Plan Now for Inside Buyouts: Business Owners and Their Advisers Must Weigh Tax Consequences, Tax Cliff or Not, When Considering a Sale
EXECUTIVE SUMMARY * Inside buyouts are often an attractive option for business owners looking to sell. The owners know and trust the buying group and have control over the process, including the timing of the transaction, specific percentage of the sale, and its terms. These attributes often make buyouts preferable to selling to a third party. * An inside buyout is the process of transferring ownership of a private company to key managers themselves, key managers in partnership with private equity, employees and employee stock ownership plans (ESOPs), or family members. * Timing is especially important, with the potential consequences of the tax cliff. Through various buyout types, sellers can avoid a possible sharp increase in capital gains taxes by executing the sale before Jan. 1, 2013. * CPAs can take an active role by helping business owners determine their best option. Inside buyouts are attractive to CPA firms because of the expanded opportunity to provide strategic and tax planning assistance and the likelihood of retaining the client long term. * Inside buyouts can take on several forms, Management buyouts transfer control to a few key employees. Management sometimes works with private equity to help finance the transaction. * Employee cooperatives or ESOPs spread ownership among a larger portion of the company and can have several tax advantages for the seller. Strategic and well-timed transfers to family members have the potential to take advantage of the current large unified estate and gift tax exclusion. * Depending on the complexity of the transaction, CPAs might need to enlist the help of outside experts. Valuation is one critical part of the buyout, and an independent voice is needed if experience in that area is lacking. * CPAs in industry are attracted to inside buyouts because, as key financial executives, they have an opportunity for equity participation in the future of their employer. Depending on the skills demonstrated to the company, industry members could negotiate an attractive package of participation. ********** Succession planning took a hit in recent years. The financial crisis of 2008 touched off an unnerving chain of events for business owners looking for an exit. Constrained lending diminished the number of able buyers and lowered valuations. Baby Boomers, particularly those close to retirement, were forced to put plans on hold. Now a confluence of financial and political factors--from an improved economy to concerns about a possible sharp rise in tax rates known as the tax cliff is turning some patient sellers into more eager ones. For companies that have deferred succession the past few years, there is still time to implement a plan before Jan. 1, when capital gains tax rates are scheduled to increase. CPAs can take an active role by helping business owners pick the best option and showing them why timing matters. Tax cuts originally passed during the George W Bush administration relating to capital gains, dividends, and ordinary income are scheduled to expire Jan. 1. Without congressional action, the top rates, now at 15%, will reset to the rates immediately before the reductions, generally 20%. Also, surtaxes imposed by the Health Care and Education Reconciliation Act of 2010, P.L 111-152, (one of the major components of health care reform) could add another 3.8% to those rates, depending on income. For succession-minded business owners, inside buyouts have been a timeless and reliable exit strategy. Inside buyouts are diverse, applicable to a full range of economic conditions, with a company's circumstances and the seller's tax situation driving the choice. For many, the nation's looming tax cliff could make now the right time to implement an exit strategy. This article discusses different ways to structure an inside buyout and explores the advantages and disadvantages. …