Chapter 17
Loose Ends and New Beginnings
Moving on is an exciting prospect—turning to a new chapter in your life. A new beginning is about new opportunities and new chances to excel. Maybe you’re the person who’ll be driving the big sport-fishing boat out to sea for a day on the water or maybe you’ll be the guy sitting on the pier soaking up the rays with a pole in your hand. Maybe you are now going to work for the new owner or preparing to take on a new entrepreneurial venture. In any event, plan to relax and enjoy life a bit and move into your next adventure doing what you know how to do best: by making a plan and executing it well. It’s time. You worked hard. You truly earned it.
Selling a business is a life-changing event. You have been busy, first positioning and preparing your business for the sale, and then working through the sales process itself. It was no doubt stressful and may not have left time to consider the future. Before you make those life changes, however, take time to think about your transition to that new life.
“I was so eager to move on with my life that I just never thought about those things.”
Transition Planning
Transition planning should be started before you make the change. You can’t negotiate terms after the sale is closed. When you’re planning your transition, keep this in mind—whether you are planning to stay on in some manner or planning to fully exit your business after the sale, expect to delay the start of that beach vacation while you support the transition of the business over to the new owner. Of course, this doesn’t always happen. Sometimes the new owner wants you to make your personal exit immediately upon closing, but others will want you to stick around. If you are remaining with the business in some capacity for the long-term or for the short-term, you will need to reach an understanding prior to closing of how that will work—and you will want to have a clear understanding of your postclosing role. Planning your exit includes planning how you will transition out of the business.
“I thought after closing on my business I would say goodbye, hold a party, and be done, but the buyer included my support for six months as a term of the sale.”
If you remain with your business after the sale as an employee, you will need to be willing to give up control and start taking direction. If you think it’s good news that, as an employee, you can now take your weekends off and let someone else worry about the business, think again—that’s not generally how these things work. You will need to pay close attention to the employment contract you are offered, including any lock-up periods, if you are dependent on your salary for your livelihood. If, after negotiation, your compensation package isn’t quite what you anticipated, consider asking for a performance bonus. After all, the buyer has performance expectations and will count on you to help them achieve their goals.
Future Insurance Needs
Two key items you will surely want to include in your negotiations are medical insurance and life insurance. In your previous life these were probably covered by your business. Health insurance is expensive when you’re buying a private policy and no longer qualify for that group plan. The same goes for life insurance, especially as you get older. As part of the negotiation consider adding terms that include a paid life insurance policy, continuing payment of your future health insurance premiums, and conversion of your current life insurance. Most business policies won’t allow a nonemployee to remain on the group policy so don’t make any assumptions about the cost of your health-care premiums. You will need to pay for a private health policy. Try to negotiate those payments into your exit terms.
Two key items you will surely want to include in your negotiations are life insurance and medical insurance.
When you owned your business, you were an officer of that business and probably had liability insurance as an officer of the company. Check with your insurance agent to find out what the limits of that policy will be following your exit. New owners are often tempted to say, “that was something that happened before we got here.” Find out what kind of tail that insurance includes, if it can be extended, and who will make the future payments if necessary. Don’t assume the new owner will continue the policy if that isn’t a written term in your deal. When you owned the business as a sole proprietor you may not have had an active board of directors. The new owners may have investors that are insisting on a board and have invited you to be on that board. What an honor! Maybe you agreed to retain part of the business following a partial buyout, and your membership isn’t as much an honor as a term you asked for so you could keep an eye on your investment. No matter what the reason, you are now on the board of a business someone else is operating on a daily basis. Before you accept that board seat, or any other board seat, you need to limit any potential liability you might have for their decisions by making sure they carry directors and officers (D&O) liability insurance.
Buyers Change Hats, and You May Too
When a business owner who has operated his business for many years finally sells it and moves on, he often morphs into something else. After cashing out, this former business owner is sitting on a pile of cash and decides to invest some of those funds. He doesn’t want to go back to work (the beach life appeals to him) but he decides he is going to put money into three or four other businesses. He morphs into an investor. He then decides to sell one or more of those businesses and transforms back into a seller. He changes hats—at one time he is a seller and at another he is a buyer. This may also be where you are headed, and it may be exactly where your buyer is now.
Taxes
When you sell your business, you will be liable for the taxes on your earnings from the sale. If you haven’t planned for it in advance, your tax burden could significantly reduce your return from the sale. What you retain from the sale is the price your business nets minus your tax burden. You cannot wait for the sale to close before you begin to develop and implement a tax strategy. The amount of taxes you will need to pay are as large a determinant on what you will retain from the sale as is the price. You can incur a much higher tax burden by simply neglecting to make a few easy decisions before the sale. Get your CPA and tax attorney involved in looking at this issue early, prior to even listing your business for sale.
You will need to work with your CPA and tax attorney to develop a tax strategy, and you will need to understand that strategy before you accept any offers. This will help you with the down select of buyers by enabling you to do a true comparison of what you will retain following the sale and after taxes. For instance, taxes might be reduced through a multiyear strategy that limits your current year tax liability.
There are several things to consider as you develop a tax strategy. Receiving the entire purchase price at closing gives you security that you will be paid (new owners don’t always survive long enough to make time payments) but a lump-sum payment will give you the greatest tax exposure. You may be more comfortable with the single payment, but it is worth the time and comparison to consider what your risk may be and whether it makes sense to accept delayed payments.
This is an area where you and your buyer may well disagree. Tangible assets are capital assets and subject to capital gains taxes. Your goal will be to include as many assets as possible, but negotiating this with the buyer won’t be easy—capital assets are depreciable, and tax deductions for capital assets are amortized over a much longer period of time, which likely works against their plan.
The tax codes also allow for the establishment of different types of trusts and annuities that potentially could be used as tools to support deferred payments and to minimize your tax burden. These programs tend to change as the tax laws evolve so be sure to ask your tax attorney for advice on which one may fit your situation as you plan to move on and transition to your next life adventure.
Asset vs. Equity Sales
Deciding whether a business sale should be an asset sale or a stock sale can cause some contention between you and your buyer because the parties in the deal have different goals. Make sure you discuss your plan with your transition team before you are ready to speak with any buyers. Generally, buyers prefer asset sales, whereas sellers prefer stock sales. An asset sale is a purchase of the individual assets of the business, whereas a stock sale is the purchase of the owner’s share of the business. While there are many considerations when negotiating the type of transaction, tax implications and potential liabilities are the primary concerns for both parties. Agreeing to which path to take may be your greatest deal-killing issue when selling a business, so if you are hard over and not willing to accept an asset deal make sure that is understood early on. Many owners end up surrendering on this point to get a deal done, but it is important you make an informed decision and understand what you are surrendering.
While there are many considerations when negotiating the type of transaction, tax implications and potential liabilities are the primary concerns for both parties.
In an asset sale, the owner retains possession of the business and the buyer purchases the individual assets of the company—such as equipment, fixtures, machinery, licenses, goodwill, intellectual property, and inventory. Asset sales generally do not include cash (bank accounts) and the owner will retain any debt unless specifically negotiated away in the deal.
In an equity sale, which is a stock sale, the buyer purchases the owner’s stock, giving them ownership in the business. The assets along with any liabilities are acquired in a stock sale. The buyer will ask that any of the businesses assets or liabilities they do not want to include in the sale be negotiated or paid off prior to the sale.
For the owner, asset sales result in higher taxes because fixed assets can be subject to higher tax rates. For the buyer, there may be tax advantages because they can gain an improved tax depreciation advantage. This lowers their initial tax burden and improves the company’s cash flow. Buyers also prefer asset sales because they help avoid inheriting potential liabilities caused by the prior owner including product liability and warranty issues, contract disputes, and employee lawsuits.
Lock-outs
After buying your business, the new owner doesn’t want to find out they bought you out of problems and funded your next business as their new competition. The terms of your purchase agreement will likely include a “lock-out” clause that keeps you from working in a similar business for a set period of time (three to five years). During this time, you will be restricted from starting a competing business or working for an existing competitor. If you’re headed to the beach this won’t have much impact; but if you’re selling your business to get out from under a bad business and will need a new job next week, this could have a big impact on your future. Be sure you fully understand the impact of any lock-out terms in your purchase agreement.
Be sure you fully understand the impact of any lock-out terms in your purchase agreement.
The new owner will also want to restrict you from hiring your former employees. Part of the reason for buying your business is because of its existing, already trained, and functioning staff. Unless there are employment agreements in place for your former employees, they are free to go to work for someone else—but not for you. You may need to explain this to a loyal former employee at some point after the sale. If the business you just sold developed software for the restaurant industry, and you are starting a new business developing software for the automobile industry, you may be in violation of your industry lock-out. If you plan to hire your lead software engineer from your old business, you may be violating a nonpirating term. If the buyer terminates your former lead engineer, you may still need to get an agreement to hire them into your new business. Be sure to review the terms of your agreement carefully and seek legal advice if you’re not sure.
Taking the High Road
After selling your business you are going to hear a lot of things “via the rumor mill,” or “through the grapevine,” or even “over the bamboo telegraph.” People will make comments about the new owners:
“Oh, you wouldn’t believe how terrible it is working there now.”
“We’re still supplying them but we’re about to cut them off because they don’t pay us as quickly as you did in the past.”
“We fixed them—we won’t let them park their truck in our place now that they are charging us for IT services.”
Sometimes it is the new owner who starts to make comments about your former employees or vendors or the way things are running in their new business.
“I don’t know why you didn’t fire that guy Jake years ago.”
“It took us a while to retrain your former employees to dress nicely—in our business, Friday is the only casual day. Boy, they were used to getting away with a lot!”
Your reply to all these comments should be a smile. Don’t respond and don’t comment. Take the high road. Don’t take sides.
Become a Consultant
After selling your business you get a call from the buyer:
“Jim, can you help us with something?”
They may be looking for advice on how an old product design works; it could be to use your established relationship to help solve a problem with a vendor; or it could be to come in and calm down your former employees who are resisting their new management. Of course, you’ll help—you’re a good guy and want to see the new owner succeed.
“Jim came in and helped us and saved us a bundle with that vendor.”
The problem occurs when they call again next week—and the week after that. You’re a good guy but suddenly you find “call Jim” has become the new owner’s hot line for support. It can become abusive before you realize it. There may be genuine cases where calling you makes sense and where you can save time and money advising the new owner, but you need to put a price on your time so it doesn’t become abusive. It needs to cost more than a dime for them to engage your services. Resolve these problems by putting a financial value on your time and consider formalizing the relationship with a support contract; just don’t be surprised when the answer becomes, “no, we can’t afford that yet.”