A Business Exit Strategy

Running a going concern requires that the owner keeps an eye on the business continually and often at the detriment to the individual(s) at the helm.  Daily operations can interfere with designing a plan to someday leave it all behind and still pocket a monetary reward on the way into the sunset. 

There is no substitute for a good plan and understanding the assets that have been amassed is key to designing a profitable sale.  Most going concerns will have a combination of real property and personal property such as furniture, fixtures, equipment, goodwill, contract rights and a trade name.  For tax purposes, these assets are segregated on the books and records of the business and have to be accounted for separately upon sale. Allocating the sale price to the various categories can be challenging, however understanding the opportunity to defer recapture of previously taken depreciation (subject to tax at 25%) and capital gains tax (subject to tax at 15%) and state capital gains tax (ranging from 0%-9%) should be paramount in the planning process.  Aggregated, the tax can be significant and several strategies are available to defer the taxes completely.  

The most important aspect is to understand the goals and objectives of the principals.  While cash is always “king” touching it can lead to unintended tax consequences.  If the sale of business assets leads only to cash, the long hard work of achieving equity can be diminished by over 30%.  A strategy that utilizes a multi-faceted approach can keep all of the cash intact and tax deferred.

Since the majority of the business assets are likely to be invested in real estate, a Section 1031 Exchange will produce the optimum tax relief.  The first step is to engage a Qualified Intermediary (QI) to guide the sale of the property as an Exchange.  At closing the net proceeds of the real property will be redirected to the QI for the acquisition of like-kind new or Replacement Property.  This can be any kind of real estate and located anywhere in the United States.  In addition, it can be more than one piece of property.  The value is exchanged, not the quantity, quality or character of the old or Relinquished Property.  The Replacement Property options are as varied as stand alone whole interest in real estate, partial interest, Tenancy-In-Common (TIC) interest, Umbrella Partnership Real Estate Investment Trust (UP-REIT), and subsurface real estate in the form of Oil and Gas Leases.  A combination of any of these options will produce a diversified portfolio of income producing property.

Receiving cash over time is one effective strategy as long as the risk is mitigated.  Becoming the lender to the new owner may create more attachments than just monetary ones.  However, sale proceeds can be redirected to an annuity company for the receipt of funds over time, guaranteed.   This concept is referred to as a “Structured Sale” and it is an attractive alternative to other assets that do not otherwise qualify for exchange treatment. 

Reinvestment of the assets will produce a steady stream of income and they can be as passive or active as the soon to be retired business owner desires.  The benefits are encased in what the cash can acquire and not the cash itself. Exit the business not the equity that has been worked for so long.