Maximize Exit Value
About the Author
Business Exit Strategist
40 years as an entrepreneur. Consultant to business owners across the country on strategic planning and SBA projects. On a mission to help every owner get every dollar they deserve.
Source: https:www.youtube.com
Key Points Covered
- Asset Sale vs. Stock Sale:
Asset Sale (Most Common): The seller transfers individual assets (equipment, computers, inventory, goodwill).
Stock Sale: The buyer purchases the actual equity/shares of the business entity. The Battle Between Goodwill vs. Tangible Assets:
Goodwill: Covers intangibles like brand name, customer lists, and reputation.Tangible Assets: Covers fixed assets like machinery, furniture, computers, and equipment.
Competing Tax Motivations:
The Seller’s Goal: Maximize Goodwill. Income from goodwill qualifies for lower long-term capital gains tax rates. Allocating too much to depreciated fixed assets triggers ordinary income tax recapture (higher tax rate).The Buyer’s Goal: Maximize Tangible Assets. Equipment can often be written off rapidly in Year 1 using Section 179 or bonus depreciation. Goodwill, by contrast, must be amortized over 15 years.
IRS Requirements & Reporting:
The IRS requires both buyer and seller to agree on the allocation and report identical numbers on their tax returns (Form 8594).
Crucial Step: Spell out the exact asset allocation explicitly in the purchase agreement created by attorneys before closing the deal.
So you want to sell your business. Let me tell you one of the biggest issues that we see from a tax standpoint whenever somebody goes to sell their business.
A lot of times when we get somebody who sold their business, it’s usually after the fact. We prefer that they come to us first before they sell so we can kind of go over some of these things. But a lot of times after the fact, what—what is one of the biggest problems that you see from a business sale that we would like to try to get people in front of?
There’s two ways to sell a business and a lot of it revolves around an asset sale. Nine times out of ten, it’s going to be an asset sale. So when you sell the—and that’s essentially what it is, you sell the assets of your company.
The other way would be a stock sale, where you’re just selling the stock, the shares of the business. Yeah, or in assets, yeah.
And a lot of time we see those some, but they’re just not the norm.
Asset sales, you—that’s really what did you sell: the computers, the chairs, the furniture, the fixtures, machinery, equipment, all of the assets of the company. And of that calculation, there is what’s called goodwill. So goodwill is all of the intangibles. That’s going to be your name, your brand, your reputation, customer list—all of the intangibles of your company is made up of goodwill.
The biggest issue we see is when somebody sells their business for, let’s say, a million dollars—sold all the assets, all the equipment, everything, a million dollars, got it. But they did not say, “Well, how much of that sales price is going to be allocated to goodwill?” Because it’s really important to know, because goodwill has, um, more preferred tax rates on the gains.
If you sell a business for a million dollars and $900,000 of that is to goodwill, well then you’ve got $900,000 worth of income there that’s taxed on a long-term capital gain rate. Whereas if you have it the—the opposite, where you have $900,000 applied to the fixed assets that you’ve depreciated through your business—you’ve taken tax deductions for—you have to—there’s an ordinary income recapture piece to it.
All that means is you’re going to pay higher taxes on that because that’s all ordinary income, or there’s a portion of it that’s going to be taxed as ordinary income. And, um, it’s just not a great tax treatment for the—for the seller, right?
If you’re selling the business, you really want a high goodwill valuation and a smaller valuation on the equipment portion.
The buyer wants the exact opposite. You’re pinned against each other. You’ve got to agree on how you want to treat it.
But the buyer wants the exact opposite because using the million-dollar business sale as an example, if you buy goodwill for 900 grand, you have to amortize that over 15 years. You have to write that off against your income over 15 years, so it takes a long time to kind of recoup that, right?
Whereas if you have $900,000 allocated to equipment and tangible items, there’s—you can often depreciate those even in like the first.
So you’re both pinned against each other, but the biggest thing is you—you both have to agree.
The IRS is silent on it because they don’t care, yeah, because two people have to agree. If one gets—if one gets it the way they want, the other person didn’t. So there’s a balancing effect there that the IRS just doesn’t.
As long as both par—all the IRS wants to know is that both parties agreed to how it’s going to be treated, and we have to actually attach a tax form to your tax return saying all of this information, how it was split up. And you have to report the business that—that purchased, so that way, because they go look and make sure they filed the same form.
The biggest thing is just making sure when you’re going through the process with your attorney, make sure that your attorney, you know, spells that out in the paperwork: that that business was sold for a million dollars, here’s your asset allocation—equipment $900,000, goodwill $100,000. Just—it’s got to be spelled out in there. It makes our life easier, it’ll make your life easier so we’re not trying to go back to somebody after the date to say, “Hey, how do we want to do this?”
Because getting that done afterwards, it’s not good. It’s not where you want to be. It’s not the situation you want to be in. So …food for thought—just try to make sure you break that out.