Sedona Arizona

Common Exit Strategy and Business Monetization Options

The thought of planning an exit strategy or monetizing your business can feel overwhelming or something too far down the road to think about. But, being proactive about guiding the direction of your business is crucial for any business owner.

Knowing your options helps you make decisions that align with your personal and financial goals. This guide covers common strategies for exit planning and business monetization. Each option has its own benefits and considerations, so it’s essential to find the one that suits your unique situation best.

External Transfers

External business transfer methods involve the transfer of business ownership and control to outside parties rather than internal stakeholders. Each method has unique advantages and considerations, making it essential for business owners to evaluate their goals and the specific circumstances of their business when choosing an external transfer method.

Common external transfer methods include:

Private Equity Group Recapitalization

In this strategy, investors buy ownership stakes in your business, giving you immediate cash for personal use and funds for business expansion. You can continue running the business while benefiting from the strategic guidance and growth strategies of the private equity group.

On the other hand, this option can lead to a loss of control, reduced personal perks, and a fixed income. You’ll be taxed on the equity converted to cash, usually as capital gains, but any retained equity isn’t taxed immediately, allowing for potential future financial growth.

Selling to a Third Party

Selling to a third party provides significant financial gain and immediate liquidity, allowing you to fully exit and pursue other ventures or retirement. This type of sale can bring fresh perspectives and resources to the business, driving growth and innovation.

This process can become lengthy and complex, requiring substantial time and effort to find the right buyer, negotiate terms, and complete due diligence. There’s a risk of cultural clashes or changes in business practices, potentially affecting employee morale and customer relationships. Owners face capital gains tax on the profit and may also encounter other taxes such as depreciation recapture or state taxes.

Initial Public Offering (IPO)

Selling your business through an Initial Public Offering (IPO) involves offering shares to the public on a stock exchange. This can provide significant capital for expansion, debt reduction, and increased market visibility, enhancing the company’s credibility and prestige. Shareholders, including original owners, can potentially realize substantial financial gains if the stock performs well.

Going public is complex, time-consuming, and expensive, requiring extensive legal, accounting, and regulatory efforts. Public companies face rigorous scrutiny and must adhere to strict reporting standards, reducing management flexibility. Market volatility can impact the stock price, leading to potential financial instability. Additionally, the focus on short-term shareholder value might detract from long-term strategic goals, affecting the overall vision and operations of the business.

Internal Transfers

Internal business transfer methods involve transferring ownership and control of a business to individuals or entities within the organization. These options, when suitable preserve the company culture and motivate key employees by aligning their interests with the long-term success of the business. Owners may experience a smoother transition that maintains stability and legacy within the organization.

One caveat that should be mentioned with internal transfer methods is they are often capped at Fair Market Value (FMV), sometimes lower. On the positive side, these options can often be structured with more flexibility and more tax efficiency for the owner.

Common internal transfer methods include:

Employee Stock Ownership Plan (ESOP)

An ESOP transfers ownership interest to employees, enhancing their motivation and loyalty by making them part-owners. The company allocates shares to employees, held in a trust until they retire or leave. ESOPs offer significant tax advantages for the owners AND the company, such as deductible contributions to the ESOP and potential tax deferrals on gains.

However, setting up and maintaining an ESOP can be complex and costly, requiring significant legal, financial, and administrative efforts. There’s also a risk with concentrating retirement funds in company stock.

Management Buyout (MBO)

A management buyout involves selling the business to your current management team, ensuring continuity of operations. This type of controlled exit can happen over several years, offering a flexible deal structure. It aligns with the team that helped grow the business, but future payments depend on the business’s continued success.

From a wealth management perspective, the business must keep producing profits to realize value, and the risk isn’t diversified. Owners are typically taxed on the proceeds from selling their shares, involving capital gains tax and possibly additional taxes on installment payments.

Gifting

Gifting shares of your company can be an effective exit strategy for estate tax and transfer purposes. Owners can systematically transfer assets out of their estate at discounted rates over several years, reducing estate taxes and preparing for a change of hands. Gifting can be part of an MBO or ESOP, with annual gifting rules allowing up to $18,000 (2024) to be given to any number of people, including employees, fostering a culture of ownership and strengthening the business.

Additionally, gifting shares to causes, institutions, and charities can fulfill philanthropic desires and avoid capital gains taxes. Charitable trusts offer benefits like no tax on the sale of donated stock and current tax deductions for donors.

§301 Stock Redemptions (Popeye Plan)

The Popeye Plan, or Section 301 Stock Redemption Plan, is an internal ownership transfer strategy where an owner’s equity is redeemed over time, tax-free, from the company’s future cash flows. This plan allows shareholders in an S-Corp or LLC to gradually sell their shares to others, such as employees or family, maintaining business stability and culture. The sale is structured as an installment sale, with payments received over time instead of a lump sum.

The redeemed shares are retired, and the owner receives funds capital gains tax-free, provided the amount redeemed each year is less than 20% of their equity. This process continues until the buyer owns the remaining shares.

For the buyer, it offers increasingly meaningful participation in the company’s growth and success. However, careful consideration of the business valuation and the execution time is essential.

Choosing the right exit strategy

Choosing the right exit strategy, whether external or internal, can significantly impact your financial future and the ongoing success of your business. Whether you’re looking to maintain business stability, achieve personal financial diversification, or fulfill philanthropic goals, understanding these six options will help you navigate this critical decision-making process.

Take the first step today by contacting us. Our uncommon wealth management approach, along with our network of exit planning partners, will tailor a strategy that meets your needs and secures your legacy. Your proactive approach now will ensure a smoother transition and a more prosperous future.

Disclosures

Life Moves Wealth Management is a registered investment advisor offering advisory services in the States of Arizona and Indiana, and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. Information contained on this site should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.

The information on this site is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal any performance noted on this site.  

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Author: Dale Shafer II, CFP®, APMA®, CDFA®

The National Association of Personal Financial Advisors
The Society of Advice

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