Proper planning before you sell your business can help manage your taxes and maintain income through retirement. Here’s what to know.
For owners, selling a business can be a complex moment. After all, for many, their business is their most valuable asset — which means that the sale isn’t just emotionally complicated, but it could also be crucial to positioning the seller for what comes next in their life, whether it’s another business venture, retirement, or pursuing another passion.
How can owners help ensure the sale of their business positions them for success?
Jeremy Miller and Eric Smith, business owner advisory strategists for Wells Fargo Wealth & Investment Management, say that business owners need to have a clear and detailed picture of their cash-flow needs before they sell because it’s the only way to know if the proceeds from the sale can provide that cash flow.
Here, Miller and Smith provide things to consider on four important areas related to selling a business:
Determine what your next chapter will look like
Smith says there’s one question owners should answer before selling a business: What do I want my life to look like after the sale? It isn’t exactly part of the exit plan, but it can be a key motivator for that exit plan.
Miller adds that part of detailing what comes next should also include a contingency in case the sale is unsuccessful. Having a backup plan in place when selling a business could lower the risk of not being able to exit when and how you want to. “Business owners should look into alternative transition options that make sense for them,” he says.
Identify your future cash-flow needs
Once you know your long-term lifestyle or retirement goals, you can estimate the amount of income you need to support that lifestyle. Miller says those needs should be positioned against the sale price of the business — minus taxes, debts, and professional fees related to the sale.
According to Miller, this is a common place where owners get tripped up. “Owners should focus on the net number they’ll walk away with after the transaction, not the gross number they receive for the business.”
Smith adds that owners are often surprised by lifestyle expenses previously covered by the business — things like memberships, vehicles, and travel. “You need to factor in all the quasi-personal expenses that the business currently covers,” he says, “because you’ll have to fund them once the business is sold.”
Owners need to be excited about the next step so that they’re working toward something, and what they plan to work toward will inform their cash-flow needs and their wealth planning.
Develop your exit plan before you need it
A properly planned business transition will require input from your financial team, including your wealth and tax advisors as well as estate plan and legal advisors. Your goal is to understand how to position the business for a successful sale, which may include minimizing tax impacts while also understanding how the sale could translate to cash flow after the transaction — especially if you’re considering retirement.
How early? Miller recommends that owners begin planning with their advisory team two to three years in advance of potentially selling a business.
Know your tax strategies prior to the sale
Pre-sale planning should include working with your financial team to develop strategies to help minimize income taxes on the sale as well as future estate taxes. These strategies may include:
Moving to a tax-advantaged state: This is a common tactic for maintaining income levels in retirement. “When owners sell a business, they need to focus on helping to minimize their short- and long-term tax obligations,” says Smith. “One of the ways they do that is changing residency from a high-tax state like California to somewhere with lower income or inheritance taxes, like Nevada or Texas. If moving is not an option, they might transfer company stock to a trust based in a low- or no-tax state prior to the company sale to help reduce future estate and income taxes.”
Maximizing charitable giving: “Many owners put their company stock into a donor-advised fund or charitable trust before the sale to help reduce potential income and capital gains taxes on the transaction,” Miller says. “They may also receive a charitable deduction, so there are a lot of potential tax savings there.” Owners could also gift assets to heirs regularly to help keep estate taxes low long term. This can be helpful if the proceeds from the business sale are well in excess of future cash-flow needs.
How owners sell a business could include ongoing income and tax advantages, too. For example, transitioning out of the business through an ESOP may have tax benefits for both owners and employees depending on the type of business and terms of the plan. Exiting owners could also offer short-term guidance to the new owners as part of the sale terms. “When someone sells a business, there may be an expectation for them to serve as a consultant after the sale,” says Smith. “In that case, an exiting owner could run a tax-efficient consulting entity that earns income.”
Preparing for your next chapter
Having a clear picture of your cash-flow needs and what you want your life to look like after the business is essential when planning your next chapter. Owners need to be excited about the next step so that they’re working toward something, and what they plan to work toward will inform their cash-flow needs and their wealth planning, Miller says. To learn more about planning for a sale of a business or transitioning a business, talk to your advisor about how Business Owner Advisory services through Wells Fargo Bank, N.A. can help.
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