Key business exit planning and strategy considerations

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Authors: Morgan Luddeke, Senior Vice President and Director, Business Transition Advisor, Fifth Third Private Bank & Sean Obermeyer, Senior Vice President and Directory, Business Transition Advisor, Fifth Third Private Bank

All business owners will eventually transition their business, whether by choice or necessity and whether they have planned for the transition or not. Early strategic planning typically results in a more successful outcome for the business owner and their family. For example, some tax planning strategies may have a reduced benefit or even be unavailable if not implemented well in advance of the sale. Missing out on these opportunities can mean less money in the business owner’s pocket and a smaller transfer of wealth to children or other intended beneficiaries in the future.

Build your advisory team

You know your business inside and out, but it is imperative to surround yourself early on with the right team of advisors who specialize in the various components of succession and wealth planning. No single advisor has all the necessary expertise to guide you down the right path, but the appropriate team of experts can identify and map out the complexities of your transition plan and bring objectivity to what can be personally and emotionally challenging decisions. This team often consists of the following specialists:

• Investment banker
• Wealth advisor
• Commercial banker
• CPA
• Business/M&A attorney
• Estate planning attorney
• Valuation expert
• Insurance advisor

Tax planning

There are two main types of taxes for a business owner to consider:

Income taxes: These taxes include such things as ordinary income tax and capital gains tax. How a potential transaction is structured (for example, as a stock sale versus an asset sale) can dramatically affect the amount of tax paid upon a sale, and this should be taken into consideration when thinking through possible sale options.

Gift and estate taxes:

In 2024, the gift and estate tax exemption amount was $13.61 million per individual (or double that amount for a married couple). In general, transfers of wealth, whether made during your lifetime or upon your death, that exceed your exemption amount will be taxed at 40%.

Many business owners consider using some or all their gift and estate tax exemption amount to transfer ownership interests in their business to family using specialized trusts and valuation discounts, which can result in a significant increase in the amount of wealth that ultimately passes to family members and others.

• Timing is a key consideration.
  • First, under current law, the gift and estate tax exemption amount is slated to decrease to about $7 million per individual at the end of 2025. A business owner who wishes to make a transfer in excess of that amount should consider taking action before the end of 2025.
  • Second, if all goes well, the value of the business will increase over time. To make more efficient use of your exemption amount, it is better to make gifts of ownership interests while the value of the business is lower. Obtaining a valuation from a qualified independent business appraiser allows you to substantiate the current value of the business for gift tax purposes. Also, as an added benefit, the appraiser typically will apply discounts for "lack of control" and "lack of marketability," which have the effect of allowing you to transfer a larger ownership interest in the business without exceeding your gift and estate tax exemption amount.

Estate planning

With your focus on the daily operations of running your business, you may have completed very little estate planning or, conversely, completed extensive estate planning, but have you considered how your business interest factored into your plan? Do you intend to transition the business to the next generation (and, if so, is the next generation ready and willing to run the business)? Or would it make more sense to sell the business and ultimately pass liquidity to your loved ones?

Understanding the options you have as a business owner to utilize estate planning techniques (including various trusts and through the use of valuation discounts discussed above) can optimize the financial outcome for your family, especially if done well in advance of transitioning the business.

Your estate planning wishes can evolve over time as your business grows, your family develops, and laws change. It is important to review your estate planning documents periodically (at least every three to five years) to make sure they continue to carry out your wishes in an efficient and effective manner.

Family governance

For an owner with family members working in the business, having conversations around goals and expectations well in advance of a transition will be a key planning component.

Many business owners also express a concern with coming into liquidity and how their children and future generations will handle such wealth. Through proactive personal planning and next–generation education, this wealth can be managed using family trusts and other planning vehicles that not only provide potential tax advantages but also protect such liquidity from spendthrift children and their creditors.

Philanthropic planning

In the year of a business sale, there will be a higher–than–usual income tax liability. If you are charitably inclined, this is a key time to consider larger charitable giving to maximize the tax advantages associated with such donations. This can be accomplished through donor–advised funds, private foundations and charitable trusts. Each charitable vehicle has different timing and complexity, and offers different tax advantages, so each option should be carefully considered and discussed to optimize the outcome for your family and the charity.

Exit timing

A 2022 survey by the National Center for the Middle Market found that a majority of the surveyed business owners spent one to two years preparing for a transition. And, while most of the surveyed owners (76%) had positive feelings heading into the transition planning process, many of them (71%) also entered into the process with negative feelings, such as anxiety, worry, frustration and sadness.

The negative feelings associated with transitioning a business are understandable and common. Business owners often devote their lives to creating and growing their businesses, and a sale or other exit event is a major life change that conjures mixed emotions.

Developing a realistic timeline for your exit, with the assistance of your team of professional advisors, can help to reduce stress and make sure you have sufficient time not only to prepare the company for sale but also to accomplish desired tax and wealth transfer planning goals.

Type of exit

Do you plan to sell your company to an outside party, such as a private equity firm or strategic buyer, or perhaps to an inside party, such as your management team or other employees? Or is it your goal to transition ownership of the business to your children or other family members, whether by gift or sale?

There are pros and cons to each type of exit. Some aspects to consider include:

• The importance of maximizing the sale price (more likely with an outside buyer) versus benefiting key stakeholders such as family members or employees.
• Receiving all the sale proceeds up front (common with an outside buyer) versus receiving sale proceeds over time on an installment basis (common when selling to inside buyers or family members).
• Your willingness to hold an equity position in the business after the sale (often required by private equity buyers in the form of rollover equity).
• The strength of your management team.
• If applicable, a realistic assessment of family members’ abilities to run the company.

Maximizing value

It is extremely helpful to have a realistic assessment of the value of your business early in the process. Investment bankers and valuation experts, especially those with experience in your industry, can be particularly helpful with this step.

Before beginning the sale process in earnest, it may be beneficial to allow extra time to improve one or more aspects of the company’s performance, with the goal of making the company more attractive to buyers and increasing the future sale price. Areas of focus may include:

Performance

• Sustainable and verifiable earnings and cash flow.
• Realistic growth strategy.
• Unique market position, product and technology.
• Established and diverse customer base.

People

• Stable, motivated management team.
• Non–reliance on owner for future growth of business.
• Salaries and bonuses aligned with industry standards.

Processes

• Accounting and financial records up to date and ready to deliver to buyer.
• Non–operational expenses cleaned up. Financial controls in place.

Receiving an unsolicited offer to buy your company can be flattering, but the lack of competition tends to favor the buyer. In many cases, a seller will have much better leverage to obtain an appropriate price, deal structure and cultural fit by engaging an investment banker to run a competitive sale process where potential buyers are forced to put their best foot forward.

Planning for life after exit

What will your life look like after the sale? Are you headed into retirement, or will you put the sale proceeds into a new business venture? Or perhaps, like 87% of owners in the National Center for the Middle Market survey, you’d like to retain some role in your company post–sale. Creating an action plan can help you mentally make the transition from your current endeavor to the next stage.

Additionally, comprehensive pre–sale planning can give you a better understanding of your future spending needs and how much you will need to realize from the business sale to support your desired lifestyle after exit. For instance, you may have expenses that are handled through the business but serve both business and personal purposes (like a cellular plan, life insurance premiums or vehicle expenses). Once you sell your company, those expenses will become your responsibility. Tackling this topic early can help to reduce potential stress during the sale and avoid surprises later.

A well–crafted business transition plan takes some time and careful consideration and is most successful when a business owner assembles a team of experienced professional advisors early in the process. What can seem like an overwhelming undertaking up front can become a manageable series of tasks when the right advisors are at your side.

Business Transition Advisory Team can help prepare you for the sale of your business

Navigating a business transition or liquidity event is complex, both financially and emotionally. Whether you’re selling the business or passing it down to family, we can work alongside you and your outside advisors to help optimize your financial and business outcomes. We have extensive experience working with teams of professionals during business transitions and taking the lead as the liaison among these advisors and between you and your team. We encourage our clients to take their time making decisions and to rely on the expertise of their team. The Business Transition Advisory Team is there to offer support throughout the entire process. We would welcome the opportunity to assist you and your family in reaching your goals through a successful transition.

For more information, contact your Fifth Third Private Bank advisor.