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Selling Your Business in Today's Economy

Guest post by: Barbara Weltman

Article Overview: Have you decided to retire or move on to something else? Today's economy makes it tough to sell a business outright (banks just aren't lending). Still, there are ways that you can sell your business and reap the rewards you've so justly earned.

Selling Your Business in Today's Economy

Have you decided to retire or move on to something else? Today's economy makes it tough to sell a business outright (banks just aren't lending). Still, there are ways that you can sell your business and reap the rewards you've so justly earned.

Installment sales

You may prefer to get your entire sale price up front, but this may not be realistic in the current lending climate, where buyers generally cannot obtain sufficient financing to buy a business (of course, there are exceptions). In order to avoid a substantial reduction in the sale price for your company, agree to accept payment over time. This is called an installment sale.

A portion of each installment payment you receive will represent capital gain and a portion will be interest income. Caution: Even if you complete the sale in 2010, the capital gains rates in effect at the time of receiving the installments will apply. You can elect to report all of the gain in the year of the sale, even though you haven't received full payment. This option should be discussed with your tax advisor.

A buyer may expect to pay installments from business profits. If profits are not sufficient and your buyer defaults, be sure you have the legal right to recoup ownership of the company.

For more about the tax implications of installment sales, see IRS Publication 537, Installment Sales (the 2010 version of this publication is not yet available).

ESOPs

You may be able to sell your company to employees using an employee stock ownership plan (ESOP). The corporation sets up a trust for the ESOP into which it contributes either shares of its stock or cash to buy shares. In some cases, the corporation borrows money to buy shares and contributes cash to the trust to repay the loan. Shares are then allocated to plan participants (employees) in a manner similar to a profit-sharing plan; vesting rules apply. An ESOP produces the following tax breaks:

For the corporation:

• Shares of stock, or contributions of cash to buy shares or repay a loan are tax deductible. Contribution limits are lower for S corporations than for C corporations.
• In S corporations, income for the percentage of ownership held by the ESOP is not subject to income tax at the federal level (and usually not at the state level either). This means earnings of the S corporation escape federal income tax; they are not taxed to the corporation because it is an S corporation and they are not taxed to the ESOP because it is an exempt trust. For example, there is no income tax on 40% of the profits of an S corporation with an ESOP holding 40% of the stock, and no income tax on the profits of an S corporation wholly owned by its ESOP. However, the ESOP still must get a pro-rata share of any distributions the company makes to owners.
• Dividends used to repay an ESOP loan, passed through to employees, or reinvested by employees in company stock are tax-deductible.

For employees:

• They are not taxed on contributions made to the plan on their behalf.
• For stock in C corporations, departing employees can roll over the shares to an IRA or other qualified retirement plan. If they opt to report the income, then any future appreciation on the shares will be taxed at capital gains rates when the shares are eventually sold. No rollover of S corporation stock is allowed.

For you (the owner):

• A sale of 30% or more of an interest in a closely-held business enables an owner to defer tax on the gain from the sale by buying "replacement securities;" gain is recognized when and to the extent that replacement securities are sold.

ESOPs can only be used if your business is incorporated; they can't be used for limited liability companies or sole proprietorships. Of course, you can incorporate at any time, but be sure to factor in any additional legal and tax costs for the move. Always work with a knowledgeable attorney and accountant for this purpose.

Typically, professional fees and other costs for setting up an ESOP are substantial ($25,000 to $50,000 for even small companies). Thus, such plans are not used for very small companies (e.g., fewer than 50 employees).

For more information about ESOPs, visit the National Center for Employee Ownership. (Note that some information is restricted to members.)

Bring in new blood

If you can afford to wait for some time before selling, you may be able to cultivate buyers by hiring them to work for your business now. Potential buyers may be relatives (e.g., your adult children) or outsiders. Like renting a home with the notion of eventually owning it, working for a business with the option of buying it later on is an attractive opportunity for many individuals.

This option can work only if you are willing and able to wait until the buyer can carry the business on his/her own. Then, you can work out the details of a sale.

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Article Tags: banks, Barbara Weltman, buyer, economy, ESOPs, rewards, seller, selling, selling your business, small business



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