Although the legislative trends decided by next month’s elections won’t be known until the lame duck session of Congress and later, based on what we know now it may be a good time to consider selling a small business.
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“With the upcoming fiscal cliff and tax rates at historic lows, the owners of closely held companies have some decisions to consider,” according to buyout specialist Scott Miller, CPA.
Transition planning before the tax cliff becomes effective on Jan. 1 could benefit numerous business sellers, he observed. “Tax rates, especially capital gains rates, are literally at a historic low. After Jan. 1, 2013, they will go to 20 percent automatically. Add the health care surtax of 3.8 percent on top of that, and you have a rate increase of almost 60 percent.” [8.8 divided by 15 equals 58.7 percent].
“Tax Armageddon is coming,” he said. “Now is the time to act. There is a small window left in 2012 to capitalize on the current tax laws.”
“If you are a business owner, and decide not to do anything this year, you may think Congress will get its act together and lower the rates, but those increases are automatic,” he observed. “Even if there’s a change in the White House, if the Republicans do not get 60 Senate votes—and they won’t—the Democrats have an effective veto, and if they lose the Presidency things will get so partisan and bitter that there is little likelihood that they will be in the mood to compromise. Tax rates will reset to the much higher numbers.”
Moreover, there will be fewer qualified buyers as time goes on. “Baby Boomers are sitting on untold trillions of dollars of net worth, their equity in closely held companies,” said Miller. “In 2005 they were younger, and were candidates to buy other companies, but now they’re not thinking of acquisitions but of selling. Generation X is 40 percent smaller than the Baby Boomers, so where will the qualified buyers come from?”
Anyone thinking of selling or retiring should seriously consider an inside buyout, he indicated. This includes selling or passing of ownership interest in the closely held company to “insiders” such as key managers, employees, family members and employee cooperatives.
After several years of severe recession, many companies have financially recovered to the point where sale prices are rebounding, and expectations of sale proceeds are now attractive. If business owners hesitate and wait hoping for the further recovery of profitability, they may delay into a period of time when tax rates are significantly higher, according to Miller.
When a business owner is thinking of selling to insiders, the business owner is in control of the process. This is an advantage over trying to sell the company to a third party, Miller emphasized. Since the owners are in control of the process, they decide when the transaction will occur and what percentage of the company will be sold.
Many business owners have a clear predisposition in favor of selling to insiders. Insiders are often key employees who helped build the business, and they often have been at the company for many years. The owner typically has come to trust those key employees, and wants them to succeed. Typically, the owner will provide considerable assistance in helping the employees acquire the company, often by providing some seller financing.
“Sales to insiders can take the form of a sale to management, or to employees via an ESOP,” Miller said. If a family is involved, there is the opportunity for gifting, he added. “There could be a combination of an inside sale to family members and gifting. It’s a real opportunity because the gift tax rates will be much higher in 2013.”
And despite the approaching year end, there is still time to accomplish an inside sale, Miller noted. “Owners are in control in the inside sale situation, and there is still time to get something done,” he said. “But if you were trying to sell to a third party, the train has probably left the station.”