Exit Strategy Planning for Manufacturers

Every business owner should have an exit strategy that helps recoup the maximum amount for his or her investment. If you’re considering selling your manufacturing company to a third party, understanding the tax implications can help you plan for and, in some cases, reduce the impact of your tax bill. To help ensure the transition is as smooth as possible, here are some considerations.

Maximizing Value

Start by obtaining a professional valuation of your company to give you an idea of what it’s currently worth. The valuation process can help you understand what factors drive the value of your business and identify any weaknesses that reduce its value.

Once you’ve received a valuation, consider making changes to enhance the business’s value and potentially increase the selling price. For example, if the valuator finds that the business relies too heavily on your management skills, bringing in new management talent may make the business more valuable to a prospective buyer.

A valuation can also reveal concentration risks. For instance, if a significant portion of your business is concentrated in a handful of customers or one geographical area, you could take steps to diversify your customer base.

Structuring the Sale

Corporate sellers generally prefer selling stock rather than assets. That’s because the profit on a stock sale is generally taxable at more favorable long-term capital gains rates, while asset sales generate a combination of capital gains and ordinary income. For a manufacturer with large amounts of depreciated machinery and equipment, asset sales can generate significant ordinary income in the form of depreciation recapture. (Note: The tax rate on recaptured depreciation of certain real estate is capped at 25%.)

In addition, if your company is a C corporation, an asset sale can trigger double taxation: once at the corporate level and a second time when the proceeds are distributed to shareholders as a dividend. In a stock sale, the buyer acquires the stock directly from the shareholders, so there’s no corporate-level tax.

Buyers, on the other hand, almost always prefer to buy assets, especially for equipment-intensive businesses, such as manufacturers. Acquiring assets provides the buyer with a fresh tax basis in the assets for depreciation purposes and allows the buyer to avoid assuming the seller’s liabilities.

Allocating the Purchase Price

Given the significant advantages of buying assets, most buyers are reluctant to purchase stock. But even in an asset sale, there are strategies a seller can employ to minimize the tax hit. One strategy is to negotiate a favorable allocation of the purchase price. Although tax rules require the purchase price allocation to be reasonable in light of the assets’ market values, the IRS will generally respect an allocation agreed on by unrelated parties.

As a seller, you’ll want to allocate as much of the price as possible to assets that generate capital gains, such as goodwill and certain other intangible assets. The buyer will prefer allocations to assets eligible for accelerated depreciation, such as machinery and equipment. However, depreciable assets are likely to generate ordinary income for the seller.

Allocating a portion of the purchase price to goodwill can be a good compromise between the parties’ conflicting interests. Sellers can enjoy capital gains treatment while buyers can generally amortize goodwill over 15 years for tax purposes.

If your company is a C corporation, establishing that a portion of goodwill is attributable to personal goodwill — that is, goodwill associated with the reputations of the individual owners rather than the enterprise — can be particularly advantageous. That’s because payments for personal goodwill are made directly to the shareholders, avoiding double taxation.

You may need to take certain steps to transfer personal goodwill to the buyer. This may include executing an employment or consulting agreement that defines your responsibility for ensuring that the buyer enjoys the benefits of your ability to attract and retain customers. Buyers may want a noncompete agreement. These are common in private business sales and can help protect the buyer from competition from the seller after the deal closes.

Get Started Now

Different strategies can help you enhance your business’s value and minimize taxes, but they may take some time to put into place. Whatever your exit strategy, the earlier you start planning, the better. Our manufacturing industry specialists can help you navigate the ins and outs of selling your manufacturing company.  Contact us to discuss your unique situation.

For more valuable information, check out our Q &A Over Coffee podcasts – Podcast #3, “I Want Out: Planning Your Exit” with Randy Krivo, is another great exit strategy planning resource.

 

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DISCLAIMER: This blog is provided for informational purposes only and is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant. Presentation of the information in this article does not create nor constitute an accountant-client relationship. While we use reasonable efforts to furnish accurate and up-to-date information, the evolving landscape surrounding these topics is supported by regulations or guidance that are subject to change.

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