management in place, and the owner can take a four-week vacation, then the company could be sale-ready in less than two years.
Which comes first, the exit or succession plan? Ideally begin with an exit plan 15 years from your retirement date to implement strategies giving you a clear vision of your financial future outside the business. Once you have financial clarity for your retirement you can then focus on succession, becoming less of a manager and more of a coach mentor.
What Do I Do Next?
This can be larger than you anticipate. Exiting a business will have an emotional effect on a business owner. An owner who has been associated with their business for 20, 30 or even 40 or more years will undoubtedly have an emotional response when preparing for their exit.
The business isn’t just what we do, but becomes who we are. Owners have deep ties to their teammates, families, suppliers and the community. These relationships are long and deep.
The owner must begin letting go emotionally and managerially during the exit and succession process. Spending less time in the office will allow the team to stretch and grow. This time away will allow the owner to travel and develop or continue other interests which will occupy their time in retirement.
Each exit is different and based on the owner’s short- and long-term goals. Some owners want to stay attached with the business as a consultant or the chairman of the board and other prefer separation. The key is to have a strategy to meet your desired outcome.
Going into the exit process with the awareness of the three elephants will help you face the challenge you are about to encounter. First you need clarity of your financial future with an exit plan, then you are liberated to move into the succession and planning your retirement.
Start early as time is your best friend.