Monday, August 07, 2006

Successful Woman, Successful Business Sale

One of my girlfriends is selling her auto mechanic shops. Yeah, a woman who owns more than one car repair shop. She has about three, locally, and is getting rid of them all. On the one hand, it's kind of sad to see a woman-owned business drop out of a male-dominated field - especially one that's so successful. On the other hand, I'm happy for her because she'll make a bundle. I've given her a few planning tips to avoid having to pay all of the capital gains tax on the sale, and I'm sure other business owners could benefit.

First, consider her situation. My friend is young, in her mid-forties. Also, she is divorced with two kids - one in her second year of college, one who will graduate from high school next year. She probably won't retire and do nothing, but I think the chances of her ever punching a clock again are slim to none. So, long story short, she'll need a good, steady stream of income for a long time.

The answer to this question lies in how the sale is structured. One option a person could have in this type of situation is to carry back the financing of the sale. This means that the buyer of my friend's business would make payments directly to her. I don't think this is a good idea, and fortunately, neither does she. Basically, it means she gets out of the auto repair business and into the debt servicing business. Like I said, I don't think she's going to retire, but I don't think she wants to spend her days chasing checks. Besides, the point of having and then selling the business is to secure her future, not to sit around wondering if she's ever going to recover the value of her business.

To minimize headaches and maximize her income stream, she needs a large sum of money that she can put to work for her. My friend will get this large sum of money, as most people do, through third party financing. Some bank will pay her the purchase price, and the buyer will pay the bank principal and interest over time. If she gets a corporate buyer, they may be able to skip the financing altogether.

Of course, just getting a bank to hand you a lump of cash isn't structuring. Besides, she would immediately owe a ton of money in taxes - money that would be gone forever. There's more to be done, mostly, I think, setting up a private annuity trust and selling the business through it. It's a really good option for her, and most successful business owners, for three reasons: 1) it allows her to defer all of the capital gains tax until she begins taking payments from the trust, and, even then, the tax burden is spread out over the course of those payments; 2) she can get the proceeds out of her estate, so that it passes to her kids estate, gift, and generation skipping tax free (they will pay income tax), and it passes to them in trust, if she wants it that way; and 3) she gets a stream of income to support her and her kids for the rest of her life or over however many years she chooses to receive it.

It works like this. She sets up the trust and then places the business in it. The trust sells the business, and then invests the proceeds in whatever other investments are appropriate. The trust then makes periodic payments to my friend out of the principle and income of the investments. There is no tax on the sale to the trust because the trust has technically purchased the business at fair market value (that's why it's making payments). The transfer of the business to the trust isn't taxable, but part of the payments she receives from the trust will be taxable as capital gains, income, and recapture of depreciation. Of course, part of the payment will be non-taxable return of capital.

She can only get these benefits if the trust has certain provisions in it. The trustee of the trust must be independent of her, meaning she can choose whoever serves, but that person is not beholden to her. She cannot have any control over the assets in the trust or how they are invested (though she can give a little informal advice from time to time), and the annuity itself cannot be secured in any way.

I'm sure the sale of my friend's business has more capital gains lessons to reveal. I'll follow the sale and let you know if there's anything interesting you should know.

Paula Straub See my Brand New Site
760-917-0858