It’s What You Keep That Matters

It is not necessarily what you get for your business; it is what you get to keep. Without proper advance planning, the after-tax proceeds from the sale of a business may be far less than the owner’s expectation and may not support the retirement life-style anticipated by the seller.

When asked by us how much the business is worth, it is not unusual for the owner to tell us what they need to retire. Further discussions reveal that the business may be worth less than what is needed to fund that retirement goal.

Smart estate planning can contribute to closing the gap between the owner’s retirement goals and the value of the business. Doing so enables one to significantly reduce the taxes paid to the IRS and therefore enhance the value of the deal.

One estate-planning technique that can be used in conjunction with a sale is called a Charitable Remainder Trust or “CRT” for short. If you have a low cost basis in your business, you stand to pay a hefty tax bill when you finally sell your business. A CRT offers a powerful way to reduce the income tax bite. Its main features are as follows:

• Avoiding any income tax when the business is sold. Entire sale proceeds can be reinvested providing a higher cash starting point.
• The seller receives an annual payment from the CRT and pays income taxes only on the amount distributed out of the trust.
• Upon the death of the seller, any remaining assets in the trust will go to a charity. However, in exchange the seller receives an up-front tax deduction that can be used to offset other income taxes. This is true even if the charity happens to be a private foundation that is directed by the seller’s family.

Higher Net After-Tax Proceeds

The CRT technique requires that the seller place the business within the trust in advance of the sale. By doing so, it offers a tax-deferred environment to conduct the sale and then subsequently invest the proceeds.

An obvious difference with using a CRT is that you do not receive a lump sum payment. Rather, the lump sum payment sale resides within the CRT. This may not be a major constraint, especially if you were intending to spend the proceeds over a long period of time.And of course, the upside to all this is that you are not faced with an immediate tax bill. Income taxes are also stretched out over this same long period of time.

Higher Likelihood of a Sale

By reducing the tax bite, a seller is now more open to considering less attractive offers since these may still achieve the desired after-tax outcome. In today’s competitive marketplace, having this flexibility can greatly increase the probability that a sale may actually happen. The CRT is one of several powerful techniques that can be used to exploit a once in a lifetime event such as selling a business. After all… it’s what you keep that matters…not just the price at which you sell.

This article was written by Roy T. George, Vice President, Bernstein Global Wealth Management & Jeff Johnson, Managing Principal, Northern California Office, Corporate Finance Associates

Business Ownership & Real Financial Freedom: The Buzz That Nobody Talks About

My clients depend on me to provide sound advice when they’re considering business ownership. I ask them all the same simple question: “Why do you want to be a business owner?” They excitedly rattle off their list of reasons, which typically include:

• “I want to be my own boss.”
• “I want to be accountable only to myself.”
• “I want to pursue a field about which I am passionate.”
• “I want to increase my income.”
• “I want to have a more flexible work schedule.”
• “I want to see the results of my own hard work.”

There are variations on this list, but the principles are the same. However, for all but a very few of my clients, the single most important objective is one that almost always goes unstated (and even unrecognized) until late in their careers and that is Real Financial Freedom for themselves and their families.

I define Real Financial Freedom as “the freedom to spend the rest of your life doing whatever you choose, without having to worry about your financial security.” Real Financial Freedom is achieved when your diversified base of investment assets reaches your pre-determined target.

When compared to those most commonly stated goals of business owners, Real Financial Freedom takes the longest to achieve—but receives the least amount of attention from the owner. Real Financial Freedom is something that most business owners expect to happen if they work hard, but few make any conscious plans towards achieving.

I see it time and time again; This intoxicating – and often fatal – brew which seduces business owners, particularly those who have built a successful business over many years. At a time when the owner should be awakening to a desire for Real Financial Freedom, his company’s revenues, profits, cash flow and his personal income have never been higher. All the years of hard work and personal sacrifice are paying off and the machine he has built is purring along like a Bentley.

The value of his business has grown to the point that he now believes he has achieved Real Financial Freedom. Can’t you see him? He wears a mantle of pure contentment and self assuredness. He wears polo shirts to the office more days than not, and he almost never wears socks anymore. His hair is getting on the long side. He’s gotten into the Brew.

In his impaired state, the owner has overlooked an important prerequisite for Real Financial Freedom: a diversified base of investment assets. Though his total net worth may have reached his target level, most of this remains concentrated in the value of the business. To aggravate matters, the business is also the owner’s primary source of income. Real Financial Freedom remains distant, but he is unconscious to this fact. What was supposed to be sweet freedom is actually a cruel illusion: He is certainly not free to do whatever he chooses for the rest of his life.

What Happened? Where Am I? – The Sobering Truth

Perhaps the best way to demonstrate where things go wrong is with an illustration. In this example the business owner and his financial advisors have determined that his Real Financial Freedom target is $10.1 million. That is, after taxes and transaction costs, he must end up with $10.1 million in diversified investment assets to meet his financial objectives. Working backwards, if we assume that taxes and transaction costs will be 25% of the company’s value and that the owner has no outside investment assets the resulting target company value is $13.5 million.

Research shows that other companies in his industry have sold recently for 5 times EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). This company’s EBITDA will be $2.70 million in this, its 20th year, yielding a company value of $13.50 million.

The above simple chart is tracking the company’s performance, everything looks great for 20 years. Now, notice a “zig” in the EBITDA and Company Value lines in year 20. This zig reflects the impact of an unplanned, uncontrollable and unforeseen event that triggers a 25% drop in the company’s revenues (and EBITDA). This could be caused by almost anything: the weather, a product recall, a terrorist attack, interest rates, illness. There are MANY things beyond the owner’s control that can impact a business. Some of these events are positive, some negative. The negative ones, of course, are what we are concerned about.

After the zig, even if the company is lucky enough to recover and continues to grow at the historical rate, the value of the business does not reach the Real Financial Freedom target for six more years! This could have been avoided altogether if the owner had completed the last step towards Real Financial Freedom: creating liquidity through the sale or recapitalization of the business in order to facilitate diversification of his investment assets. Remember that? This six year recovery period represents a lot of additional work, a lot of additional risk, and a lot of the remaining years of the owner’s life just to get back to his target level.

The lesson for the business owner is simply: accept that sooner or later, Real Financial Freedom will be your primary objective. Then all you need to do is:

• With the help of a good advisor, establish your own financial target;
• Recognize when you have reached your financial target;
• Protect and preserve the value you have created by diversifying your net worth. This is accomplished through a well-planned and executed recapitalization or sale of your company.

Now you are ready to enjoy Real Financial Freedom!

This article was written by Jay Carter, Principal, Charlotte Office Corporate Finance Associates

Feature

Capital Placement Situation: Portland, Maine is home to several colleges, yet most feature limited housing. Rockport, Maine based developer Joseph M. Cloutier saw a need for a high-end apartment complex aimed specifically at the city’s 15,000 college student population. He asked CFA to arrange financing for the 100 suite complex designed to house 400 students. Bayside Village will meet the needs of students’ busy schedules, with amenities like sheltered parking, wireless internet, a fitness room, and bicycle storage.

Solution: Corporate Finance Associates designed a multi-layered capital structure including development stage funding, construction financing, term debt, and municipal tax increment financing totaling $26mm through a combination of short term investors, private equity, and bank financing timed to meet the projects funding milestones.

About CFA

For over fifty years, we’ve been making deals that maximize value for our customers while earning their trust and building long-term relationships. Our commitment to remaining independent from any direct investment or lending affiliates ensures that we deliver unbiased guidance. Selling, buying or financing a business is a complex process that requires thorough preparation, skillful negotiation, and intimate market knowledge. With CFA, you’ll work locally with a senior principal, who can provide expert valuation, analysis, and dealmaking skills, as well as preferred access to a vast network of national and international buyers. Serving as your partner throughout all phases of the engagement, your CFA principal will guide you through every challenge, advocate on your behalf, and leverage our company’s wealth of experience and resources to see you through to a successful close. Local service is provided by over 30 offices in North America and 12 partner offices in Europe