SELLER’S REMORSE
GEORGE WILSON ADAMS CPA MBA
December 20, 2021
Selling a business is one of the most important decisions an owner will ever make. You have one chance to get this transaction right because there is no going back. This article discusses key issues that pertain to selling your business, based on my own real-world experiences as a CPA with clients who take the plunge. One phenomenon I’ve personally seen is “seller’s remorse” where the former owner of a profitable business feels regret and wishes he had held on to it.
Here are some major issues to consider before you sell your business:
Look Before You Leap
Business owners consider selling their business for many reasons including health or financial issues, a desire for more leisure time, or simply exhaustion from dealing with the challenges and burdens of running their business. But always remember that a profitable business is like a goose that lays golden eggs. The income generated by a typical profitable business is usually irreplaceable: A business owner who sells is unlikely to have residual after-tax funds that can be invested in a way that generates the same income the business produced.
If you sell a business you may owe taxes on the sale and will end up with after-tax cash and very few good choices on where to invest the money. Most certificates of deposit pay interest that is less than the current prevailing rate of inflation. The stock and bond markets are volatile and fluctuate substantially day-by-day.
When you sell you will probably have to payoff any debts associated with the business, which further reduces after-tax funds left over from the sale. Many people are subject to a Debt-Tax Trap where there are insufficient funds from the sale to pay taxes and business debts.
Finally, selling your business is likely to profoundly change your daily life and may impose upon you more leisure time than you can absorb. I’ve seen many former business owners ‘climb the walls’ because they don’t know how to use the 40 to 50 extra hours of leisure time they have each week after selling their business. Each of these issues should be carefully considered before selling. Once a business is sold there is no going back.
Because of the personal nature of small family businesses many former owners feel like they sold a part of themselves.
Taxes
In most cases taxes will be owed when you sell your business, depending on how the sale is structured. There are two ways to sell:
- Sell equity or stock in your business. If your business is organized as an LLC or Corporation then you could sell your equity interest to the buyer. A sale transaction structured in this way is generally taxed as a capital gain, which is a favorable, less costly outcome to the seller. However, few buyers will agree to buy the equity interest in a business for a variety of reasons.
- Sell Assets. An asset sale is how most businesses are sold. The IRS requires that the sale price be allocated to each asset sold (IRS Form 8594) and gain or loss is measured accordingly. Intangible assets like goodwill or customer lists are usually taxed as capital gains (a favorable treatment for the seller). Real estate is subject to several different types of tax including a flat 25% federal tax on so-called un-recaptured Section 1250 gain.
It is extremely important for the seller to obtain a tax projection prior to the sale in order to quantify the income taxes that will be due. This sheds light on the proposed selling price and on whether or not an owner can afford to sell at a given price. One of the most important aspects to selling a business is getting the allocation of sale price right.
Risks of Owner Financing
Since the 2008 economic collapse banks have become far more restrictive in financing people who want to buy a business. New lending criteria require banks to separate out the value of intangible assets like goodwill. These intangible assets are generally not available as collateral because the bank can’t seize them if the buyer defaults on a loan.
The net effect of a more restrictive lending environment is that more and more sellers are forced to offer seller-financing which bridges the gap between what a bank will finance and the total sales price.
A seller who offers financing is functioning like a bank and should think, act and charge interest like a bank does. Further, an individual offering seller-financing is assuming far more risk than a bank with millions of dollars (or more) in reserves. Thus, the interest rate charged for seller-financing should be much higher than the rate charged by a bank. The price of interest must be proportionate to the risks of seller-financing.
An additional cost of seller-financing arises from the taxation of so-called recapture income. The IRS considers all the depreciation claimed on assets sold as subject to recapture, which means these past deductions are claimed as income in the year of sale (subject to various technicalities beyond the scope of this article.)
If you sell your business and offer seller-financing through an installment note then your gain from the sale is taxed as you receive payments from the buyer. The exception to this general rule is recapture income: all recapture income is taxed to the seller in the year of sale even if the seller never collects a penny from the buyer.
For more inisghts into seller financing see my article on this subject:
Have Your Cake and Eat It Too
There is an alternative to selling your business while still acquiring more leisure time: Hire a part time manager who replaces a portion of the work performed by the business owner. Hiring a manager means trading dollars for leisure time. For example, a business owner may desire to work only 20 hours a week and hire a manager to run it for the remaining time needed.
This strategy avoids potentially devastating taxes from selling the business, and allows the owner to keep business profits (net of the after-tax cost of the manager’s salary, payroll taxes, and worker’s compensation premiums.)
Retirement doesn’t need to be an all or nothing situation. By hiring a competent, trust-worthy manager, business owners can buy the leisure time they want while still keeping their business, and keeping their options open for an eventual future sale.
Hire a Buyer
It could be the case that the person you eventually sell your business to is the manager you hired to run it part time. If you structure your affairs wisely, today’s part-time manager could become tomorrow’s buyer of your business.
The manager will learn your business and acquire a comfort level with it as an insider. You will learn about the manager and will be able to make an informed decision on whether or not to offer seller-financing when the time comes to sell. Further, you could sell a portion of your business to the manager. This creates a positive impact on motivation.
The Fixed Income Mentality
People who retire no longer generate income from work. Their income is typically fixed and consists of social security, pensions, and earnings from investments. This fact imposes a new perspective on personal finances: since income is fixed all attention shifts to costs. I’ve seen retired people with millions of dollars in investments who choose to live like paupers because they are afraid to outlive their savings.
The income from a profitable business can seldom be replaced with earnings from investments in CD’s, stocks, bonds, etc. And the transaction costs incurred from selling a business can be very expensive as discussed above.
The fun and excitement of selling your business will wear off quickly. Reality will settle in soon after the sale. A goose that lays golden eggs should be treasured. Hold onto it as long as possible.
I do offer business valuation services to those who want to know what their golden goose is worth.
Photo Acknowledgements and Credits: Goose Photograph by ©Denis Nata | BigStock.com / Golden Eggs by ©Preto Perola/BigStock.com / Composition & Modifications by Shawn Hill | VASTmicro
George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
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Brewer, Maine 04412-2339
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