Perhaps you attended a speech in a scenario like this: The audience wanders into the auditorium and takes their seats. Before someone introduces the main speaker that person says he has an important message to deliver. The announcement explains that there are multiple exits to the room and tells the attendees to look around to find the exit nearest them. When there is a need to use the exits, the audience should proceed in a careful manner to that exit. With the conclusion of that announcement, the main speaker is introduced and the audience listens attentively. Likely, the announcement is made because of a law in that community that requires that instructions be given with regard to how to leave in an orderly manner.
A great comparison can be drawn between the scenario just described and almost anyone’s business. If it’s not your personal story, then you have met someone who started their business as a hobby in their garage or basement. Essentially, this person ‘wandered into the firearms business.’ Over a period of years, this individual’s business grew to the point where a store front location was required and eventually a shooting facility was added.
Growth to the business, as with any business, comes only because of success. Growth requires time to manage profitably, and that time is likely not spent looking for, or thinking about, the ‘exits.’ The comparison continues as this is where many business owners wish there had been a requirement similar to that in the auditorium, when an individual–perhaps an accountant, attorney or business coach–had given a speech similar to our example.
Too often looking for the exits occurs only when someone is ready to get out of business. A couple interviewed for this article stated they called for advice only at the point a competitor visited their business with an offer in hand to purchase their business.
Others have come to a point in time where a stressful situation, a medical or family situation, or simply age or exhaustion cause a person, or couple, to decide that it is time to look for the exit.
Surely, many a business has changed hands, or even closed, because of these situations. Another individual spoken to for this article had experienced many successive years of operating a profitable business. However, a less than stellar 2012 and 2013 had this owner convinced it was time to simply hold a clearance sale and close the business. Yet, two years ago this individual had taken a salary in excess of $100,000.
The business changing hands, or closing, in either of these situations would allow the current owner to get out of the business, but would do so at a very sizable financial loss.
If you are years from wanting to get out of the business, this information is reaching you in plenty of time. If you want to get out of the business now, allow this article to persuade you to consider delaying your exit because of the potential for additional dollars for you.
Of course, if you are thinking you will transfer the business to the next generation of your family, we will look at the situation somewhat differently. The same could be said if the new ownership is to be an employee. In any situation we will start with the current day and your ownership of the business.
Think first of an individual who is an employee of a business. At the end of the year they receive a W-2 for their work, and their tax return is somewhat easy to complete. They may have deductions for mortgage interest, child care, medical expenses and a few other expenses that occurred over the course of the year.
The case of the business owner is somewhat different. Though it should be a discussion between you and your accountant, claiming your cell phone as an expense for your business is a possibility. Instead of an allowance, your children can become employees of your business by performing some work. If you are doing some of your business work at home, your residence may qualify as a partial business expense. The list of possibilities goes on and on. These possibilities are reserved, however, for owners of businesses.
Most likely your accountant has been advising you as to how you can maximize business ownership to your advantage with regard to taxes. The logic of maximizing the benefit of business ownership is that you are not as concerned with what the business is reporting as a profit when the owner can legitimize what would be non-deductible personal expenses to an individual.
All of this is fine until the owner of the business decides he or she wants to sell the business. If the business is to be sold, the first question is about the price. With some degree of variation, the person selling the business will be asking to be paid for the inventory.
The owner should be asking for payment for inventory at ‘landed cost’ instead of the cost of the item. As an example, think about any item being sold and the price paid to the wholesaler or manufacturer. Secondly, think about that same item having been received by the dealer, unpacked, tagged with a price and displayed on the shelf. Obviously the product sitting on the shelf of a dealer has a higher cost than the same item sitting on the shelf at the manufacturing facility.
Secondly, the selling dealer should expect a fair market price for the fixtures, equipment and the ‘build out’ of the business. The ‘build out’ is things like carpeting, offices, light fixtures, rest rooms and all the other necessities to change a bare and empty building into an attractive sales floor.
Speaking of a building, this is where you determine the price for selling the building. A market analysis, likely produced by a local real-estate person, can provide guidance on establishing that figure.
At this point it could be said that the selling dealer has only recovered money that has already been invested in the business, with the exception of the appreciation or depreciation of the building.
However, this is where a business that has a history of profitability over the years rewards the selling dealer. The purchaser of the business likely is going to ask to see from two to five years of profit-and-loss statements. Of course, the purchaser is looking to see how much money you have made in the business. This two-to-five years of profit-and-loss statement speaks to the reason why the current owner will not want to be maximizing the ability to have the business provide them with a vehicle, employ additional family members or allow the business to be paying this type of additional expenses.
Looking at these years of profit-and-loss statements, the purchaser should make an offer to pay an additional amount that takes into consideration the net profit of the business over the years. One example would be an offer of taking the average of the net profit of the past five years and taking 2.5 times that number. There is no set pattern of how this works. The purchaser is making the determination of how this calculation is made based upon personal experience in purchasing other businesses and information from advisors.
This dollar amount is referred to as “blue sky” or “good will.” Considering this and the price for inventory, fixtures, equipment, build out and a building, the selling dealer and the purchaser will finally come to an agreement for the price of the business.
Though you would hope this would be the conclusion of the negotiation, more is to come. The next step is the allocation of the funds. As an example, if the fair market value of the fixtures, equipment and build out is $100,000, but the selling dealer has depreciated all of this to a “book value” of $10,000, there will be a tax bill on the $90,000 difference. A similar situation could occur for the building. The good will or blue sky will likely be a taxable amount.
The owner, who is expecting to sell the business, receive a sizable check and move onto the next stage of life, is likely going to have an unpleasant surprise—the possible need to write a check to the Internal Revenue Service for a large portion of what the dealer thought he or she was taking home.
This is where financial advice from an attorney and accountant will be of value to you if you decide to sell. Their counseling will help you structure the agreement so that the income will come to you over a period of years.
The person purchasing the business is very likely not going to come with all cash on hand. An old adage of selling a business is that the selling dealer should not take their existing business as collateral in the loan. The reason for this is the challenge of getting the business back in the case of the buyer running the business into the ground.
Selling the business requires planning—not just in valuing the business but in the years before so as to maximize the selling price and in the transaction so as to keep as much of your hard-earned money as possible.