When it comes to succession plans, construction company owners often focus on when they intend to leave the business or who will replace them. But, numbers play an important role as well — particularly if you intend to sell the business to help finance your retirement.
Obtain a valuation
A business valuation is an important start. Obtaining a valuation will help you understand the various factors that drive your construction company’s value. Armed with this information, and sufficient time, you can then take steps to enhance the value of your business before you dispose of your ownership.
For example, your management team may be weak in certain areas or relies too heavily on your involvement. By retaining new management or improving your existing team, you can increase the company’s value to prospective buyers.
Further, consider if a high percentage of your projects are concentrated in a particular trade or a few key customers. By better diversifying your projects, you may be able to boost your business’s value while reducing its risk.
These are just two circumstances of the many factors that a succession plan can contribute to increasing the value of the company. Keep in mind that the right strategies will depend on the types of potential buyers you expect to target. For instance, a strategic buyer may be less concerned with the quality of your management team than a financial buyer.
It’s important to start thinking early on about the tax ramifications of a business sale. These depend on a number of factors, including the organizational structure of your company and the manner in which the transaction is structured.
If your business is a corporation, for example, you can structure the transaction as a stock sale or an asset sale. Selling stock is advantageous because your gain generally is taxed at lower capital gains rates. Asset sales are typically taxed as a combination of capital gain and ordinary income, depending on how the purchase price is allocated among various assets.
What’s more, C corporations (or, in some cases, S corporations that have converted from C corporations) are double taxed: once at the corporate level and again when the proceeds are distributed to shareholders.
Unfortunately, few buyers are willing to buy stock. For one thing, they don’t want to acquire all of your company’s potential liabilities. Further, acquiring assets generally provides the buyer a higher tax basis in depreciable property.
Explore sale options
Assuming the sale of your construction business will be structured as an asset sale, there are ways to mitigate the tax impact. One common approach is allocating the purchase price among various assets to try to minimize the transaction’s tax cost. To sustain IRS scrutiny, however, the allocation must bear a reasonable relationship to the assets’ actual value.
As the seller, you’ll want to allocate as much of the price as possible to assets that qualify for favorable capital gains tax rates, such as real property. The buyer, on the other hand, will favor allocations to property that can be depreciated quickly, such as equipment and vehicles. This is usually undesirable for a seller, however, because gain on fully depreciated property is taxed as ordinary income.
Negotiation is key. Goodwill can be an asset that provides grounds for compromise because it has potentially beneficial tax consequences for both buyer and seller.
In addition, alternative payment forms may allow you to defer taxes on a portion of the sale price. For instance, you might negotiate an installment sale or an earnout provision. Under an earnout arrangement a portion of the sale price is contingent on the buyer achieving a certain level of earnings. Another option, if your business owns real estate, is to exchange it for income-producing real property in a tax-free exchange.
Even if you have no intention of retiring or selling your company in the near future, it’s important to begin developing your succession plan. Frazer, LLP is ready to assist you in the development of your plan.. Please contact us for help.
Luis L. Rendon, CPA