Top 10 Tax (and Non-Tax) Issues to Consider When Selling Your Business

by: Scott Whalen
Verified by: CPA

November 17, 2022

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The sale of any business is generally a positive event for the owners, but it can also be an incredibly stressful time. For many entrepreneurs, this is the biggest deal they’ll do in their lifetime. For some owners, it is selling a business that has been part of their family for generations, and for others it is selling a company they built from the ground up. 

Whatever the case, there are many important considerations to keep in mind. First and foremost is the ultimate decision to sell, along with what you hope to accomplish with the sale. In addition to the obvious monetary considerations, questions surrounding the future of the business, your employees and your customers must be addressed. Once a decision to sell has been made, much work will need to be done to get to a successful closing. This article will address some of the most important tax and non-tax issues that should be thought about during the process, including:   

  1. An experienced team
  2. Proactive planning
  3. Valuation
  4. Sale structure
  5. After-tax cash
  6. Employee incentives and compensation
  7. Deducting selling expenses
  8. State tax considerations
  9. Due diligence process
  10. Life after the sale

Selling your business is a highly complex transaction with significant financial and tax implications. Smith and Howard’s Transaction Advisory team is here to help you achieve the best possible outcome. Contact an advisor today to schedule an initial consultation. 

1. An Experienced Team

Selling a business is complicated and requires an experienced team to successfully navigate all that is required to get to closing. In general, the team should consist of an attorney and an accountant specializing in mergers and acquisitions, as well as general business and financial advisors. Consideration should be given to working with an investment banker who can help find the best buyer and price for your business.

If your current advisors do not have the right experience, you can end up with a deal that results in less money, puts you at risk for future obligations and could even cause the decline or demise of your company. An experienced team will help make the process go smoother and ensure that your goals are met.

2. Proactive Planning

With an advisory team in place, it’s imperative to start planning for the sale as early as possible in order to maximize profits, while at the same time meeting your other business and personal goals. Planning often begins years in advance of a sale in order to make changes and grow so you can realize the full value of your business. 

Waiting until the last minute to start the planning process will limit the options that are available. By taking time to prepare, sellers will be able to educate themselves on all the intricacies they must be aware of throughout the transaction and will be able to better evaluate what a successful transaction will mean to them, their employees and their business. 

3. Valuation

What is the business worth? It is a good idea to know the answer to this question prior to starting the sales process. Whether you get a formal valuation done or get advice from a knowledgeable investment banker, having a reasonable expectation as to current value specific to your industry is important. Timing must also be considered when looking to maximize value, as general economic conditions or industry specific developments can affect price. Once you understand the approximate value of your business, you can determine whether now is the right time to sell.

4. Sale Structure 

The structure of a transaction will be one of the most important factors to negotiate to ensure a successful deal. That’s because the structure determines not only the tax consequences but also the steps that must be taken to transfer ownership. Usually the first structure decision is whether to do an asset or a stock sale. In general, sellers prefer to sell stock and buyers prefer to buy assets because of the tax consequences. However, there are legal and other issues that differ depending on whether an asset or stock transaction. Because the structure decision affects almost every step in a sale, it is essential to address early in the negotiations.

5. After-Tax Cash

It is easy to receive an offer for the sale of your business and think, “I’m rich!” However, the taxes that will be due will definitely make you less rich. That is why it is important to compute the estimated tax costs associated with the transaction. The tax analysis of a transaction involves reviewing structure and building a model that computes the taxes based on the selling price and related expenses. Federal, state, and transfer taxes must all be reviewed. It is only after you have computed all your taxes and other costs that you can truly know how much cash you will have as a result. 

6. Employee Incentives and Compensation

Employees play a vital role in every business. They are often foundational to the overall success, and resulting value, of the business. Sellers may want to reward valued employees with transaction bonuses or even equity to help facilitate the close. On the other hand, buyers might seek agreements with key employees to incent them to remain with the company for a period of time following the sale. Ensuring that these matters are handled in a thoughtful, tax-efficient manner is crucial to maintaining employee morale and ensuring a smooth transition.  

7. Deducting Selling Expenses 

Business owners will incur a wide range of expenses in the course of a business sale. These selling expenses, including attorney fees, broker fees, and fees that you pay your accounting firm, are not always tax deductible. 

Ensuring you get the maximum allowable deduction for selling expenses requires an intentional approach. It is important that expenses and the related agreements are reviewed with an eye toward protecting your tax deductions. Selling expenses can run into the millions of dollars and securing the allowable tax deduction results in more money in the seller’s pocket. 

8. State Tax Considerations

The sale of a business for cash is usually a taxable event. Many consider and understand the federal tax consequences but fail to take into account the state taxes. With state rates varying from 3% to more than 10%, ignoring the effect of state taxes on the transaction can be a costly mistake.

Not only do rates vary from state to state but so do rules on how to tax certain transactions. This means that the structure of the sale will need to consider the state tax implications. For example, if a Florida resident sells stock in a corporation there will generally be no state taxes on the sale since Florida does not have a personal income tax. However, if the sale is structured as an asset sale the owner may end up paying state taxes on the gain, with additional complexity if the business operates in many states. On a multi-million dollar transaction the amount of state taxes can significantly reduce the net cash to the seller which is why state taxes should not be overlooked. 

9. Due Diligence Process

Once you decide to sell your business and have entered into an agreement as to the general terms of the sale, usually with a signed letter of intent, the real fun begins. The due diligence process is when the buyer and their advisors review all aspects of your business with a fine toothed comb. Legal, accounting, operational, employee issues and more are scrutinized by the buyer so that they can get assurance as to the value of the business.

Due diligence can be extremely time-consuming and can cause the seller to neglect the current operation of the business. To avoid the potential detrimental effects, sellers should consider engaging extra help to pull all the requested information and schedules together that the buyer requests since employees may not be in the know during this phase of the process and thus are not able to help. If a business is not prepared for this part of the process, the buyer may request a reduction in price or worse, the sale may not close.

10. Life After the Sale

You’ve sold the company, now what? It’s becoming increasingly rare for the sale of a business to be a straight cash deal with no future commitment by the seller to the business. Many buyers want sellers to remain involved in some capacity. Employment contracts and non-compete agreements may be required.

Earn-out clauses over a period of time are common and are a way to ensure sellers will be around to help grow the business. They can also provide an opportunity for sellers to get more for the business while allowing buyers to mitigate the risk of paying too much. Under an earn-out agreement, the seller receives certain payouts if the business meets certain performance goals over a multi-year period. Negotiating the specifics of an earn-out agreement is a must to avoid potential disputes in the future. 

Whether continuing to work due to an employment agreement or to meet earn-out conditions, a seller may be in an unfamiliar position of having to answer to a boss. This is often the most difficult challenge for sellers who are used to calling all the shots. On the other hand, this period can be an opportunity to ensure that the business operations will continue after involvement ends. If all goes as planned, the seller will be in a position to decide what’s next after meeting any required commitments to the buyer.  

Smith and Howard: Experienced Transaction Advisors

At Smith and Howard, we’re committed to going above and beyond basic tax guidance and financial due diligence. Our expert advisors have vast experience assisting both buyers and sellers and are well-equipped to help you navigate the complexities of selling your business. We are pleased to guide you through a successful transaction as an integral part of your experienced team. 

We appreciate the role our clients’ businesses play in their lives and communities, and are committed to helping business owners fully explore the options available to them as they prepare to sell their business.  

To learn more about how Smith and Howard can help you achieve your financial goals for the sale of your business, contact an advisor.

How can we help?

If you have any questions and would like to connect with a team member please call 404-874-6244 or contact an advisor below.