7 Landmines to Avoid in Your Roofing Business Exit, Part One
Editor’s Note: This is part one of a two-part series that will continue in the April 2020 edition of Roofing Contractor.
Exiting your business can be a very emotional, intimidating and taxing proposition. This complex process requires input from your accountant, tax adviser, attorney, business appraiser, estate planner, financial adviser and insurance adviser, among others. Coordinating and understanding the disjointed advice can be overwhelming.
Our job as exit planners is to design a customized blueprint for your exit, while coordinating all the moving parts associated with transferring the business.
Certified Exit Planners are specialists in this process. Their role is analogous to that of an architect. Picture the duties of an architect — they understand and design every part of a building but don’t necessarily have the capability to install a furnace. They design, specify and create a blueprint that coordinates the building process.
The exit planner works in a similar holistic fashion. They design the exit plan, creating a blueprint for the business owners and their advisors as a way to understand and coordinate the various disciplines in the exit process in order to meet the owner’s goals and reduce the tax impact.
The exit planner does not write the legal documents, recommend investments or prepare estate planning documents. They are designers and process consultants to provide a plan and clear vision of your financial future before you go the various advisers.
Business owners intuitively understand and manage their everyday risks in a measurable manner. But most owners have never exited a business and are unaware that the odds are against them. My experience as a business owner who bought and then sold a 200-employee business has helped me understand firsthand the complexities that come with selling and transferring a business. This two-part article will highlight several concerns to open your mind when it comes to a business exit.
Beacon Exit Planning has observed seven recurring problems in its experience advising owners from coast to coast. These are minefields that can derail owners from successfully achieving their inevitable exit.
1. Outliving Your Money
Guess what the number one fear is for affluent Americans? Surprisingly, it is not public speaking or even death, which used to be the biggest fear.
Now for those over 55 the greatest fear is running out of money in retirement, according to the results of Bank of America’s Merrill Edge® Report released in May 2014.
Most business owners are considered affluent. Their business pays them generously, supports their lifestyle, travel, autos and entertainment. Industry studies shows that their largest segment of wealth is trapped in their illiquid business, which amounts, in our experience, to more than 70%.
So the owner’s challenge is how to live independently from the business, cash out without being clobbered by taxes, retire and not outlive their money. Welcome to the world of exit planning.
2. Odds of Selling to a Consolidator or Competitor
According to the U.S. Chamber of Commerce, fewer than 20% of the companies brought to market actually sell. According to FMI Corporation, this figure is closer to 10% with construction companies.
I could write a white paper on increasing the odds of a successful external sale, so please take this simple advice if your goal is to sell to a competitor or consolidator:
• Do not wait until a buyer approaches you on a “one on one” negotiation. Once it is “sale ready,” plan to market your business to several competitive bids, which may increase your odds for achieving the highest price and financial independence from the business.
• Find an experienced and proven mergers and acquisition professional two years before selling and get the company “sale ready” in order to receive the highest possible price.
• Determine early what price you need and the after-tax net of the sale in order to maintain your post-exit lifestyle.
• Get a certified valuation adviser to determine the actual “synergy value” so you have a realistic understanding of your company’s justifiable value before going into the negotiation.
3. Odds of Selling to Management or Family
Fewer than 30% of family businesses will transfer to the second generation, and only 10% will transfer to the third generation, according to the Family Firm Institute.
Another way of saying this is that 70% of family businesses will fail to transfer to the second generation and 90% will fail to transfer to the third generation. So if you were the founder of your business, your grandchildren would have about a 3% chance of taking the company into the third generation.
Most contracting business sales are in the lower to mid-level markets ($5-60 million) will be an internal sale, transferring via an ESOP (Employee Stock Ownership Plan), an MBO (Management Buy Out) and through gifting. The good news is, if the internal sale is structured properly, the after-tax results can often exceed an external sale.
4. Taxes of Zero to 55% Plus
Each exit path has a different tax implication. Many factors come into play, such as entity structure, tax history and characteristics, and the deal structure itself. Simply put, if external sales (consolidator, competition) are not properly structured, they could take the biggest wallop and leave you with the fewest dollars. This is counterintuitive since many times, external sales will generate the highest sales price.
However, with a prospective tax yield of about 55% or greater, it could leave you with significantly less than you thought. Remember, it is not how much you get, but how much you keep, that is the bottom line.
The interesting thing is that an internal sale to employees, management or family can have a much smaller tax consequence than an external sale. Sadly, most deals are structured in a way that creates more of a tax burden for the seller and the buyer than required by the IRS.
The onerous approach I’m speaking about is the payroll method, where a payroll check is issued to the buyer, who pays taxes on the income. The buyer then pays the seller who again pays capital gains taxes on the amounts he or she received. You’ve effectively double taxed the proceeds of a sale. The results of this process can be alarming. It’s even more burdensome if you are a C-Corporation with another extra layer of taxation.
Now don’t get me wrong, the multiple that an outside buyer is willing to pay you is so great that it could far outweigh the net proceeds that an internal sale could provide. Generally, we find the multiple for these sales between two and four. Here again, an exit planner is able to illustrate the various scenarios to provide you with a glimpse of what you can expect during the actual transaction.