Advice on selling a business

[ash]

I am looking to exit from an ownership and operational role within my company. I have an equal partner who is not excited about this idea, but is a good guy and is willing to look at various ways to accomplish this (ie. compensate me for my equity).

Our company is a service business, is virtual (no capital assets), and is based largely (although not solely) on our relationship with clients. It is not a good candidate for sale to a third party, thus one of us will need to stay on board. He doesn't want to leave at this time. It is however, easy to manage, and highly profitable.

I'm looking for advice and help in two areas:

1) Method of compensation. My partner wants to minimize risk and would prefer obviously to pay me over time, instead of a lump sum. I'm agreeable to this, but we have to come up with a method that will work. For example, simply applying a formula and coming up with a valuation doesn't protect him if the company goes to hell after I leave. We've discussed a percentage of sales, but this doesn't relate to a specific value for the company, unless we bound it with minimum and maximum values perhaps.

2) I want to minimize my tax burden. The company is a California C Corp, about 10 years old. It seems as though I'd want to subject the payments to capital gains taxes and avoid the income tax. I won't need the money after the sale, so if there is some method for reinvesting it and delaying or avoiding taxes, I'm all ears.

Obviously I will need to talk to my accountant with regard to the tax issue, but I'm wondering if anyone on the board has done something similar to this and can offer any advice.

Thanks in advance.

 

[Martha]

Your questions are related--how you get paid will effect how you are taxed.  My feeling is that you should go to a business lawyer who can help you design a plan that minimizes taxes and risk.   Your goal is to sell your shares either back to the company in a redemption  (where the company is buying the shares) or to your co-owner. You can have the payments structured over time.  If you do a redemption there are lots of tests that have to be met to get capital gains treatment.  For example, you may not be able to tie the payments to profitability or a percentage of sales.  Depending on the type of business, odds are I would have the company redeem your shares by paying the value over time.  I would secure the payment with a security interest in the shares and/or the company assets.  I may or may not require a personal guaranty of your co-owner.  Instead of tying payment to profitability, I would rather agree that your co-owner wouldn't have to guaranty payment, and only the corporation  would be obligated to pay you.  The big caveat here is that I do not know anything about your business, its tax situation, or its assets, so the "real life" answer to how to structure this may be different.

Figuring out the price is another issue.   The C corporation may have significantly depreciated its assets so if the business itself was sold a big tax bill would be due.  Your co-owner has to think about that when he is considering how much he or the corporation should pay for your shares. 

 

[TromboneAl]

I sold my business last February. I receive essentially half the gross revenue for three years. The lawyer wrote the contract in such a way that the money I receive should be treated as capital gains.

As I understand it, by selling the intellectual property rather than the business itself, I will be able to treat the money as capital gains.

 

[ash]

Thanks guys, this is exactly the type of information I'm looking for. Before I talk to an accountant or lawyer, I hope to have enough info to at least ask the right questions and understand the answers.

Martha, concerning capital gains versus income taxes: Is the idea of basing payment on sales or profit a red flag, even if the transaction is for equity and not an asset?

Primary assets of the company are:
* Lots of good AR
* Lots of recurring revenue from contractual services to clients
* Good employees
* Very little fixed assets

Also, is there any possibility of reinvesting the money from the sale to defer taxes?