INSIGHTS
Business Transition Planning Guide
by RSM US LLP
ARTICLE | February 21, 2025
Owners of middle market companies eventually face a pivotal question. After you have dedicated years and often decades to building a successful business: What's next?
For many, the answer requires determining how to transition your company in a way that aligns with your values, protects your legacy and secures the futures of your employees and their families. While the idea of business transition planning can feel distant, one truth remains: it's not a question of if but when. Planning for a transition now is the key to ensuring a smooth and successful outcome.
Transitioning a company isn't just about spreadsheets and valuations—it's about defining what success looks like. Whether your goal is to maximize financial returns, preserve the culture you've built or pave the way for family leadership, understanding your priorities is essential. A well-thought-out plan allows you to explore more options and navigate complex trade-offs.
Owners who take a proactive approach to planning a transition have better outcomes. Early preparation opens the door to greater flexibility, closer alignment with personal and professional goals, and an enhanced ability to address critical factors like cash proceeds, taxes, legacy and the owner’s future role in the business.
In this guide, we'll explore the primary paths for transitioning a company to:
For each path, we'll highlight opportunities, challenges and considerations to help owners clarify their options and take the first steps toward a successful business transition. Regardless of the path you choose, your most important step is starting the conversation today.
Exit transition path: Employees
It may make sense to transition your business to employees when:
- No members of your family are willing or able to take on ownership and leadership of the company
- The company has most of what it needs to thrive internally—you are not seeking outside capital or strategic guidance
- You want to keep the company independent and see it continue to operate much like it does today
Company characteristics
What makes a company an ideal candidate for an employee ownership transition? It starts with more than just financial performance—it's about the foundation you've built and the values you've instilled.
Companies that thrive under employee ownership often share key traits:
A strong, positive company culture
Teams that trust and support each other are better equipped to take the reins and continue to drive the business forward post-transition.
Significant growth potential
A forward-looking business with room to expand gives employees a tangible stake in the future.
A capable and well-resourced management team
Leadership matters, and a skilled team can guide the business through the transition and beyond.
Companies with these qualities are often those that have consistently invested in their people—creating a legacy of growth, stability and shared success. This makes transitioning to employees not just a possibility, but a natural next step in the company's evolution.
Owner’s priorities
An employee transition isn’t about a quick exit—it’s about purpose and legacy. For many owners, financial gain isn’t the primary driver. Perhaps you’ve already achieved financial independence, or maybe you envision remaining involved in the business, guiding its future through a gradual transition. While financial considerations are certainly important, they often take a back seat to higher priorities: protecting your legacy and ensuring the wellbeing of the employees who helped build your success.
This type of business transition is ideal for owners who value long-term stability over an immediate payout. Unlike a strategic sale or private equity buyout, employee transitions are typically slower paced, designed to preserve the company’s character and culture. Over time, owners can still achieve comparable financial outcomes—but the journey is more measured, reflecting a commitment to continuity and care for the people who drive the business forward.
Common types of business transitions to employees: ESOPs and management groups
When transitioning a company to its employees, a key decision is whether to transfer ownership broadly across your entire employee base or more narrowly to a select management group.
For those seeking to broaden the ownership base, the employee stock ownership plan (ESOP) is the most common path (see below), and employee ownership trusts (EOTs) are gaining in popularity as well. For a transition to a management group, some form of management buyout (MBO) is most likely. But it is important to remember that you can use all these options—more on this below—and that there are many variations in these sorts of transitions beyond those we describe below.
Several factors will feed into whether broad or narrow employee ownership makes the most sense for you and your company:
Company size
An ESOP can be costly to set up and may be less advantageous for a small company where there is little enterprise value to spread. There is no specific floor, but an ESOP would likely make the most sense for a company with at least 40 employees and about $15 million to $20 million or more in enterprise value. At that size, an ESOP can help to build a stronger culture and allow all employees to share in the company’s success. By the same token, a smaller company may be a better candidate for transitioning to a select management group, simply because it will be more affordable to the buyers.
Cash resources
With an ESOP, your company essentially funds the purchase of its own shares—creating a buyer for its stock—which can be a costly process. The transaction is typically financed from internal liquidity, loans taken on by the ESOP (which become a company liability), or the issuance of new shares, leading to potential dilution. A company may help finance an ownership transition to a smaller management group as well, but generally less equity is transferred at one time with a management buyout so the cash needs are not the same.
Taxes
There are tax advantages to an ESOP. The contributions to the plan by the company are tax-deductible, and stock awards to employees accrue tax-deferred until sold. However, these tax advantages are generally not sufficient to move the needle on their own. Similarly, if equity is transferred to key employees as compensation, the company may receive tax deductions, but generally not in the same magnitude as with an ESOP. Again, the business purposes and goals for a proper ownership transition should likely take priority over tax benefits.
Complexity
As a qualified retirement plan, an ESOP is highly regulated and can be complicated—and costly—to set up and annually administer. A sale to management would usually be more straightforward from a legal perspective. This is not an overriding problem and can be easily solved by using expert advisors when setting up the ESOP.
You can also combine broad and narrow ownership strategies to create a tailored business transition plan. For instance, you might divide your equity evenly, implementing both an ESOP and a sale to management. In such a structure, the members of the management team would hold a proportionally larger share of equity than individual employees in the ESOP group. This hybrid approach can offer the best of both worlds: broadening ownership to enhance company culture while ensuring your senior management team gains a meaningful and affordable stake in the business.
Terms to know
Employee stock ownership plan:
Employee stock ownership plan (ESOP): A qualified retirement plan established as a vehicle for awarding company stock to employees, usually based on compensation and/or tenure. An ESOP is structured as a trust with a company-appointed trustee. The company funds the trust to buy company stock from existing owners, assumes loans entered by the trust, or seeds it with newly issued shares. Employees can generally cash out shares at market (or assessed) value when they leave the company or roll the value over to another qualified retirement plan. As a qualified retirement plan, ESOPs are regulated under the Employee Retirement Income Security Act (ERISA).
Employee ownership trust:
Employee ownership trust (EOT): An EOT utilizes a legal trust structure that holds a company's shares on behalf of all its employees, essentially allowing them to collectively own the business without directly holding individual shares. An EOT is often used as a strategy for business succession planning where the current owner sells their shares to the trust for the benefit of the workforce; this provides employees with a stake in the company's profits and can incentivize long-term commitment to the business. Unlike an ESOP, an EOT is not considered a qualified retirement plan and therefore is not regulated under ERISA.
Managed buyout:
Managed buyout (MBO): A purchase of a company’s stock from existing equity owners by a management team financed by some combination of compensation, seller financing and/or management’s own resources.
Challenges and opportunities
Timing
A well-executed transition to management may take a great deal of preparation and a long lead time. It can take years to build a management group that you trust to continue with your company’s legacy. Moreover, if your company is highly valued, starting a business transition earlier gives the management group more time to absorb the financial impact of gaining ownership, which gives you a longer runway for extracting enterprise value.
Owner's role
Think about your ownership and your position at the company as two separate things. Selling your equity to an ESOP or a management group does not mean you sever ties with your company—you can remain involved on your own terms. There is arguably more flexibility to do this with an ESOP than with a transition to a management team that may be looking for independence, but in almost any change of company ownership there will be a period of transition. Most owners start winding down day-to-day involvement once they initiate a transition to employees, but it is not mandatory, and you have control over how you do it.
Size
The larger your business, the more an ESOP (or partial ESOP) may make sense. Financing the purchase of a sizable company can be a significant challenge for a small management group. Even if the owner provides equity at no cost to management—an uncommon scenario—it could create substantial tax liabilities for the recipients. An ESOP, on the other hand, distributes value across a broader employee base, making it a practical solution for larger businesses. As noted, you can also adopt a hybrid approach by splitting your equity between an ESOP and a sale to a management team, combining the benefits of both strategies.
Audit and assurance considerations
A financial statement audit is not legally required to set up an ESOP or execute a sale transaction with your management team. However, an audit can bring confidence and peace of mind to all parties involved, including you as the owner. An alternative to an audit is a review of the company’s financial statements. If you are pursuing an ESOP or transitioning to senior executives, you will need to value your company’s stock to complete the process. If you have performed an audit or a review in advance of a valuation, all parties to the transaction will likely be more confident in that valuation since they will know it is based on verified financials.
An audit is as important for you as the owner as it is for the other parties because you want to be certain you are realizing the full value of your company and doing it in a way that is accurate and fair. Bear in mind that ESOPs of a certain size (100-plus members) require annual audits in conformity with ERISA standards. These are not the same as company audits, instead focusing mainly on ESOP transactions and activities, but they do require an annual valuation, which may carry more weight if it is based on audited financial statements.
Timeline
For an ESOP, a typical timeline might be six to 18 months, starting from exploring the concept and then running through the necessary financial modeling, assembling a team of advisors, conducting negotiations and due diligence, and finally executing the transaction.
For a transition to management, the timeline can vary significantly depending on factors like the readiness of the management team, the complexity of the transaction and the amount of enterprise value that the owner needs to extract over time (which depends on the size and value of the company).
Tax considerations
Tax implications of an ESOP include:
- Potential tax deferral for the sellers of equity
- Tax deductions for the company as it makes contributions in cash or kind to the ESOP
- Tax savings on S corporation income allocated to the ESOP
- Tax-deferred savings for employees on their stock awards until they are sold
With a transition to management, tax treatment would be transaction-specific and person-specific and would depend on how the stock is being valued, awarded and financed.
Other advisors involved in a transition to employees
Trustee
For an ESOP, the company would need to appoint a trustee who would administer the ESOP trust and sit in the buyer’s seat when purchasing company stock. The trustee has a fiduciary duty to the ESOP and its beneficiaries (employees) to conduct proper due diligence in all matters, including when pricing and buying company stock.
Attorneys
There is considerable legal paperwork involved in either setting up an ESOP or executing a sale of stock to management.
Financial advisors
Advisors may be needed to render a fairness opinion on stock valuation or assist a management group with tax and wealth decisions.
Accountants
Many tax and financial aspects of both ESOPs and transitions to management require the expertise of a CPA.
Featured case studies: Employee business transition
Manufacturing
Empowering employees and retaining control through an ESOP
Ten years ago, a large family-owned manufacturing company made a pivotal decision to establish an ESOP. At the time, the company employed approximately 600 people. The family chose the ESOP route to preserve control of the business, avoid selling to an outside party and align with the company’s strong, people-first culture.
The family sold the entire business to the ESOP, committing fully to a transition that prioritized both employee ownership and long-term stability. RSM played a key role in guiding the family and management through the complex process. This included advising on the transaction structure, addressing tax implications and managing key business considerations to ensure a smooth implementation.
The results speak for themselves. A decade later, the company has grown to nearly 1,000 employees and boasts an enterprise value of $300 million. By transitioning to an ESOP, the family not only safeguarded the company’s legacy but also empowered its employees to share in the success of the business, further strengthening the culture and fostering long-term growth.
Construction
Broadening ownership for a 90-year-old construction company
A 90-year-old construction company, originally family-owned, faced a critical challenge in its ownership transition strategy. As the company’s value grew significantly over several decades, it became increasingly difficult for a small group of key employees to serve as the sole market for purchasing stock from retiring owners.
To address this issue, RSM worked closely with the company to evaluate potential solutions. This included an in-depth analysis of the pros and cons of adopting an ESOP and modeling the financial impacts of such a transition.
Ultimately, the company decided to implement an ESOP, allowing it to purchase a portion of the shares and establish a framework for future retiring owners to sell their shares. This approach provided a sustainable solution for ownership transitions while extending the opportunity for equity participation to a broader group of employees.
Today, two years after the ESOP’s implementation, approximately 100 employees are participating in the plan. The decision to adopt an ESOP has strengthened the company’s commitment to shared success and positioned it for continued growth and stability in the years to come.
Engineering
A methodical and measured transition
A small engineering company with 50 employees, four of whom are the founders and current owners, had been in business for approximately 20 years.
As two of the founders neared retirement, they wanted to transition their equity. They explored an ESOP but felt as though their size did not justify the cost yet.
They wanted to transition to their successors, so a plan was established to start transferring chunks of ownership over the following five years to reduce the value transferred in any one given year.
That arrangement made the cost manageable for the company by spreading it over a number of years and kept the executive team engaged and personally invested during that period.
Exit transition path: Family business transition
For active business owners, the most common reason to transition a company within the family is to preserve their legacy. They wish to see their name continue, and there is a member of the next generation skilled and ready to carry on leading the company.
Company characteristics and situational considerations
There are certain factors that make a family business transition more probable—and potentially more successful. These include:
Suitable candidate
For this path to be feasible, there must be a next-generation family member who is both willing and able to take over the business. Often, a child wants to take over but is not considered capable, or vice versa. Alternatively, two or more children may compete for the leadership role, and only one may be considered competent. For this reason and many others, a family transition path can be emotionally challenging.
Size of company
If you are planning to gift your company to family, the limits of estate tax exemptions make it more difficult to transition a large company versus a small company given the size of annual gifting exclusions and the unified tax credit for gifting and estates. A large company also presents a bigger management challenge—the experience and maturity of whoever takes it over will be a key consideration. While there are no set rules, the sweet spot for a full transition within the family tends to be businesses valued below $200 million although larger companies can still accomplish a transition to the next generation.
Owner’s priorities
An owner who decides to transfer a company within the family based on a desire for legacy will often not receive the full enterprise value of the company due to common valuation principles for privately owned, closely held companies. If your main goal is to maximize cash proceeds, you are usually more likely to achieve it by selling the company to a third party than by transitioning it to a family member.
Decision point: Purchase or gift?
In a family business transition, a key decision is whether to structure the transfer as a purchase or a gift. This may be purely a financial decision based on how much of the company’s enterprise value you need in cash to live on. If you are already financially independent, then you may want to gift the company using a trust or other estate planning tool. If not, a purchase or buyout could make more sense. We often see a combination of these tactics.
You may also structure the family business transition as a purchase if you have several children but only one of them is going to run the business. For example, it could be structured so that the child who will run the business pays for the company over time to funnel cash to the other children who did not inherit in the same way. Or, in another scenario, you may be remarried and want to ensure that the company passes to your biological children rather than to your spouse’s family.
Alternatively, if minimizing estate and income taxes is your principal goal, then it commonly makes more sense to structure the transition as a gift rather than an outright sale. There are many estate planning vehicles for this—for example, intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATs) and family partnerships.
Because every situation is unique, there is likely to be more than one approach to the transition strategy. A business owner doing full-fledged estate and business transition planning could end up combining a purchase, gift, sale to a trust and perhaps a residual bequest, among other options.
Terms to know
Gift
From a tax point of view, a gift is any transfer of assets to an individual in return for which the full consideration in cash or kind is not received. Assets can be cash, real estate, stock or other forms of property. A gift is subject to gift tax if the gifted value exceeds the annual or lifetime gift tax exclusion limits.
Grantor retained annuity trust
A legal arrangement that allows a grantor to gift assets to an irrevocable trust while still receiving payments from the assets for a set period. At the end of the term, the remaining assets are passed to beneficiaries. A GRAT can help minimize taxes on large gifts to family members because the grantor uses little or none of their lifetime gift and estate tax exclusion on assets transferred to the GRAT. GRATs are commonly utilized for transfers to the next generation.
Intentionally defective grantor trust
A legal arrangement that allows a grantor to gift assets to an irrevocable trust while retaining the right to pay income taxes on the trust's income. The grantor is considered the owner for income tax purposes but not for estate tax purposes. An IDGT can be useful for families that want to pass assets to generations to come (not necessarily the next generation) without incurring high estate taxes.
Family limited partnership
A legal entity that allows family members to jointly own and manage a business. General partners manage the business while limited partners invest but don't participate in management. An FLP allows senior family members to retain control while younger family members learn before taking over. FLP interests can be gifted to others tax-free up to the annual gift tax exclusion.
Family office
A private company that manages a family's financial and nonfinancial needs. The primary goal of a family office is to help a family preserve and grow their wealth across generations.
Challenges and opportunities
Dealing with family dynamics
Fair does not have to mean equal when it comes to dealing with your children in a family transition. Perhaps only one child is engaged in running the business. It may make sense to transfer the bulk of the ownership to them while giving the other children different assets of similar value, perhaps passive assets like real estate or farmland. Passive ownership of the business is another consideration. Most owners try to do this with an even hand to start with, but it is understood that the child who takes over the business and grows it successfully may in time have a much more valuable property than the children who inherited the more passive assets. Family dynamics can be the biggest hurdle in these situations. Dealing with them honestly and directly makes a flawed transition less likely.
Series of decisions
There is no single path to a successful family transition because every family and every situation is unique. Think of it more like a series of right decisions. For example, you could do a transaction where the child taking over management of the business also gets direct ownership. Alternatively, all your children (including those not involved in the company) could share ownership through a trust while the child running the business is instead compensated through salary, perhaps significantly. There are many different tools and techniques, and you will need to decide which ones will best align with your unique family needs.
Owner’s role going forward
Transitioning your company to family does not automatically mean retiring. Most business owners want and expect to stay around for a while and make sure things are running properly. Trusts can provide a lot of flexibility regarding an owner’s level of involvement going forward. However, if you are structuring the business transition as a straight purchase and bank financing is deemed necessary, you may not have such flexibility. We have seen situations where the bank made it a condition of a loan that the original business owner remained active and present despite having already passed management responsibilities to their child.
Audit and assurance considerations
As an owner, deciding whether to perform a company audit prior to moving forward with an in-family transition would be largely a personal decision. It is not legally required and may depend on the specific circumstances and family dynamics. The important thing is that all parties to the transaction agree on the value of that transaction. This can get complicated especially if your company is large and complex, or if different family members have different claims, or if the company has never been audited. Either way, a company valuation based on audited financial statements is likely to carry more weight.
If you decide against having the business’ financial statements audited, you could always seek a review opinion from an auditing firm. A company review is a formal analysis of your financial statements and accounting—it is less intensive than an audit but is a recognized form of accreditation if performed by a reputable firm.
Timeline
Timelines in family transitions can be quite lengthy. It can take a long time just to sort through family dynamics and make the decisions needed for an effective family transition, especially if those who may be in line to take over the company lack the business expertise required to transition quickly. When a business owner begins to address the transition question, it may take years for them to come to terms with the inevitability of their ownership tenure ending, let alone get to a point where an actionable plan is emerging.
Once the key decisions are made, a transition plan based on a purchase strategy can be accomplished fairly quickly. A plan based on gifting and trust structures is usually more complex—it takes time to set up and often years to play out, depending on the details. For example, if you sell your company stock to a trust in exchange for a note that will be paid back over time from the company’s cash flows, the transition is not complete until the note is fully paid off. It can typically take five to 10 years to do a full estate plan and reach the point where everything has been transitioned and there is no estate tax due. Similarly, a straight sale can take time because of seller financing issues.
For these reasons, it is best to start planning very early. This may feel premature at the time, but by starting the process soon, seeking professional advice and staying in touch with trusted advisors, you can maintain flexibility as circumstances change.
Tax considerations
Transitioning a business to family through gifting and trusts involves complicated tax planning. Each situation is unique. Whatever path you take, working with estate planning attorneys and other advisors can help you:
- Determine the value of the business
- Decide the right method of transfer
- Minimize tax liabilities
- Maximize cash flow
Other advisors involved in a transition to family
Tax advisor
A dependable tax advisor can play a meaningful role in a transition to family, including helping with the overall approach, timing and structuring of the business transition.
Estate planning attorneys
Business transitions to family can involve complicated trust, tax and estate issues for which you need competent legal advice that might be outside the scope of your in-house counsel.
Financial advisors
Advisors can provide a range of required skills in a transition, including wealth and cash flow planning and fairness opinions on stock valuation.
Other trusted advisor
Sometimes it is useful to have a close confidant or mentor who is not a professional advisor to act as a sounding board and guide you as you refine your business transition planning options. This could be another business owner, longtime friend, family member or family advisor, for example.
Featured case studies: Family business transition
Manufacturing
Equipment manager completes multigenerational transfer
The founder of a successful equipment manufacturing company wanted to transition ownership to select members of the second and third generations who were both capable of and enthusiastic about running the business. At the same time, the founder aimed to be fair to other family members who were not involved in the business.
To achieve this balance, a comprehensive plan was implemented over a 10-year period. The strategy included a combination of gifting and a structured sale to intentionally defective grantor trusts (IDGTs). These tools facilitated the gradual transfer of ownership to the next generation while preserving the founder’s financial security.
Throughout the transition, RSM provided critical guidance and support. This included evaluating various transition options, conducting cash flow modeling, and offering estate tax planning and valuation services. The tailored plan ensured that the founder maintained the desired cash flow to support their lifestyle well into retirement. By the time the founder and their spouse passed away in their nineties, the family had successfully avoided a taxable estate. This was made possible by the significant transfer of wealth, which had more than quadrupled in value, to the next generation. The transition not only secured the company’s legacy but also maximized wealth for future generations.
Family-owned
Preserving a family legacy across four generations
A family-owned company now thriving under the leadership of its fourth generation—the great-grandchildren of the founder—owes its success to a well-executed transition plan initiated by the second generation.
Years ago, the grandparents of the current leaders established a strategic transition plan to transfer ownership of the business to a trust when the company was valued at approximately $40 million. This timing allowed the transfer to occur without incurring any estate tax. Over the subsequent two decades, the company experienced tremendous growth, with its value now reaching $350 million. This remarkable appreciation has significantly benefited both the third- and fourth-generation beneficiaries.
The transition process required careful planning and execution over a 21-year period. It involved six to eight transactions using various IDGTs and GRATs. These tools not only facilitated the tax-efficient transfer of ownership but also ensured the long-term preservation of the company’s wealth and legacy.
The foresight and disciplined approach of the earlier generations have positioned the company for continued success and prosperity, securing its place as a lasting family legacy.
Exit transition path: Third-party sale
For a business owner, there are several circumstances that could make selling your company to an unrelated third party the most attractive option.
You may have a successful and valuable business and want to see your legacy continue, but you do not have an obvious successor. Nobody in your family or your management team is willing or able to step in and take over. Under these circumstances, the best course of action is often to seek an external buyer.
Alternatively, you may have no wish to retire in the foreseeable future, but do not have the resources you need—either capital or expertise—to take the company to the next level. You may have to go outside to find what you are looking for in exchange for equity.
And, of course, there are different combinations of these factors, each of which can lead you in a different direction.
Company characteristics and situational considerations
A key decision from the start would be whether you are looking for a strategic buyer or an investor. A strategic buyer could be a competing company or customer in the same industry, for example. Typically, a strategic buyer would acquire the entire business and either integrate it with their own operations or run it at an arm’s length while imposing operational control.
By contrast, a third-party investor—such as a private equity firm or another institutional investor—typically will take a large equity stake and offer some flexibility regarding whether or not you remain in a management role.
Regardless of the appropriate buyer type, the more professionalized your business is and the more developed your employees and management team are, the more value you can expect when selling to a third party.
Which direction you go in depends very much on your priorities and needs. For example:
Legacy
If preserving your legacy is your number one goal, you may be less inclined to seek a strategic buyer who may want to absorb your company entirely, change or eliminate its name, and ultimately take over operational control and decision-making.
Continued involvement
If continued involvement is your top goal, it might make sense to sell some or all your equity to an institutional investor. Of course, there are also ways to structure deals with strategic investors that preserve your autonomy, at least for a time. Whatever type of sale you make, there is likely to be a transition period where your presence is required.
Access to resources
Some companies seek a strategic buyer to gain access to a specific operating resource that they cannot get any other way. For example, if you are a food producer and your competitor has the best distribution network in the industry, something that might take you decades to build, selling your company to them could make sense. A significant step-up in revenues and profits and enterprise value may serve you better in the long term than retaining independence.
Financial outcome
If you want to simply retire and extract the greatest possible financial gain from the transaction, then a third-party sale could be the quickest way to get there. A strategic sale may make more sense under this scenario, but you would need to carefully explore all options. A third-party sale may be the best option, with determination between strategic and institutional investors depending upon the business characteristics.
Terms to know
Negotiated sale
A transaction in which the buyer and seller of a business agree on terms and price through a process of negotiation. Generally, a negotiated sale is more flexible and confidential than competitive or public bidding, although it may not achieve the highest possible price.
Unsolicited offer
An offer to buy a company that the owner did not request. The owner may not be actively looking for a buyer. The offer could come from various channels, including a competitor, customer, supplier, private equity firm or other investor.
Controlled auction
A structured bidding process where a small group of qualified buyers competes to purchase a business. The seller controls the auction process, selects the bidders and typically limits their number.
Asset sale
The purchase of some or all the assets of a business by a buyer, rather than its stock or shares. Assets can be tangible (equipment, inventory, etc.) or intangible (trademarks, goodwill, etc.). The seller usually retains company liabilities, including debt obligations, and pays income tax on the gain or loss. This type of sale is often preferred by buyers since they receive a step-up in the tax basis of the assets and avoid assuming unknown or contingent liabilities. In the U.S., some acquisitions can be structured as asset sales for tax purposes while retaining the benefits of an equity sale (continuity of operations, etc.)
Equity sale
The purchase of a company's ownership by a buyer, whether through stock or shares or other ownership units. The buyer acquires all assets, liabilities, contracts and obligations. This is usually quicker and easier than an asset sale, and sellers often prefer it because they can receive preferential capital gains tax treatment on the sale.
Challenges and opportunities
Where to get advice first
A tried-and-true piece of advice to a business owner contemplating a sale is to call your most trusted advisor first. You need to sort out your personal priorities and goals and decide what is best for you and your company. For this, a consultant or trusted advisor is best suited, someone who can help you rank your priorities—legacy, continuing involvement in the business, work/life balance, financial gain, and so on. Once you have made your decisions, an advisor could help you plan for any pre-sale transfers to family members or employees to minimize tax friction at sale. If you have already made a promise to a buyer, you may be able to shape it to become more tax-advantageous or more commercial while achieving the same end. Your advisor could also help you determine what price you would be comfortable with given your overlapping priorities and concerns. In fact, you would bring those priorities and concerns with you in selecting a banker, choosing one whom you think could best deliver what you want. It is important to work things through with your advisors before you engage with an investment banker or get too far along with a buyer.
Address problem areas early
Address any financial and operational problem areas in your company before bidders find them and use them to negotiate a lower price. If you have practiced good business hygiene by having your business audited regularly, you may have already addressed many of these problems, keeping your company “sale-ready” on an ongoing basis. Once you are approaching a sale, engaging an advisor to conduct sell-side diligence and perform a quality of earnings (QoE) analysis may be the best way forward. With middle market companies, for example, nonpayment of sales taxes is one of the most common financial issues discovered during diligence. The company may not have collected sales tax or even been aware that its services were taxable. Sales tax is the most highly audited area by state tax authorities. Solving problems like these before the buyer discovers them can be a straightforward win for a company owner looking to present clean financials and maximize the sale price.
Understand the nuances of equity vs. asset sales
Whether a transaction is structured as an equity sale or asset sale can make a significant difference to the complexity of the deal and its tax treatment, so you should be clear on your preferences and priorities in advance. Sellers typically prefer equity sales because they can transfer the business as a going concern and may be eligible for capital gains tax exemption on the proceeds. Buyers generally prefer an asset sale because it allows them to acquire your company’s operating assets without incurring its balance sheet liabilities. They may also be able to generate depreciation and amortization deductions on the assets, which reduces taxable income. However, an asset sale can be more cumbersome for a seller, who may need to create a new legal entity and transfer assets to it. There is also a middle ground, popular in founder exits or family-led exits, that allows a legal equity sale to be treated as an asset sale for tax purposes. If your buyer is set on an asset sale or a hybrid, any added costs on your side should become part of the price negotiation.
Audit and assurance considerations
Whether a third-party purchaser requires audited financial statements depends on the acquirer and the circumstances, including the timeline. An audit takes time to complete and is backward-looking, focused on the latest fiscal year-end. In assessing and valuing your company, a purchaser would usually be more focused on your sustainable earnings and future cash flow.
An audit can bring peace of mind to all parties involved, including you as the owner. A valuation based on audited financial statements will usually carry more weight. Audits may offer reputational value as well. A company with a history of doing regular audits has demonstrated its commitment to financial rigor and transparency, which can increase the appearance of quality (and possibly value) in a buyer's mind. Audits can also be a good way to spot problems early on and fix them well before you enter the sale process.
An alternative to an audit is a review of the company's financial statements. A company review is a formal analysis of your financial statements and accounting—it is less intensive than an audit but is a recognized form of accreditation if performed by a reputable firm.
Timeline
Planning and goal setting are the very first steps in a company sale. As a business owner, it is critical to have a clear view of your own goals and priorities from the outset. It is never too early to start—whether you are responding to an offer or initiating a sale, the longer the runway the better. This not only allows you to assess your own priorities but gives you time to address any financial and operational problems in the business to maximize its appeal and value.
For example, if you are 12–18 months from a sale, look to see if there is low-hanging fruit you can address. Do you want to take value out of the business before the sale process commences? Do you want to make process improvements to improve earnings and increase the purchase price?
This is early-stage planning, and you should do it before the investment bankers get involved. Ideally, at this point you would initiate a sell-side QoE analysis so you could review the financials thoroughly before the buyers come in and do their own diligence. QoE analysis helps you identify unaddressed financial and operational problems in your business that a buyer will eventually find and use to their advantage in price negotiations. You and your advisors should fix what can be fixed—such as outstanding tax liabilities—and develop reasonable interpretations for other issues that you can use in negotiations. This must be done early—if you try to do it midstream through a 30-day exclusivity period, there is little room for preparation, nuance or perspective.
Once you get into detailed negotiations and the investment bankers are involved, your QoE analysis will help them build detailed financial models and accurate forecasts of future cash flows, which is ultimately what your enterprise value is based on.
Tax considerations
Capital gains tax is often a key issue in the sale of a business, but not the only one. Tax treatment will vary depending on whether the transaction is structured as an equity sale or an asset sale.
Certain shareholders of qualified small business corporations may be able to exclude some or all the gain using the section 1202 qualified small business stock exemption.
With an asset sale, you may face a combination of ordinary and capital gains taxes, with less room for exclusion. So, although taxes may seem like a personal issue, they become a factor in the sale negotiation if the buyer wants an asset sale and you prefer an equity sale. You should consult with an estate or tax attorney as early as possible to make sure you understand your options and are able to represent your interests properly in discussions with the buyer.
Other advisors involved in a transition to a third party
Management consultants
These professionals have specialized knowledge and experience in early-stage planning, goal-setting, preparation for negotiations, business analysis and general counsel throughout negotiations.
Sell-side QoE advisors
You should aim to complete a sell-side QoE analysis early in the process so you can address operational and financial problems before they emerge in the negotiations.
Estate attorneys and financial advisors
It will be important to get outside counsel to help protect you and your family’s portion of the transaction and deal with the numerous tax issues involved.
Corporate lawyers
Any deal entails considerable legal paperwork that will require the attention of contract specialists.
Investment bankers
At some point you will likely need an investment banker to help structure and value the deal, provide sales and marketing information to prospective buyers, conduct price negotiations price, and execute a transaction.
Tax accountants
Ensuring tax compliance and optimizing tax strategies are keys to a successful transaction. Tax accountants also assist in valuing the business, structuring the sale for tax efficiency, and navigating legal and regulatory requirements.
Third-party transition case study:
Retail
Preserving value by uncovering tax liabilities
Owners of an online direct-to-consumer retail business explored a potential divestiture. The company’s entire physical presence was in Texas, and it utilized third-party non-U.S. manufacturers.
The company was not collecting local sales taxes. It was only paying sales taxes on its purchases.
Sell-side due diligence included an evaluation of the company’s historical sales to identify where the largest unpaid sales tax liabilities existed and whether a voluntary disclosure program could help the company manage its exposure.
Following the sales tax evaluation, the company recorded the sales tax liability as an adjustment to EBITDA, using an intermediate approach that estimated the high-sales-volume states and outcomes based on voluntary disclosures in select states.
The pro forma EBITDA adjustments helped the company price the transaction at the optimal net cash outcome.
Transition your business in the best way possible
All successful business owners eventually face the problem of developing a good exit strategy. This could be thrust upon you suddenly if you receive an unsolicited offer for your company, or it could be the result of years of careful planning around a time-horizon of your choosing. Either way, it is a complicated process. The sooner you prepare for this inevitability, the more likely it is that your transition path will allow you to reach your personal and professional goals.
RSM has a long history of working with company owners to plan and execute successful business transitions. We can give you guidance and counsel as you sort through your goals, priorities and personal circumstances. We can also provide you with the technical competencies needed to bring efficiency and clarity to business transitions of all types and sizes—for example, asset and business valuation, estate and gift tax planning, wealth and tax counseling, audit and due diligence, sell-side advisory, earnings analysis, strategic finance, and family office services.
Let's Talk!
Call us at (360) 734-4280 or fill out the form below and we'll contact you to discuss your specific situation.
Source: RSM US LLP.
Reprinted with permission from RSM US LLP.
© 2024 RSM US LLP. All rights reserved. https://rsmus.com/insights/services/private-client/business-transition-planning-guide.html
RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent assurance, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/about for more information regarding RSM US LLP and RSM International.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.