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Key takeaways:
Many business owners understandably focus on their organisation’s current situation - growing their company and succeeding in the current market. Planning for an eventual sale or transition can seem like a distant concern. However, when the right offer comes along or life circumstances change, that future consideration suddenly becomes urgent.
The value of early planning
It's natural to defer decisions that seem far off however experience shows that implementing an exit plan well in advance of a transaction leads to much better outcomes than attempting to undertake concurrent with a sale. This is especially true for tax matters - early planning ensures your affairs are structured tax-efficiently, maximising after-tax proceeds and minimising issues that could concern potential buyers
Tax consequences without planning
Without proper planning, the effective tax rate on a sale can vary significantly. Some owners mistakenly assume little can be done about the tax liability. Others delay planning until an exit nears, limiting their options. Existing structures may be outdated or flawed based on ever evolving global tax law. Surprises about tax exposures can impact the transaction value and create friction.
The first step is to consider some of the following questions and discuss them with your advisor:
- What is my estimated tax liability if I sold today?
- How are businesses in my industry valued, and what common tax issues arise?
- Should I carve out any assets/divisions pre-transaction for a better tax result?
- What are the tax impacts of a transaction on employees, minority investors, and option holders?
- How are non-cash proceeds like seller financing, buyer stock, and earnouts treated for tax purposes?
- Are my transfer pricing policies appropriate for global transactions?
- Do I have unknown foreign tax/withholding exposures?
- Do I have any other potential tax exposures that could impact value?
- Who is the most likely purchaser (management, private equity, strategic, other) and how does that affect structuring?
- Have I addressed compliance issues and key employee incentives?
Benefits of a tax plan
The questions outlined above can facilitate a productive discussion with your tax advisor about the available tax planning alternatives for your eventual business exit. An experienced advisor can implement a comprehensive tax plan that offers:
- Flexibility for various exit scenarios
A well-designed plan will provide you with the flexibility to pursue different potential exit paths, such as a sale to a strategic buyer, financial buyer, or even an employee stock ownership plan, while minimising tax implications.
- Immediate tax planning opportunities
In addition to preparing for the future exit, a tax plan allows you to take advantage of current tax planning strategies that can provide benefits in the near-term before any transaction occurs.
- Minimised global effective tax rate
Proper structuring and planning can significantly reduce your overall effective tax rate when an exit transaction eventually takes place, maximising your after-tax proceeds.
- Tax-efficient operational structure
Your operations can be structured in a tax-efficient manner that reduces tax risk and makes it easier for a potential buyer to understand and get comfortable with during the diligence process.
- Aligned foreign operations and transfer pricing
If you have multinational operations, a tax plan ensures your foreign entities and transfer pricing policies are appropriately aligned with your overall tax objectives for an exit.
- Deferral for non-cash proceeds
For exit transactions involving non-cash proceeds like seller financing, earnouts, or equity in the buyer, a tax plan enables deferral strategies to delay paying tax until cash is actually received.
The advantages of comprehensive tax planning are numerous. The key is starting the process early and working with an advisor to implement a tailored plan that meets your specific needs and exit goals.
Know your objectives
The ideal plan depends on your circumstances, objectives, business profile, and deal structure. It requires an approach tailored to your evolving needs. Taking steps now allows access to the full range of planning opportunities when you decide to sell.
Revisit any existing structure to ensure it still meets your objectives.
If you want to learn more about tax planning in M&A transactions or get in touch, click here.
Frequently Asked Questions (FAQs)
If you sold your business today, your estimated tax liability would depend on factors like your business structure, the sale price, your basis in the business assets, and whether you qualify for tax reliefs. You may owe capital gains tax or income tax on any gains from selling business assets or stock depending on the deal structure and tax laws in your home and foreign jurisdictions in which the business operates.
Proper planning is key to minimising the tax burden for these stakeholders in an exit transaction.
Have I addressed compliance issues and key employee incentives?
You should review and address any potential compliance issues before selling your business to avoid negatively impacting the valuation or deal negotiations. Additionally, you will want to ensure you have properly structured any key employee incentive plans, equity compensation, severance, etc. and considered the implications for an exit event.
To carve out assets or divisions before selling for a better tax result, you should consider:
- Separate certain assets or divisions into new legal entities before the sale to benefit from potentially lower tax rates on the sale.
- Analyse if carving out will allow you to utilise tax attributes like net operating losses more efficiently in the remaining or divested businesses.
- Transfer pricing and indirect tax implications of any carve-outs to minimise taxes and comply with regulations.
When selling your business, the tax impacts on employees, minority investors, and option holders depend on their specific circumstances:
- Employees may owe income tax on any compensation received, like severance pay or payouts from equity incentive plans.
- Minority shareholders/investors will likely owe capital gains tax when selling their shares unless they qualify for special tax reliefs.
- Option holders could face income tax on the bargain element when exercising options before the sale, and potentially capital gains tax on any gains from selling the shares.
The tax treatment of Non-cash/deferred cash proceeds from a business sale vary depending on the jurisdiction and you should ensure you understand if the relevant countries have provisions to easily allow for the matching of taxes owing to the receipt of cash:
- Are tax reserves permitted against seller financing/promissory notes to allow for matching of tax when cash payments are actually received?
- Are stock proceeds going to be taxed on a current basis vs. When sold?
- Are Earnout/contingent payments taxed when determined or when received?
Proper structuring is important to maximise tax deferral opportunities for these non-cash proceeds.
To ensure your transfer pricing policies are appropriate for global transactions, you should:
- Review them regularly to ensure compliance with evolving OECD guidelines and local regulations in each country where you operate.
- Conduct benchmarking studies to analyse if your intercompany pricing aligns with arm's length principles for the functions, assets, and risks involved.
- Prepare robust transfer pricing documentation to support your policies during tax audits.
- Consult transfer pricing experts to analyse if your policies are legally defensible across jurisdictions.
Conducting a thorough tax due diligence review with your advisors is crucial to uncover and remediate any potential foreign tax exposures before marketing your business for sale. Undisclosed issues could negatively impact the sale valuation or deal negotiations.
To identify potential tax exposures that could impact the value of your business during a sale, you should:
- Review past tax returns and correspondence with tax authorities for any outstanding issues or audits.
- Analyse your tax positions and structures to ensure they align with the latest regulations and guidance.
- Conduct tax due diligence to uncover any compliance gaps or uncertain tax positions that buyers may view as risks.
- Consult tax experts to assess transfer pricing, permanent establishment, and other cross-border tax exposures.
Proactively addressing and remediating material tax exposures before marketing your business can prevent negative impacts on valuation.
When considering who is most likely to purchase your business, there are a few key buyer types to evaluate and how they may impact the deal structuring:
Management Buyout (MBO):
- If a management buyout by your existing leadership team is likely, this could allow for more flexible deal terms like an "earn-out" structure where part of the purchase price is tied to hitting future performance milestones.
- An MBO may also enable a more tax-efficient transition by spreading out payments over time versus an upfront lump sum.
- However, financing an MBO can be challenging for the management team, so seller financing or external investors may be required.
Private Equity Buyer:
- Private equity firms are typically focused on maximising returns over a 3-5 year holding period before exiting.
- They often prefer an asset purchase to obtain a stepped-up tax basis and may push for an equity rollover from management to keep them incentivized.
- Structuring will likely involve putting stringent operating controls, governance rights, and profit distribution preferences in place for the PE firm.
Strategic (Industry) Buyer:
- A strategic buyer like a competitor or company seeking to enter your market may be motivated by synergies from combining operations.
- They commonly use equity/stock as acquisition currency, so the deal could be structured as a stock-for-stock merger or equity purchase.
- Strategic buyers often retain the existing management team, at least initially, so structuring employment/non-compete terms is important.
Understanding the likely buyer type and their motivations is crucial for negotiating an optimal deal structure that aligns with your own objectives around value maximization, tax efficiency, management incentives, and future involvement.
You should review and address any potential compliance issues before selling your business to avoid negatively impacting the valuation or deal negotiations. Additionally, you will want to ensure you have properly structured any key employee incentive plans, equity compensation, severance, etc. and considered the implications for an exit event.