Exit and Growth Strategies for Middle Market Businesses

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Taxes Increasingly Important in Sale Strategies

By Robert Massengill | Aug 03, 2015

Upward Chart Money SignBusiness owners evaluating transition alternatives for their companies have a variety of  choices.  They can take their companies public, merge, sell to a third-party or sell internally.  While each of these alternatives has their benefits and limitations, prioritizing goals for the sale is a big step is narrowing down the choices.

Regardless of the method chosen for the sale, taxes play an important role and there’s a saying that “it’s not what you get, but what you keep.”  In today’s environment of increased capital gains rate, the ACA surcharge and growing state income tax rates,  more and more owners are seeking tax advantaged sale structures.  For owners with transition goals that include more than just price, there is no transaction more efficient than selling internally using an employee stock ownership plan, ESOP.

Sellers have the ability to indefinitely defer their capital gains tax, employees receive a deferred retirement benefit and companies can eliminate federal and most state corporate income taxes.  While tax efficiency isn’t the only criteria for a sale, it’s a strong motivator.

Consider the following example of a company generating cash flow of $3MM.  Assume the valuation is 6X cash flow and the company has no debt.  This yields an enterprise and equity value of $18MM.  The business is a C corporation, has an asset basis of $4MM and the owner has a stock basis of $3MM.  We’ll further assume an offer has been presented from a third-party and the owner is comparing a sale of assets or stock to the third-party and an ESOP. Read more »