Resisting the Rush: Why the New House Tax Plan Should Not Drive Your Decision to Sell Your Company
The draft legislation released by the House on September 13 is stirring up a perfect storm -- creating a scramble for those thinking about selling their companies and how to minimize the taxes on the transaction. With the proposition of a maximum capital gains tax of 25% (currently 20%) and returning the unified gift and estate tax credit limit to $5 million rather than the current $11.78 million for a single taxpayer, four years earlier than scheduled -- tax planning for 2021 now takes on a higher level of urgency.
Combined with the pressures of the pandemic and the Great Resignation, the urgency is more acute for business owners, leaving many to ask, “Should I sell my company outright or, if a family business, gift my stock to the next generation before the end of the year?”
Fear-motivated exit planning and rushed deals rarely go well.
The Tail is Wagging the Dog.
Understanding the implications of tax policy is a critical element in structuring an exit. However, tax policy changes should not drive the decision to exit.
A client conversation recently drove this point home. The owner, George, has already gifted shares to two of the adult children that are active in the business, Dan, and Steve. George has been keeping an eye on tax policy since the election, nervous about the proposed changes to both the capital gains and estate tax laws. He’s considering whether he should accelerate his plans to gift shares to those adult children that are not active in the business and one in particular, Mike, given his age and maturity. George acknowledges that Mike has an approach to both work and money that is much more indulgent than Dan and Steve’s approach. Their value sets are starkly different. On its face, this can make for some interesting family dinner conversations. But when in the context of co-ownership of a company, it could go from interesting to divisive and ugly very quickly.
Many parents believe that equal is fair when it comes to dividing up an estate amongst the next generation. So in this case, so everyone should get the same number of shares of the business. Granting Mike shares means all of the sudden Dan and Steve have an inactive business partner with very different values, motives, and priorities, but equal say and vote. What could go wrong?
Plenty. Cue the bickering, feuds, and hard feelings if the family doesn’t set ground rules for how they are going to run the business. The money saved in taxes could end up being shared with lawyers or squandered because company ownership can’t get along, make good decisions, and grow the company. And is the tax savings worth a fractured family?
Just because the tax policy may change quickly, ownership decisions like this should not. The dog decides when to wag the tail, not the other way around.
It’s More Than a Transaction. It’s a Transformation.
Exiting ownership of a business impacts the owner well beyond taxes and money. It changes everything in their life and the lives of their colleagues and family. Business ownership, and work in general, feeds our needs in other ways. It connects us to others socially. It stimulates our minds and bodies. Like a potent drug, it drives us forward, giving us a reason to get up and get going each day to fulfill one or more purpose.
For the owner that sells the company outright and walks away, that changes overnight. The intellectual challenge and engagement they enjoyed for years is gone once they set the champagne glass down. The social network – from daily conversations to their social circle – shifts abruptly. Unless you put in the time, effort, and planning to build new for replacing these aspects of a happy life, it could be like an addict quitting cold turkey. (The same holds true for transitioning into retirement.)
Decisions this significant warrant careful planning, preparation, and execution. Further, support and guidance from experienced advisors improves your outcomes. This is not a time to DIY it or allow the tax code to hold an “ownership intervention” on your behalf.
Deciding to Get Out Doesn’t Mean You’re Ready to.
Readiness for exit is a state of fact, not a state of mind. The business is attractive and able to thrive without you, the owner, or it’s not. Your financial plan is either sustainable or you’re risking sharing kibble in the kids’ basement in retirement. The last person that should have a say in your readiness is some politician from any party affiliation legislating tax policy.
Only you can determine when to engage in an honest assessment of your own personal and financial readiness, as well as the company’s readiness for transition. This assessment is step one and the best practice for making these critical exit decisions. It’s the only way you can make better informed decisions around what you need in personally and financially in retirement or know if the sale of the business is necessary to fund retirement. Otherwise, how do you know whether the value of the business is where you need it to be and if it’s not, whether you have enough time to improve it?
Further, being “ready” means you have developed a thoughtful approach for replacing the fabric of your work life with something new – whether it be another business idea you want to pursue, the philanthropic efforts you want to be a part of or other life-fulfilling projects to pursue.
Timing is everything: And there are two reasons the timing it bad.
According to the Exit Planning Institute, one in two business owners are forced out of ownership before they are ready. Exits are rushed due to death, disability, divorce, distress, or disagreement, which are often referred to as the “Five Ds.” When a company is sold in a fire-sale like that, money is usually left on the table because there is no time to dress it up. Damn Uncle Sam should not be the sixth D.
If you have the luxury of time to take the steps to improve the transferability of the business, you should, similar to how you keep you house in reasonably good condition so you could sell it immediately for the best the market would bear should you suddenly need to.
The other aspect of bad timing is the fact that there are only thirteen weeks left in 2021. Some sections of the proposed legislation, such as the capital gains clause, may be effective as early as September 13, 2021, so that ship may have already sailed. Even if it hasn’t left the docks, unless the sale or share-transfer process has already begun in earnest, it is highly unlikely that a company can go to market, find a buyer, come to agreement, and pen a well-considered deal before December 31, 2021. As a rule of thumb, the most aggressive deals take four to six months. Some can come to agreement within nine to twelve months where others take longer. Assuming that the company is attractive and ready. But if the owner, the business, and the sale process aren’t all ready for and already in conversations, it’s probably not going to happen. And if it does close by December 31, the deal will be rushed. Like a fire-sale, chances are high that money and/or more important values will be left on the table.
We’ve set out the case for what an owner shouldn’t do in light of the potential tax legislation. But what should they do
Get on your accountant’s schedule to talk about tax planning for 2021 as soon as possible, regardless of your intention to sell or not
Resist the urge to rush just because of the potential tax changes. Take a beat.
Use the potential tax changes as a kick in the tail to start thinking about your exit - now – what you want, need, would be nice to have, and, realistically, when might you be ready in fact.
Assess your transition readiness and that of your company. Set the goal to get yourself read as a matter of verifiable facts. That way, you have a better chance of determining your timing by choice.
Begin assembling your go-to team of advisors to help you through the exit planning process. This process has many elements to consider and takes time.
If by chance you’re already engaged in the sale process, lean on your advisors for guidance.
Require business sale and transition experience and expertise from your deal team, including your attorney and your tax accountant.
Recognize that the advisor you’ve worked with for years may not meet that requirement. Respectfully augment the team with an additional expert or replace them for this transaction.
And lastly, comment or send me an email at info@provenancehill.com if you want to kick it around.
Be well!