One of the most common questions I receive as a small business advisor is how to properly prepare your business for succession. Succession planning refers to planning to hand off your business to another party.

Common reasons for succession planning can include a business sale, a business partner divorce, premature death, premature disability and retirement. Understanding the importance of succession planning and how to properly implement the strategy will help to protect both your business and your loved ones when you are ready for this transition step to occur.

Have a Plan

The first and most important step to take with regards to a succession plan is to in fact have a plan in place. To many times a business owner or their family are caught off guard without an execution plan in the event of a forced succession.  A succession plan should include the following key concepts:

• The strategic long term and short term visions for the business
• The ideal departure plans for the business owner or owners
• Any potential heirs or successors should be identified
• Determining a transition plan for the business to the heir, new owner or otherwise identified successor
• A discussion of any potential tax implications and how to reduce them

Choosing the Right Exit Strategy

There are several possible business exit strategies to consider when developing a succession plan, including passing a business onto an heir or a group of heirs, selling the business to an existing business partner or selling the business on the open market. Each of these choices has both advantages and disadvantages to take into consideration and the type of business and current business structure will often determine which option is the most appropriate.

Business Valuation

An important by product of having a succession plan in place is that it forces you to get a business valuation. It is important to note that not all businesses have a concrete value. For example, if someone were to own a consulting business that centered solely around an individual’s key talents and time, its valuation may not exist. So, working through a succession plan will help to place a realistic valuation on the business so that it can be sold or properly valued in the event of a voluntary or forced succession.

Develop a Communication Plan

In some cases, a business owner will have a well thought out succession plan, but it is neither written down nor communicated to the important parties. A succession plan should ideally be prepared by an experienced tax professional and/or financial professional who can work through not only the legal parameters of a succession, but also any tax minimization strategies. Once the succession plan has been professionally written, the plan should be communicated with vital family members, business partners or key employees.

Overall, developing a succession plan for a business is an important step to take. A succession plan can assist a business owner in developing an accurate valuation for future sale and tax valuation, it can help to protect loved ones in the event of a possible forced succession and it can help to minimize possible taxes.

How Capital Gains Affects Your Business – TIME IS NOT ON YOUR SIDE !!

By: Bill Marrero

You are probably aware that the current capital gains rate of 15% will increase to 20% after the end of this year unless Congress enacts legislation to extend the Bush tax cut. You may not be aware, however, of the additional Medicare Tax on investment income that will also apply as a result of health care reform legislation passed in 2010. The Medicare Tax adds an additional 3.8% tax for most types of investment income, including capital gains, for single taxpayers earning more than $200,000 and married taxpayers with combined income of more than $250,000.

Therefore, the combined impact of these increased taxes on business owners who sell their business after 2012 could be a 58.7% increase – from 15% to 23.8%! As an example, if the profit from the sale of your business is $250,000 you would pay $37,500 under the current capital gains rate. At the 20% rate those taxes would increase to $50,000. If your income qualifies you for the higher rate of 23.8%, your tax liability would increase to $59,000!

The average time it takes to sell a business is 6 to 18 months: at Alliant, our average is somewhat less. In any event, if you are contemplating selling your business please be aware that selling it after this year may significantly reduce the profit from the sale!

If you are planning to sell your business in the near future, now is the time to get started! Delaying that decision could end up costing you a significant amount of money. Please call when you are ready to proceed.

How Capital Gains Affects Your Business – TIME IS NOT ON YOUR SIDE !!

By: Bill Marrero

You are probably aware that the current capital gains rate of 15% will increase to 20% after the end of this year unless Congress enacts legislation to extend the Bush tax cut. You may not be aware, however, of the additional Medicare Tax on investment income that will also apply as a result of health care reform legislation passed in 2010. The Medicare Tax adds an additional 3.8% tax for most types of investment income, including capital gains, for single taxpayers earning more than $200,000 and married taxpayers with combined income of more than $250,000.

Therefore, the combined impact of these increased taxes on business owners who sell their business after 2012 could be a 58.7% increase – from 15% to 23.8%! As an example, if the profit from the sale of your business is $250,000 you would pay $37,500 under the current capital gains rate. At the 20% rate those taxes would increase to $50,000. If your income qualifies you for the higher rate of 23.8%, your tax liability would increase to $59,000!

The average time it takes to sell a business is 6 to 18 months: at Alliant, our average is somewhat less. In any event, if you are contemplating selling your business please be aware that selling it after this year may significantly reduce the profit from the sale!

If you are planning to sell your business in the near future, now is the time to get started! Delaying that decision could end up costing you a significant amount of money. Please call when you are ready to proceed.

Time is not on your side !!!!

A tremendously valuable company that garners the
attention of buyers in the marketplace, and is apt to receive multiple offers of
purchase, doesn’t just happen due to good luck or fortune.   Behind every
company of value stands years of preparation.   Preparation is the key to
winning.   Bobby Knight, one of the greatest basketball coaches of all time
said, “The will to succeed is important, but what’s more important is the will
to prepare.”   Brian Tracy, a great motivational speaker and leading expert on
success in business, has stated that there is no such word as overpreparation.
In discussing effective speaking, Tracy says that 90% of an effective speech is
determined by how well the speaker has prepared.

Likewise, preparation is the key to a valuable company
and a successful exit.   There are five key areas that business owners must
continuously focus on as they prepare their company for an exit at the highest
possible value.

• Ensure that key financial statements are
  prepared timely and accurately.   Good, clean financial statements open the door
  to prospective buyers by giving them a clear insight at a company’s financial
  status.   This creates a level of confidence into the company’s true condition and sets it apart from the
  competition.
• Build a customer base that is loyal, increasing, and
  diversified.  A prospective buyer wants to know that customers are fiercely
  loyal to the company because of the company’s excellent service and value.   By
  diversified, I mean that the business is not dependent on any one customer for
  survival, but that the customer base is adequate to withstand the loss of one or
  more.
• Manage the company within the parameter at all
  times that Cash Is King.   Strong positive cash flow is at the very top of a
  prospective buyer’sinvestigation.   The
  more cash generated the higher the value and the greater likelihood of multiple
  offers.   Be sure that cash flow is measured, projected, and controlled with a
  solid financial infrastructure.
• Run the company with the understanding that
  people are the most valuable asset.   Continually evaluate people and ensure
  that key people are competent and treat the company as their own.   Make sure
  all reward and incentive systems reward competence and loyalty.
• Finally, but most importantly, lead at all times
  with integrity. Potential buyers can quickly determine if they are dealing with
  a credible leader.   Their confidence soars in a company when they know they are
  dealing with a person of integrity, because they can trust what they are
  purchasing to be what it claims to be.

Preparation in the above five areas will result in a
company of high value.

The Bush era tax cuts, which were set to expire on Dec. 31, 2010 and were extended for two years, are going to expire on Dec. 31, 2012.  If this happens the regular top rate on capital gains will rise from 15 percent to 20 percent.  In addition, the provision known as the “Pease Limitation” will return in full force.  This provision increases effective tax rates on high income earners by reducing the value of their itemized deductions.  This will add about another 1.2 percentage points to the capital gains rate of high income earners.

And that’s not all.  The health reform enacted in 2010 imposed a new tax on the net investment income of high income taxpayers, including capital gains, effective Jan. 1, 2013.  This will add another 3.8 percentage points to the capital gains rate.

Put it all together, and unless another tax cut extension occurs (highly unlikely), the top tax rate on capital gains is currently scheduled to increase from 15% to 25% on Jan 1, 2013.  Additionally, since 1978 the top capital gain rate has been increased to 28% on several occasions.  So the possibility exists that the top rate has a chance of going above 25%.

With all the conversation about capital gains tax, the pending expiration of the Bush Tax Cuts and the additional tax associated with the 2010 health care legislation, now is the time to take action by any business owner considering selling his/her business during the next few years.  A 15% capital gain tax rate is certainly much more appealing than the risk of experiencing a 25% to 30% rate.

One of the biggest hurdles you’ll face in running your own business is staying on top of your numerous obligations to federal, state, and local tax agencies. Tax codes seem to be in a constant state of flux making the Internal Revenue Code barely understandable to most people.

The old legal saying that “ignorance of the law is no excuse” is perhaps most often applied in tax settings and it is safe to assume that a tax auditor presenting an assessment of additional taxes, penalties, and interest will not look kindly on an “I didn’t know I was required to do that” claim. On the flip side, it is surprising how many small businesses actually overpay their taxes, neglecting to take deductions they’re legally entitled to that can help them lower their tax bill.

Preparing your taxes and strategizing as to how to keep more of your hard-earned dollars in your pocket becomes increasingly difficult with each passing year. Your best course of action to save time, frustration, money, and an auditor knocking on your door, is to have a professional accountant handle your taxes.

Tax professionals have years of experience with tax preparation, religiously attend tax seminars, read scores of journals, magazines, and monthly tax tips, among other things, to correctly interpret the changing tax code.

When it comes to tax planning for small businesses, the complexity of tax law generates a lot of folklore and misinformation that also leads to costly mistakes. With that in mind, here is a look at some of the more common small business tax misperceptions.

1. All Start-Up Costs Are Immediately Deductible

Business start-up costs refer to expenses incurred before you actually begin operating your business. Business start-up costs include both start up and organizational costs and vary depending on the type of business. Examples of these types of costs include advertising, travel, surveys, and training. These start up and organizational costs are generally called capital expenditures.

Costs for a particular asset (such as machinery or office equipment) are recovered through depreciation or Section 179 expensing. When you start a business, you can elect to deduct or amortize certain business start-up costs.

For tax years beginning in 2010, you can elect to deduct up to $10,000 of business start-up costs paid or incurred after 2009. The $10,000 deduction is reduced (but not below zero) by the amount such start-up costs exceed $60,000. Any remaining costs must be amortized.

2. Overpaying The IRS Makes You “Audit Proof”

The IRS doesn’t care if you pay the right amount of taxes or overpay your taxes. They do care if you pay less than you owe and you can’t substantiate your deductions. Even if you overpay in one area, the IRS will still hit you with interest and penalties if you underpay in another. It is never a good idea to knowingly or unknowingly overpay the IRS. The best way to “Audit Proof” yourself is to properly document your expenses and make sure you are getting good advice from your tax accountant.

3. Being incorporated enables you to take more deductions.

Self-employed individuals (sole proprietors and S Corps) qualify for many of the same deductions that incorporated businesses do, and for many small businesses, being incorporated is an unnecessary expense and burden. Start-ups can spend thousands of dollars in legal and accounting fees to set up a corporation, only to discover soon thereafter that they need to change their name or move the company in a different direction. In addition, plenty of small business owners who incorporate don’t make money for the first few years and find themselves saddled with minimum corporate tax payments and no income.

4. The home office deduction is a red flag for an audit.

While it used to be a red flag, this is no longer true–as long as you keep excellent records that satisfy IRS requirements. Because of the proliferation of home offices, tax officials cannot possibly audit all tax returns containing the home office deduction. In other words, there is no need to fear an audit just because you take the home office deduction. A high deduction-to-income ratio however, may raise a red flag and lead to an audit.

5. If you don’t take the home office deduction, business expenses are not deductible.

You are still eligible to take deductions for business supplies, business-related phone bills, travel expenses, printing, wages paid to employees or contract workers, depreciation of equipment used for your business, and other expenses related to running a home-based business, whether or not you take the home office deduction.

6. Requesting an extension on your taxes is an extension to pay taxes.

Extensions enable you to extend your filing date only. Penalties and interest begin accruing from the date your taxes are due.

7. Part-time business owners cannot set up self-employed pensions.

If you start up a company while you have a salaried position complete with a 401K plan, you can still set up a SEP-IRA for your business and take the deduction.

A tax headache is only one mistake away, be it a missed payment or filing deadline, an improperly claimed deduction, or incomplete records and understanding how the tax system works is beneficial to any business owner, whether you run a small to medium sized business or are a sole proprietor.

And, even if you delegate the tax preparation to someone else, you are still liable for the accuracy of your tax returns.

Throw the keys to the buyer, grab a check and hit the exit. That’s the expectation of many owners selling their businesses. But it’s also an increasingly rare scenario.

More sellers are being asked to help finance sales of businesses for buyers, so that sellers are paid in installments over time.

Many buyers these days also want or require sellers to continue to work at the firms, post-sale, so that  buyers can more easily take over the managerial role without disrupting employee or customer relationships.

These trends are a sometimes unpleasant surprise for owners who hoped  that sales of their business would enable a complete retirement.

Kathryn MyersNina Howard, in May 2011, demonstrates face massage techniques to a class at Bellanina Institute, the training facility located in her Ann Arbor spa.

One report released last month suggests that many owners count on an eventual sale of their firms to fund their golden years. More than half of 1,255 business owners surveyed by the American College in Bryn Mawr, Pa., said they were concerned about getting the highest possible value for their businesses to help fund their retirements, according to the report.

The rise in seller financing is due in part to the fact that some buyers still aren’t able to secure sufficient third-party funding. It also reflects lingering concerns among buyers about business debt, or declining or flat business returns.

As many as 90% of the 2011 transactions at Generational Equity LLC, a business brokerage in Dallas, had a seller-financing arrangement, says Terry Mackin, managing director. That compares to 25% of the transactions handled by that firm before the recession, for example. Last year, the firm handled more than 40 deals nationwide, mostly in the $3 million to $5 million range.

Sellers of all ages often need to finance as much as 50% to 80% of the sale if bank financing is unavailable, says Joseph L. Caffrey, president and CEO of Worldwide Business Brokers LLC, a brokerage based in Virginia Beach, Va., with eight locations on the East Coast. Mr. Caffrey’s firm handled roughly 50 transactions last year, generally in the $2 million to $5 million range. He says that when a business has collateral, such as real estate, banks are more willing to lend to the buyer, but the seller will often still need to finance 20% or more.

Nina Howard of Ann Arbor, Mich., who sold her spa last year, thinks she could have gotten about $1 million for her spa in 2007. But she wasn’t ready to retire then.

Sales, then about $1.5 million, were hurt by a weak economy and had dropped more than 30% by 2010. A buyer who surfaced last year didn’t like the fact that the spa had some leftover debt from an expansion Ms. Howard undertook years ago, she says.

So Ms. Howard agreed to accept a value that was “significantly less,” she says, and to hold a 50% ownership of the business, post-sale, to keep the debt in Ms. Howard’s name. As part of an “earn-out” agreement, she now is required to work alongside the spa’s new owner for another four years, as its chief creative officer, at which point the debt should be paid off.

She had hoped to no longer work at all after the age of 60. Now 59, “I don’t have as much energy,” she says. Like many owners, she had little other savings because she had reinvested everything into Bellanina, the 17-employee day spa and massage school she started 1996.

Overall, about 37% of U.S. small-business owners were 55 or older in 2007, according to the latest available U.S. Census Bureau data, released in June 2011. That’s up from 31% in 2002.

Last year’s $155,000 median sale price of a small business was 18% less than in 2008 but 3% higher than in 2010, according to online marketplace BizBuySell.com, which compiled data on more than 6,700 sales of firms with $362,700 in median revenue.

Jeff Berkow in December sold Power Pallets, the Las Vegas wood-pallet  manufacturing firm he founded seven years ago. The 66-year-old covered 15% of the sale, agreeing to take payments in installments over five years.

He declines to say how much he got for the company. But he says he chose to stay connected to the company by becoming a lumber broker. This, he says, makes him more comfortable about getting paid the 15%.  “My preference would have absolutely been to get 100% cash up front,” he says.

1. Understanding Valuations: You need to understand  your industry

For example, does your industry use capitalization rates or percentage of sales or multipliers against SDE (Sellers Discretionary Earners)?  You need to know how to adjust off of these multipliers.  A slight difference in the industry category, for example, an assisted living facility vs. a skilled nursing facility, can mean a great difference in how you look at profit margins and what capitalization rate to use.

Also, a difference in the size of the business or project can alter multipliers as well, since various aspects of economy of scale come into play.  Yet, understanding these multipliers are just the beginning.  A good business broker or intermediary will recast the valuation based upon the nuances of a particular practice or business to fine tune the valuation to its true number.

2. Non-Disclosure Agreements:  The Need for Confidentiality and Confidentiality Agreements

In particular, sellers of a business are very concerned about having the confidentiality of their business being breached.  If word was to get out that their business was for sale, it could have a significant impact on morale, their ability to retain employees, their relationship with their competitors, and, in short, their bottom line.

A perspective Buyer, at the onset, needs to know and be educated on this aspect of  buying a business.  A broker/intermediary can assist both parties in ensuring confidentiality is maintained by not only assisting with the education process, but also ensuring the proper paperwork (e.g., NDA – Nondisclosure Agreements) are inserted into the process. And just as important, ensuring this paperwork is strong, creditable, and binding.   Too often, a buyer or seller use off-the-shelf contracts and NDAs that have not been vetted and provide little to no protection for either party.

Along with this aspect, as a seller, it is nearly impossible for you to personally attempt to sell your business and maintain that aspect of confidentiality. A third party needs to be inserted into the process to ensure non-disclosures are in place prior to divulging the name of the business. If you are the owner of the business, it becomes almost impossible to discuss the possibility of selling the business to a potential suitor without giving up which business it is.

3. Knowing the Market: You have to know what you are up against

Knowledge is power.  It also just makes good business sense.  Both a buyer and seller of a business need to know what other similar businesses have sold for or are on the market for; otherwise, you are just flying blind.  Having access to or finding that data pool can be difficult at best, particularly when it comes to businesses.

A good business broker has current and historical data that they can bring to the table to assist in this process.  Even as a seller, this data is extremely important since you may price your business either over or under price  of its true value.  Even over pricing your business could present problems.  In essence, you may pass by offers that are good but you don’t realize it.  As such, your business can sit on the market for a long period of time unnecessarily–the adage of “time is money” comes into play.

Obviously, as a buyer of a business, you do not want to overpay for a business.  If you do, you live with that mistake for many years to come.  A business broker or intermediary can not only help you gather the needed data, but also can help you know how to take that data and arrive at a true and fair price for that  particular business.  As mentioned, you first have to understand the baseline price but then you need to be able to know how to adjust off  that baseline to know what you should offer.  The key is having the data and knowing what to do with it, which is one of the roles of the broker.

4.  Negotiating the Sale: The value of  an intermediary

Emotion, emotion, emotion.  Similar to location–location–location, “emotion” can play a big part in the whole  selling process.  The importance of having someone act on your behalf, with knowledge of the industry, and having negotiated similar deals, can not be overestimated.  It can save you an inordinate amount of time and money.

Within this equation, is the aspect of emotion.  Having a broker help to “calm the seas” and effectively convey the pros and cons of an offer or counter-offer is extremely important, because sometimes it is not what you say but how you say it and who is saying it.  There is a natural combative interaction between a buyer and seller, and as such, having a third party on one side or both sides is a prudent way to alleviate the tension.

Thus, Step One is having an intermediary in the process. Step Two is ensuring that the intermediary has the experience, knowledge and temperament to articulate your point of view (buy/sell price, concessions, structure, etc.) in a manner that is understood and well received by the other side.

5.  Understanding the Whole Process: There is much to do

The buying and selling of a business is a process.  From a seller’s point of view, it is understanding the following:

• how to analysis their business (without emotion or prejudgement)
• the collecting of data
• the pricing
• the packaging
• the searching for and qualifying of the perspective buyers in a confidential manner
• the deal structuring
• the negotiation
• the closing and post-closing (e.g., non-compete, transfer, misrepresentations, etc.)

From a buyer’s perspective, it is understanding the following:

• how to analysis the business (without emotion or prejudgement)
• the collecting of data
• the searching for and qualifying of perspective businesses
• the deal structuring
• the negotiation
• the closing and post-closing

Underneath each of the above are various subsets to consider and work through.

Class Dismissed…At Least for Today

At the end of the day, although these steps can be “negotiated” solely by a buyer or seller, there is much merit to the idea of having an experienced third party, in the way of a business broker/intermediary, to provide their services to the buy/sell process to help avoid mistakes and missteps that can live with you for years to come

When companies are considering acquiring another company, they do extensive due diligence. They analyze balance sheets, income statements, debt history, customer lists, physical assets and equipment, the product and/or service offerings, etc. This is done to make sure that the buyer knows what they are buying.

However, there is another aspect of due diligence that is typically not done. I call it the non-financial audit. This is an analysis of the organization: its strengths and weaknesses, biggest needs, strength of management, culture, values, work environment and impact of a sale on customers and employees.

The first step to buying your own business is to make sure it is the right move for you and your family. Owning one’s own business is still very much “the great American dream,” but it’s not for everybody. Here are some questions that you should ask yourself before taking the next step.

How long have you been thinking about buying a business? Many people are interested in buying their own business, but are not willing to make the commitment necessary to move forward. They continue to look just like those who continue to look at new and expensive automobiles, but will never spend the money necessary to buy. One veteran observer has said that the longer you look, the less likely you are to buy.

What is your time frame to find a business?
If you’re thinking of buying a business in two years, it’s good to start your education. BizBuySell is a good place to start. Keep in mind that it really doesn’t make much sense to start your search now, since any business you find now will have been sold by the time you are ready to buy. It’s important, however, to arm yourself with all of the information and education available before you begin the search.

What is your primary reason for buying a business? If you are not motivated to buy a business, you won’t. You must go into business for yourself for the right reasons. If you’re tired of the corporate world, just have a “job-job,” or perhaps even a dead-end job, then business ownership may be right for you. Certainly if you’re unemployed or being transferred to a place where you don’t want to go – buying your own business can be a viable solution.

Are you willing to invest a majority of your liquid assets in a business? Buying your own business requires a serious financial investment. If you’re the type who does not want risk, you might want to rethink owning your own business. It is not for the faint-hearted.

Are you independent enough to make your own decisions and be in control? Operating a small business requires continual decision making. You’re the boss, and you are in control. All of the decisions are yours – right or wrong. And, you will make a lot of wrong ones. The question is, can you recover and keep going forward? If you brood about poor decisions or they keep you awake at night, owning your own business may not be for you.

Is your family supportive of your owning a business? If your family, especially a spouse, is not behind you 100 percent, then you should think twice about business ownership. It’s very important that you have the support of your spouse. He or she has to understand that running a business can be time-consuming. On the plus side, however, many businesses do allow for flexibility so you can attend the afternoon little league game.

Are you open-minded about different opportunities, or are you looking for a specific type or business? It’s best if you are open-minded, especially if you are a first-time buyer. There are many types of businesses available, and you don’t want to limit your choices. You should be looking for a business that will provide the income you need (or ability to do so), that you can afford, that has numbers that work, and, most importantly, that you can see yourself running.

Do you have reasonable expectations? Do you think that you can buy a business with lots of cash flow for $100? It’s important that you have realistic expectations about what your money will buy. Many sellers are willing to assist in financing the sale of their business, but remember, they’re not going to give it away. Keep in mind that many business owners have spent years building their business, and it may represent the biggest financial asset they have. They’re not going to just hand it over to you.

Can you make the “leap of faith” necessary to buy a business? Many prospective business owners do their homework, do everything necessary to begin the purchase process, and then back out of the transaction. They just don’t have the courage to go forward. There is nothing wrong with that; not everyone should buy and own their own business. However, if you don’t think you can part with your money and take over operating the business on your own, you may want to take a second look at business ownership.

Do you need a guarantee? If you are looking for a guarantee or a sure thing, then business ownership is not for you. You can and should look at all of the financials, tax returns, and all of the books and records. Remember, however, that they all represent history. You can’t buy anyone else’s history. A new owner makes changes, no matter how subtle. Their management style is different, and times change. You have to look at the business with the attitude of how you can improve things. The financial history of the business is certainly important, but it does not guarantee the future of the business – you do.