The transfer of a business doesn’t have to be complicated for closely held businesses. Nor does it have to be so expensive.
Privately owned businesses employ just over half of US workers. Of 113.4 million non-farm private sector workers, small firms with fewer than 500 workers employed 55 million and firms with fewer than 20 employees employed 20.2 million. Closely held businesses are substantial contributors to the Nation’s economic health and such, successful "passing of the torch" from one generation to the next really matters. It is estimated that about 40.3 percent of small business owners expect to retire soon, and almost half of them have no succession plan in place.[1] This lack of planning amounts to a lot of American workers who are facing employment uncertainty.
From my experience, there are several reasons business owners are behind on planning. They shoulder many demands and while they are preoccupied with evolving and keeping a business afloat, retirement age tends to sneak up on them. They may not feel they have a marketable business or a suitable successor so the business will “probably just cease”. Some are defined by their work and have a difficult time coming to terms with the idea of life beyond the business. Often, the sticker shock from the costs and complicated variables involved with a corporate transaction cause avoidance.
It’s quite a juggling act to figure out how best to obtain the cash needed from the business in order to retire without losing over half of it to taxes and fees. High net worth business owners are usually paying 35-40 percent taxes year over year and will later pay up to 20 percent capital gains on the proceeds of the sale of their business. By the time they have owner-financed a buyer, paid accountants, attorneys and business broker commissions, they set off on retirement with a fraction of the actual valuation of their company. Not to mention there are risks involved with hoping the buyer has what it takes to continue the success of the business to be able pay their debts. For sellers, it’s unfair punishment for being successful.
So what is one to do? Many know ESOPs are an ideal vehicle for an owner who is looking to get cash out of their business in a tax-efficient manner. But ESOPs can be cumbersome and costly to administer and tend to be most appropriate for larger organizations. ESOPs also require the owner to sacrifice equitable interests and this is usually a deal-breaker for family-owned firms. Surprisingly it is less common knowledge that defined benefit and non-qualified deferred compensation plans can be highly effective ways for owners to cash out when retirement approaches. These plans allow the owners to move substantial amounts from the business to their personal retirement, simplify the ownership transition process and reduce overall tax consequences. An additional perk is leaving a strong paternal legacy with employees while maintaining complete control over the disposition of company stock. Depending on the value of the business, owners can potentially avoid needing to involve a business broker altogether. At the very least their 7-10 percent commissions can be significantly reduced.
In reality a good number of the private businesses that exist on Main Street today need only a corporate attorney, a good CPA and a Wealth Manager or Retirement Plan Consultant who is competent in executive benefit plan design. They may not even need a marketable business to be able "cash out" the value of their company. Financial planners, tax professionals and closely held business owners should “just say no” to overpaying unnecessary taxes and business brokerage fees. Our mission at RISE Consulting is to share what we know to empower them to do so.
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[1] Family Business Facts: America’s Economic Engine. Conway Center for Small Business. Retrieved March 2020. (https://www.familybusinesscenter.com/resources/family-business-facts/).
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