Welcome, aspiring and long-time business owners, to the world of strategic planning and financial foresight. As a Certified Public Accountant (CPA) and experienced business consultant, I understand the allure of envisioning the day when you sell your business and reap the rewards of your hard work, it is the American Dream. However, it is crucial to shed light on the realities of exit transactions, which often involve deferred and contingent payments rather than an immediate windfall. In this blog post, we will explore the reasons behind payment structures in business sales and the importance of early planning to ensure a smooth transition. So, let's embark on this journey together.
Why Cash Isn't Always King
Before we delve into the intricacies of payment structures, it is essential to understand why business sales rarely involve 100% cash transactions at closing. The truth is that a vast majority of privately-held businesses are sold to internal buyers such as managers, family members, or Employee Stock Ownership Plans (ESOPs). These potential buyers typically lack the necessary financing to pay the entire ownership value upfront, making full cash payments unrealistic.
Moreover, even if an external buyer possesses the required funds, they may prefer to structure the payment over time to mitigate risks associated with the transition. As businesses have evolved from manufacturing to service-based economies, intangible assets such as human capital and intellectual property have gained prominence. Buyers are keen on minimizing the uncertainty surrounding employee retention, and they often request the active involvement of the exiting owner during the transition. Consequently, a portion of the selling price may be contingent upon achieving specific goals in the post-sale period.
The Distinction: Notes vs. Earn-Outs
When payments for the sale of a business extend beyond the closing date, they typically fall into two categories: contingent payments and note payments. Contingent payments are conditional and disbursed only when certain predetermined events occur. On the other hand, note payments are essentially IOUs, with the buyer making installment payments over time, transforming the exiting owner into the financier of the transaction.
It is crucial to recognize that both contingent and note payments come with inherent risks. Future payments are subject to uncertainties and may not be received as planned. Additionally, it is important to consider the tax implications of receiving sale proceeds in future years, as they will be subject to the prevailing tax rates at that time.
Planning for the Journey Ahead
Now that we have demystified the dream of immediate and complete payment at closing, let's shift our focus to proactive planning. It is never too early to begin strategizing for this significant milestone in your business journey. To gain clarity on when, how much, and under what conditions you will receive your exit proceeds, consider engaging in a comprehensive assessment process.
As a CPA, outsource CFO and business consultant, I offer a short assessment that can help you address all the pertinent issues related to the payment structure of your exit transaction. This assessment allows us to collaboratively explore your specific situation, estimate future payments, factor in potential tax implications, and ensure that you are well-prepared for this once-in-a-lifetime event. Click here to take a survey on your readiness to exit your business.
Conclusion: A Paradigm Shift in Perspective
While the vision of a business sale leading to immediate financial freedom may seem distant, it is essential to face the realities of the journey. By understanding the reasons behind payment structures and proactively planning for your exit, you can navigate the transition process with confidence. Remember, as a CPA and business consultant, I am here to guide you and provide valuable insights to ensure you receive the value you deserve when exiting your business.
If you're ready to gain a deeper understanding of your payment options and embark on your exit planning journey, I invite you to contact our office. Together, we can navigate the complexities and help answer the fundamental question, "When will I receive the value for exiting my business?"
Miller Glover, CPA