Naturally, with the sale of the business to a third party, the importance of the family dynamics is less crucial, as they will not have to work together in the business. However, after a business owner decides to sell his business upon retirement (or to have it sold at his death), there are three main issues that arise.
The first is one of valuation: How will the family business be valued? There are different ways to value a business, including (a) the income approach, (b) the market approach, (c) the cost approach, to name the most common.
Under the income approach, the valuation expert or appraiser calculates the future anticipated cash flow from the business and expresses it as a single present dollar amount. Variations on this approach exist, one for each variation on the definition of “income.” For example, some approaches count income from after-tax profits, others pre-tax profits, and others still from EBIT (earnings before interest and taxes).
The market approach seeks to compare similar businesses with the seller’s business to arrive at a comparable valuation. This is akin to what is done with residential real estate valuations. The cost approach determines a business’ value by considering the value of its assets. This approach is also called the asset based approach. Essentially, the valuation method here is to determine the value of the business by a hypothetical liquidation of its assets. Because goodwill is not included in this valuation approach, it often understates the true fair market value of the business, although it serves as a helpful “base” value as a check against the conclusions of other valuation methods.
The second question a business owner must think about with his business exist strategy is who would be empowered to negotiate the sale terms. This is mostly a business and personal question, one that is best answered by the owner himself or herself, rather than by legal counsel.
The third question a business owner must ask himself once he decides to sell his business is how will the estate and/or income tax consequences of the sale be dealt with. If the owner dies owning part or all of the business, it will be included in his estate, and possibly subject to estate taxes. This remains true even if the business is to be sold upon his death. The government will value the business at the date of his death (unless the so-called alternative valuation date applies which is six months after date of death where the business’s value and other assets in the estate are depreciating). Similarly, if the business owner sells the business during his lifetime, then he will likely incur a capital gain tax from the transaction. Before selling, the owner should speak with his tax attorney so they can structure things in a tax smart way.
