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Business Sale Planning – how top CPA’s help their clients

In our work as M&A brokers, many business owners come to us emotionally ready to sell but unrealistic about the value and condition of their business, and out of time or unwilling to re-position the business. Lack of planning and misinformation are common causes. Exiting right requires holistic planning and early involvement by a team of advisors, often starting with the company’s CPA.

List of CPA Exit Planning Services

  • 3-5 years before a client wants to exit their business, a CPA can assemble a team of advisors that include a wealth advisor, business and estate planning attorneys and M&A broker. The CPA can recommend a valuation or a sale readiness assessment, run tax calculations under likely deal terms, and strategize an exit plan.
  • 2-3 years before exit:  provide finance and accounting exit advice/services, recommend cease co-mingling of personal expenses and adjust related-party transactions to market, clean up the balance sheet, shore up accounting systems, staff, policies and practices, organize all financial records, create important management reports.
  • 1-2 years before exit:  perform a sell-side Quality of Earnings (QOE) which generally includes items such as: an analysis of historical reporting, revenue recognition procedures including rebates, discounts, allowances, credits and collections, analysis of accruals and contingent liabilities, identification of non-recurring revenue and expenses, working capital level analysis, adequacy of capital expenditures to sustain performance and operational plans, changes in personnel and compensation, stratification of revenue and gross margin by customer and product, and other items as appropriate to understand the underlying economics of the business
  • During the sale process:  provide tax / deal structuring advice, provide financial and tax due diligence support, provide financing support for lender(s), and recommend post-closing investment support

Early involvement by CPA’s in exit planning can help company leaders increase shareholder value, improve marketability, and ensure that owners are be able to exit on their own terms and time frame.

Loui Cionci, ABV, CPA, is a senior M&A advisor and business appraiser with Exit Strategies Group.  For more information on exit planning or selling a California business, Email Louis Cionci at LCionci@exitstrategiesgroup.com or call 707-781-8582.

When It’s Time to Sell, Put Your Strengths First

Putting your strengths first will help you sell your business. While this may seem obvious, a surprising number of business owners will either improperly index the strengths of their business or fail to emphasize those strengths adequately. In this article, we will examine five key business strengths that you should focus on when it comes time to sell.

Understand Your Buyer

You know your business, but you don’t necessarily know what buyer is best for it in the long run. If you’ve never sold a business before (and most business owners haven’t), then you may not know how to best position and present your business for sale.

A business broker is immensely valuable in this regard. These professionals are very good at determining which prospective buyers are serious and which ones are not. Additionally, a business broker will use their own databases of prospective and vetted buyers and try to match your business up with the prospective buyers that are most likely to be a good fit. When dealing with a buyer, a seasoned business broker will put emphasis on your strengths whenever possible.

Be Sure to Maintain Normal Operations

Selling a business can be very demanding and underscores, once again, the value of working with a business broker. A business broker will focus on selling your business so that you have more time to focus on the day-to-day of running your business.

The last thing you want is to waste your time on buyers who are not serious. Remember, if your business suffers as a result of the time you spend away from your business in the sale process, then the value of your business to prospective buyers could suffer.

Determining the Best Price

If you incorrectly price your business, you could dramatically reduce the interest. Business brokers are experts at pricing businesses and can help you determine the best possible price. Many business owners have unrealistic valuations and others may even undervalue their businesses or they fail to incorporate all aspects of their business. Working with a professional business broker can help you quickly achieve the best price. The best price possible will work to maximize the strengths of your business.

Getting Your Business Ready for Sale

There is a lot that goes into getting your business ready to sell. The simple fact is that getting your business ready to sell isn’t a one-dimensional process, but instead involves every aspect of your business. Getting your business ready to sell isn’t about making it look presentable and putting a “new coat of paint” on things, although this is a factor.

Instead it is necessary to have every aspect of your business in order. From paperwork such as tax returns, contracts and forms to a business plan and more, it is important to consider every aspect of your business. You should consider what you would want to see if you were the one looking to buy the business. Be sure to do everything possible to build up your strengths.

Confidentiality

If word gets out that your business is up for sale, there could be a range of problems. Employees, including key management, could begin looking for other jobs and suppliers and key buyers could begin to look elsewhere. In short, a breach of confidentiality could lead to chaos.

Getting your business ready for sale means factoring in the strengths and weakness of your business then fixing weaknesses whenever possible and building upon your strengths. Working with a business broker can help you address every point covered in this article and more.

Copyright: Business Brokerage Press, Inc.

Contact an Exit Strategies M&A advisor for further information or help selling and preparing to sell your business.

Does Your M&A Advisor have a Stamp of Approval?

When choosing a business broker, M&A advisor, investment banker or transaction intermediary to sell your company it’s wise to consider their professional designations.  Having one or more designations from the right professional organization provides validation that the individual is committed to his or her craft and has sufficient experience to manage a complex sale transaction.

For California brokers that sell main street businesses and businesses at the very low end of the middle-market (say up to $10 million revenue) there are two primary designations:

  • CBB (Certified Business Broker) is offered by the California Association of Business Brokers.  It requires that Brokers complete 16 hours of course work and have completed at least 5 transactions within the last four years.  You can find an advisor with the CBB designation here.
  • CBI (Certified Business Intermediary) is offered by the International Business Brokers Association.  The IBBA mainly serves the U.S. and Canada.  To obtain the CBI requires 68 education hours and at least 3 completed transactions.  Find advisors with the CBI designation here.

For advisors that regularly sell lower middle market companies there are two main mergers and acquisition (M&A) designations:

  • The Alliance of Merger and Acquisition Advisors is an international organization that offers the Certified Merger and Acquisition Advisor (CM&AA). To obtain this designation requires attending a 5 day course.  Find CM&AA’s here.
  • Lastly there is the Merger & Acquisition Master Intermediary (M&AMI) designation offered by the M&A Source, also an international organization and the largest association of middle-market M&A advisors in the U.S. with over 300 intermediary members. The M&A Source is a sister organization to the IBBA.  To obtain the M&AMI credential, advisors need at least 3 years of M&A experience and 40 credit hours of professional education, and must have completed at least 3 M&A transactions.  Find M&AMI’s here.

Some advisors also maintain business valuation accreditations such as the Certified Valuation Analyst (CVA), Accredited Senior Appraiser (ASA) and ABV (Accredited in Business Valuation).  These designations demonstrate a high level of proficiency in this critical part of the sale process.

All of the above designations require passing a competency test and committing to a Code of Ethics. Having a competent and ethical advisor is critical to successfully selling your business.  Having at least one of these designations should be one of your criteria when selecting an advisor.

I should point out that business brokerage in California is licensed by the Department of Real Estate.  However, having a real estate license says nothing about an advisor’s ability to handle a business transaction.

Adam Wiskind is an M&A advisor at Exit Strategies Group, Inc and is a Certified Business Intermediary.  If you are interested in better understanding this subject or in selling your business, contact Adam at awiskind@exitstrategiesgroup.com.

August 21st Seminar: How and When to Exit Your Business for Maximum Value

Are you considering retirement or exiting ownership and wondering if you’re going about it the best way? Will your business sell for maximum value? Please join us for an exclusive, limited-seating breakfast seminar in Roseville on Tuesday August 21, 2018 for business owners contemplating their exit. Learn the ins and outs of successful exit strategies and how to maximize value when you sell. This free, educational seminar is sponsored by Exit Strategies Group and Exchange Bank, a local community bank serving northern California since 1890.

You’ve spent years creating value in your business and you deserve to make a full-value exit on your terms and time frame. You’ve heard about hugely successful deals and horror stories of deals gone wrong. But what separates them? Not just luck.

What is the value of your business today? Is that enough to retire or fund my next endeavor? Is the timing right to maximize value? What are my exit options and how do I select the right option? What should I be doing to prepare for an exit? How far in the future should I plan? What can I do to make my company more attractive to buyers? How can I position it to attract strategic buyers? How do I present my financials properly? How do I avoid financing a sale? How do I get more value for all my years of hard work and ensure a successful sale when I’m ready to sell?

If you’ve asked yourself any of these questions, this seminar is for you. This fast-paced 2-1/2 hour live session will provide practical answers regarding:

1) How companies are valued and what factors influence the price buyers pay
2) How to prepare yourself and your company for a better sale outcome
3) The current state of the market for business sales
4) Pros and cons of different types of buyers for your company
5) Steps and important tools in an M&A sale process, and mistakes to avoid
6) How experienced professionals level the playing field with sophisticated buyers
7) The criteria banks will use to qualify your business for buyer financing
8) How to maximize proceeds and reduce financial risk in a sale

SEMINAR DETAILS

• Date: Tuesday, August 21, 2018
• Time: 7:30am – 10:00am (check-in and continental breakfast start at 7:00am)
• Location: Exchange Bank, 1420 Rocky Ridge Dr. Suite 190, Roseville, CA 95661
• Presenters: Senior advisors from Exit Strategies Group and Exchange Bank
RSVP Required:  CLICK HERE TO REGISTER ONLINE  Or, contact Mike Lyman at 916-476-2611 or mlyman@exitstrategiesgroup.com. We will call you to confirm your reservation. For privacy, we allow only one company per business type. Register early. The seminar is free and seating is limited.

We hope to see you on August 21st. If you cannot attend but would like to be notified of future seminar dates, receive our monthly newsletter, or discuss a business sale or valuation need, please contact Mike Lyman at 916-476-2611 or mlyman@exitstrategiesgroup.com.

About the Sponsors:

Founded in 2002, Exit Strategies Group, Inc. is a full-service Northern California-based merger and acquisition brokerage firm serving $1-50 million revenue company owners.  Exit Strategies also appraises businesses for MBO, buy-sell transactions, ESOP, estate and gift tax, litigation support and other uses.  With 12 seasoned professionals and 4 California offices, Exit Strategies combines the expertise and resources of a large firm with the close senior-level attention of a boutique M&A practice.

Founded in 1890, Exchange Bank consists of 18 branches.  Exchange Bank is an SBA PLP lender with decades of experience.  Dedicated SBA M&A lending professionals committed to outstanding customer service and fast turnaround.

 

Avoid These 6 Common Deal Breakers in the Business Sale Process

Finding a willing buyer for your business is worth celebrating, briefly. In my experience, a majority of owner-negotiated “deals” fall apart before reaching the closing table.  In this post I will discuss several common deal breakers that I’ve seen, mostly involving differing expectations and poor preparation, and how you can avoid them.

But first I want to be sure you know what a Letter of Intent (LOI) is. An LOI is a non-binding agreement between a buyer and seller that memorializes major deal terms and steps to closing. It is entered in to BEFORE due diligence, legal documentation and escrow processes. Done properly, an LOI does a lot to align the expectations of each party, which is critical to consummating a sale. Deals also dissolve when a buyer negotiates terms with certain expectations, and later finds reality to be different.

So, what are these deal breakers?

Ambiguous Deal Terms

There is probably no larger risk to a deal than agreeing to ambiguous or contradictory deal terms. Writing an effective Letter of Intent can be tricky because it is negotiated early in the sale process, prior to disclosure of all pertinent information about the business. Nonetheless, the Letter should at minimum include assumptions used to negotiate deal terms, the deal structure with purchase price, a timeline and conditions to close. Additionally, it may include no-shop and confidentiality provisions and other terms to protect the buyer and seller’s interests. Regardless of the Letter’s content i should be clear, comprehensive and sufficiently detailed to anticipate future surprises.

Poor Record Keeping

The Due Diligence process provides an opportunity for the buyer to confirm that the information previously presented to them about the business is true and correct. A company with poor record keeping practices may have a difficult time providing evidence that they are in compliance with applicable laws, have enforceable contracts with suppliers and customers and accurate financial statements. Without accurate and complete records, buyers are uncertain of what risks they are acquiring and will be reluctant to close the deal.

This is particularly true for financial records. A seller should be prepared to provide prospective buyers with clean and verifiable financials for a minimum of the past three years. A special case is if the owner has claimed personal expenses that he has run through the business and wants to “add-back” as part of establishing the value of the business. These expenses should be well documented to be acceptable to prospective buyers.

Prior to taking the business to market it is well worth conducting a pre-due diligence exercise so that any weaknesses in record keeping are identified and corrected.

Misrepresentation of Facts

Business owners are anxious to sell the potential of their businesses. However their enthusiasm can lead them to put a positive spin on information at the expense of accuracy. The first time a buyer discovers something factually incorrect about an owner’s claims their suspicions will be triggered. If more inaccuracies are revealed, confidence in the deal can be eroded. Even if the exaggerations don’t add up to much, many buyers will walk away for fear there are larger surprises hidden in the shadows.

Unaddressed Business Risks

All businesses confront risks that a buyer will learn about either during due diligence or later. For example, a strong new competitor is entering the market or a key employee is retiring. If a buyer perceives that the seller is either not addressing or has not disclosed these risks they may lose interest in acquiring the business. An owner that confronts these risks head-on will be well regarded by prospective buyers and will improve their chances to close a deal. Even if an owner may not have had the time, people or cash to mitigate the risk, a buyer prospect may be able to bring fresh resources to the table and turn what was a problem into an opportunity.

Business Erosion

A buyer forms expectations about the future performance of the business based on the financial information provided to them. A buyer is generally willing to pay a fair price for the business based on those expectations. However, if between the time that a deal is struck and the transaction closes, the financial performance of the business suffers a buyer might get cold feet or want to renegotiate terms.

The sales process can consume a lot of time and energy. The role of the intermediary is to assure that the process stays on track while the owner remains focused on running the business and maintaining its performance.

Deal Fatigue

A deal that takes too long to complete is at risk of never being completed. Typically, upon signing a Letter of Intent there is a level of excitement about the prospect of a completed deal. The enthusiasm helps to carry the process during the emotionally challenging due diligence phase.

However, enthusiasm often fades if the process doesn’t continue to move forward. When either party is uncertain of the deal or is otherwise distracted they may be slow in responding to requests for information or completion of tasks. Deal fatigue can also occur when one party makes unreasonable demands or aggressively tries to renegotiate the terms of the deal. The most painful negotiators bring up the same points repeatedly. Eventually one party or the other will walk away.

There are effective strategies to combat deal fatigue: 1) screen buyers to assure that they are serious about and capable of completing the deal 2) disclose upfront material information about the business 3) write clear deal terms that don’t lend themselves to renegotiation 3) develop a deal timeline that compels both parties to keep the process moving forward.

The difference between a done deal and a busted deal is often a matter of setting and meeting both buyer and seller expectations. Employing an experienced intermediary to manage the sale process will help you avoid common deal breakers and address the inevitable biases and personal feelings of parties involved in a high stakes transaction.

Adam Wiskind is a Certified Business Intermediary in Exit Strategies Group’s North San Francisco Bay Area office. He can be reached at (707) 781-8744 or awiskind@exitstrategiesgroup.com.

Go on Vacation … An exit strategy for small business owners

Do you plan to sell your business in 1-3 years? 3-5 years? 5-10 years? If so, here’s a simple preparedness test. Take a vacation!

Ask yourself, “What would happen to my business if I left for a 3-week vacation?”  Some scenarios:

  1. Business grinds to a halt.  Since you do most of the work yourself, when you take a vacation sales drop 50% or more.
  2. Outbound selling stops.  Like many business owners, you are the main salesperson. When you’re gone, your staff takes orders and works off existing backlog. Not disastrous, but when you return, your sales funnel is empty and future sales suffer.
  3. Most everything continues.  All company processes continue uninterrupted. You return to full email and voicemail boxes and a stack of work to catch up on. Many issues have already been handled, but there are some that only an owner can resolve.
  4. Wait, you were gone?  A savvy owner has built her business into an engine that keeps on chugging in her absence. People, processes and procedures are in place so that everything is business as usual when she is gone. (I currently have a client whose business continued to grow uninterrupted when he was out for months due to a debilitating injury.)

When buyers look at a business, they think a lot about risk. Price is one thing, but risk can be more important. Which of the above businesses is least risky to a buyer? Obviously #4. And the lower the risk the higher the earnings multiple buyers are willing to pay.

So, test your situation. Take a short vacation. What happens? Based on the results of your test, start fixing the problems. Put the processes and procedures in place so that business continues when you are gone. You may need to grow. You may need to hire. You may need to replace your spouse (who goes on those vacations with you) so that only one key person is out when you are out.

After that, take longer and longer vacations. See what happens and continue to fill the gaps.

At the very least, get your business to scenario 2, ideally 3 or 4.  In a perfect world, by the time you sell your business, you can step into retirement without a hitch. All because you started retiring earlier.

Roy Martinez can be reached at 707-781-8583 or jroymartinez@exitstrategiesgroup.com

Exit Strategies Advises on Sale of Valley Inventory Services, California’s Leading Inventory Services Provider

Exit Strategies Group acted as exclusive advisor to Valley Inventory Service, Inc. on its recent sale to private investors. Terms of sale will not be disclosed.

Founded in 1972, VIS is the leading regional physical inventory service provider in California. VIS serves supermarkets, retail stores, pharmacies, distribution centers, wineries and manufacturers in the Western U.S. Using state of the art data collection hardware and software, VIS tailors its services to meet the timing and reporting requirements of clients. Valley’s service philosophy is centered around timeliness, accuracy and professionalism. The new owners intend to build on that tradition of quality service and expand into new markets.

“After we interviewed other brokerage firms, our attorney recommended Al Statz at Exit Strategies. We selected Exit Strategies because of the thoughtful advice they gave us before we hired them, the professional way they present businesses, their approach to identifying buyers, and their reputation for providing great service. I am pleased with the ultimate outcome achieved through their rigorous process, extensive knowledge and attentiveness,” said VIS CEO Jeff Link.

Established B2B service companies like VIS with competitive service offerings, proven systems and capable staff, strong reputations and  growth prospects are getting lots of attention from strategic and financial buyers in this market. We are pleased to have been able to advise on this successful business ownership transfer.

Exit Strategies Group is a California-based mergers and acquisitions brokerage and business valuation firm. Founded in 2002, the firm advises sellers and buyers in lower middle-market M&A transactions. Senior advisors at Exit Strategies have over 100 years of combined transaction experience across a variety of industries.

For more information or help completing a business sale, acquisition or merger, contact Al Statz, President, at 707-781-8580, alstatz@exitstrategiesgroup.com.

Can I Sell My Business (C Corp Stock) Tax Free?

In some cases yes!  Congress has long realized that investment in small businesses is an important driver of the U.S. economy.  Back in 1993, to incentivize investors, they developed a rule that eliminates federal income tax on some (later revised to all) of the gain on the sale of certain C Corporation stock issued after August 10, 1993.  As M&A brokers, Exit Strategies’ advisors try to point out potential tax breaks to clients and in this article I’ll discuss Qualified Small Business Stock (or “QSBS”) from a business sale perspective.

QSBS Requirements

To qualify for this tax break, your stock has to be deemed Qualified Small Business Stock per Internal Revenue Code Sec. 1202. Here’s a summary of those requirements:

  • Must be a domestic C Corporation
  • Stock was acquired at original issuance
  • Was acquired after 8/10/1993
  • Has been held for 5 years or more at the time of sale
  • Is a small business, defined as assets of less than $50 million
  • The company is NOT engaged in professional services that are dependent on the reputation or skill of one or more employees, financial services, farming, mining or resource extraction, hotels, restaurants or other similar businesses

Depending on the issue date of the stock, 50%, 75% or 100% of the gain (up to $10 million) may be excluded from federal income tax. The gain exclusion is 50% (subject to a 7% Alternative Minimum Tax (“AMT”) add-back) for stock acquired between August 11, 1993 and February 17, 2009. Stock acquired between February 18, 2009 and September 27, 2010 is eligible for 75% gain exclusion (subject to 7% AMT add-back), and stock acquired after September 27, 2010 receives a 100% exclusion, without an AMT add-back.

Andersen Tax offers a more complete list of QSBS requirements.  In case you’re wondering, the recent Tax Cuts and Jobs Act of 2017 did not alter QSBS rules, but the reduction of the federal corporate tax rate to 21% affects the magnitude of the QSBS benefit relative to a sale of assets. It is my understanding that California’s Franchise Tax Board no longer allows an exclusion on the gain of QSBS.

M&A Perspective

Even if you hold stock that meets QSBS requirements, you may not be able to benefit from the rule because acquirers of small private businesses generally prefer to buy assets, not stock. For buyers, buying assets reduces their tax bill, improves their cash flow, and reduces potential legal liabilities. To forgo these benefits (i.e. you ask them to buy stock) buyers usually expect a substantial price discount. Read my recent blog on personal goodwill for more on the C-Corp tax dilemma.

Given the magnitude of the QSBS tax break, especially when eligible for 100% exclusion, a seller of QSBS could give a buyer a substantial discount and still come out well ahead (compared to selling the company’s assets). Even Uncle Sam benefits in the long run!

Do you have QSBS?

The prospect of selling qualified small business stock is compelling, however determining whether your stock qualifies and claiming the benefits is not simple.  Be sure to work with a CPA that is well versed in QSBS requirements and the steps needed to comply with them.

If you intend to sell your business some day, be aware that tax minimization strategies such as QSBS can have a major impact on how much money you take home after taxes. Some strategies can take 5 years or more to implement, so start early, and be sure that your tax advisor is involved and up to the task.

*  *  *

Exit Strategies Group’s M&A brokerage professionals dedicate themselves to staying abreast of tax minimization strategies in business sale, merger and acquisition transactions.  Al Statz is founder and President of Exit Strategies and is based in Sonoma County California.  For further information on this subject or to discuss selling your company, Al can be reached at alstatz@exitstrategiesgroup.com or 707-781-8580.

May 10th Seminar: How to maximize the value of your business upon exit.

Are you starting to think about retirement, but don’t know how best to transition out of your business? Consider attending a free breakfast seminar hosted by Exit Strategies Group and Exchange Bank on how to maximize the value of your business upon exit.

  1. This 1-1/2 hour seminar will answer the following questions:
  2. What are the value drivers that determine how much my company is worth?
  3. What can I do to prepare my company for sale? What should I not do?
  4. What are the steps in the sales process?
  5. What is the current state of the business sales market?
  6. What criteria does a bank use to qualify my business for a bank loan?
  7. How do I maximize the proceeds from the sale of my business?

The Details

May 10th, 2018 7:30 am to 9:00 am in Santa Rosa. A continental breakfast will be provided.

Space is limited.  For your privacy, only one company per industry will be allowed to attend. To reserve a spot, RSVP to Adam Wiskind, awiskind@exitstrategiesgroup.com or call (707) 781-8744.

About the Sponsors

Exchange Bank was the #1 Community Bank SBA Lender in Sonoma County in 2017, and is a Preferred SBA Lender and a Top Ranked SBA Lender in the San Francisco District/Greater Bay Area.

Exit Strategies Group is a full-service mergers and acquisition brokerage firm serving private companies with $1-50 million in revenue. Exit Strategies also offers expert business valuation services for many reasons including exit planning, buy-sell agreements and litigation opinions.

If you are unable to attend but would like information on maximizing the value of your business, please contact Adam.

How Do I Sell My Personal Goodwill?

The concept of goodwill in a business sale is familiar to most business owners. The more the better, right? Personal goodwill (versus enterprise goodwill) on the other hand is less familiar, and trickier to deal with. If your small company (say up to around $10 million revenue) is structured as a C-Corporation, you should know about personal goodwill and how its existence could put more money in your pocket when it’s your time to sell. Here’s how it works.

The C-Corp Dilemma

Sellers of C-Corps prefer to sell the stock of their companies because it is more tax efficient than selling assets; yet the reality is that most of these sales are structured as asset transactions. Why? Because, for buyers, buying assets reduces their tax bill, improves their cash flow, and reduces potential legal liabilities. Astute buyers that are asked to forgo these important benefits (i.e. you require them to buy stock) will expect a substantial price discount. Some will just walk away.

For an S-Corp on the other hand, which is a pass-through entity, selling assets (vs. stock) usually isn’t a much of problem from a tax perspective. In some cases, selling assets can be an advantage.

But for C-Corps, selling assets is usually a big disadvantage. Here’s a simple example. Assume that the combined federal and state C-Corp income tax rate is 29%, and that the combined individual capital gain tax rate is 28%. In an asset sale, for every $1.00 of transaction price (above book value of assets), C-Corp shareholders net only 51¢. Could this happen to you?

Does the Goodwill Go Home at Night?

Goodwill value is that portion of a business purchase price that exceeds net tangible asset value. Personal goodwill (“PGW” for short) differs from enterprise goodwill in that PGW represents the value of an owner’s personal service to that enterprise, and is considered an asset owned by that person, not the business. PGW value is usually the result of an individual’s outstanding reputation and close personal relationships with customers and/or suppliers, or exceptional rainmaking or technical mastery, and other unique abilities that directly produce economic benefit for the business.

When PGW is present, the success and value of a business are largely dependent upon one or two key individuals, usually the owner(s) in a small business. Without the key individual(s), the business may have little value. In other words, the goodwill goes home at night!

Personal Goodwill Presents a Tax Savings Opportunity

In asset sales of small owner-operated corporations, there can often be two sellers: (a) the business entity, and (b) an individual selling his or her personal goodwill. Selling PGW creates a tax savings opportunity for C-Corp owner-operators.

Using the same tax rates as above, for every $1 of transaction price that can be allocated to personal goodwill, the seller’s tax savings is 21¢. This is because the $1 allocated to PGW does not get taxed at the C-Corp level (is not “double taxed”). Suppose that in a $2 million transaction, $800K can be allocated to personal goodwill. This reallocation puts $168K more in the seller’s pocket.

Devil’s Details

Allocating part of the purchase price to personal goodwill has been an arrow in our quiver for the past decade or so; however, it cannot simply be a post-closing purchase price allocation by the parties CPA’s. Rulings in several tax court cases demonstrate that PGW is under consistent attack by the IRS.

When a C-Corp seller is considering allocating a portion of a sale price to personal goodwill, these are some of the norms for supporting the existence of PGW apart from enterprise goodwill, and having a PGW allocation hold up to IRS scrutiny:

  1. There must be a separately negotiated PGW purchase agreement with the buyer. As brokers, we plan for this with the seller and buyers, before an offer is made. We coordinate with the parties’ attorneys and CPA’s of course and let lenders know that the final paperwork will change.
  2. There must be a separate paid for covenant not to compete with the seller.
  3. The buyer must have access to the seller’s personal goodwill through a written employment/consulting agreement for an extended term, with market-based compensation.
  4. The amount allocated to PGW must be based in economic reality. Though the valuation of personal goodwill is still more art than science, a third-party PGW valuation should be obtained to substantiate and set the final allocation.

This Sword has Two Edges

Selling any business with high personal goodwill is challenging. When goodwill goes home at night, valuation and marketability are generally reduced. Having a C-Corp structure adds yet another layer of difficulty and expense because of double taxation. Working with an experienced M&A broker, transaction attorney and CPA is extremely helpful when buying or selling this type of business.

Side-Step this Landmine

Better yet, if you own a C-Corp business and your expected holding period is 5 years or more, talk to your CPA now about converting to S-Corp status so that you can avoid the possibility of being double taxed when you are ready to sell.

Exit Strategies Group’s professionals dedicate themselves to staying abreast of potential tax breaks and pitfalls for private business owners as they carry out business sale, merger and acquisition transactions. Al Statz is founder and President of Exit Strategies and is based in Sonoma County California. For help or further information on this subject he can be reached at alstatz@exitstrategiesgroup.com or 707-781-8580.