In preparation for a transition, it's important for the closely held business owner to consider entity structure and how to build value in the company.
The key issue in transition planning begins with the choice of entity. The tax/legal structure of the entity affects the goals of asset protection, flow-through taxation, and cost-effective ownership transition.
Certain legal structures provide owners asset protection. They legally insulating the owners’ assets from liabilities of the business.
These structures include corporations – both S and C – and LLCs.
If legal protection cannot be obtained by the entity structure, insurance is appropriate.
Flow-through taxation can be beneficial by subjecting business income to only one level of tax. Flow-through taxation is offered with sole proprietorships, partnerships, LLCs, and S corporations. Potential double-taxation applies to C corporations.
Entity structure can also influence the economic and tax costs of ownership transition. Careful entity planning can present opportunities for reducing or income and estate taxes related to future ownership transition.
To build transferable value, the business must be:
The more profitable and well-run the business, the higher the price it will command. Ratios showing profitability and growth versus industry peers can be a useful metric of financial strength. Ultimately, however, the sale price is determined by market forces, which in the world of the private-held, is illiquid and, therefiore, prone to surprises and inefficiency.
To maximize transferable value:
Many business owners become passive about monitoring company financial details. They let collection periods increase and allow inventory levels to raise unnecessarily. Staying vigilant in operating ehnaces profitability for owners and makes an owner more likely to ultimately fetch a higher price upon sale.