Q: I’m a gay business owner in Phila-delphia. With the economy the way it is, I’m starting to think more and more about retirement ... and whether or not I can still retire someday. Can you offer any thoughts on how to plan for my retirement and what options I have for the business? A: You are certainly not alone as a concerned business owner. The economy is certainly affecting many of us, especially many small-business owners. Most are wondering how changes in the economy and the business environment might affect the timing of their plans to retire or otherwise exit their businesses. Here are a few points to consider.
How the economy factors in
Buy low, sell high. Every owner wants to sell all or part of his/her business at the top of the market. And certainly, the market for businesses is cyclical, with its health aided by a growing economy, affordable capital for acquisition financing and optimism and competition among buyers.
With the slumping economy at the forefront of today’s news, business owners are now asking, “How will this environment affect the market for my business?” A look at the past, going back 30 years and several business cycles, gives us an idea of what we can expect for business sales when the economy falters.
It is no surprise that, in years of poor economic growth or decline, the number of mergers and acquisitions did in fact drop. And, true to form, M&A activity is likely to decline again as the economy softens.
But perhaps the more interesting message that history provides is that a new (higher) level of sustained M&A activity is noticeable in the past decade. In fact, 1995 looks to be the line of demarcation, after which M&A activity expanded dramatically and remained relatively high (from a historical perspective), even in weak business environments. Although there will be annual variances, elevated levels of M&A activity appear to be based on accepted business practices that are here to stay.
In addition to economic malaise, business owners are concerned with possible tax-rate increases, specifically the capital-gains rate. A capital-gains tax is charged on the profit realized on the sale of an asset, including a privately owned business. The 2003 Tax Act reduced the maximum capital-gains tax rate from 20 percent to 15 percent for long-term capital gains (investments owned for at least 12 months), creating an exceptional tax-saving opportunity for business owners looking to sell, given that the rate had not been below 20 percent in the past 60 years.
The 5-percentage-point reduction was not a permanent change, however. Originally set to expire in December 2008, former President Bush extended the lower rate. Although the lower rate is now not due to expire until 2010, the change in the White House may raise the issue sooner. In light of the administration change in January, the capital-gains rate debate is expected to surface again.
Personal factors take priority
The decision to sell a business is not primarily tax- or economy-driven. While owners sometimes look to maximize value during an attractive M&A cycle or capitalize on a consolidation trend in their industry, most private business sales are motivated by personal factors. These can include a wish to retire, advancing age, declining health, a desire to reduce the personal risk associated with a large concentration of wealth in one asset, or the realization that family members are not interested in taking over the business.
While external factors can certainly affect the outcome of a business sale (including the price and terms of the transaction), they usually are not the driving force.
Regardless of your exit motivation, it is never too soon to start preparing for a transition. In fact, savvy business owners begin to prepare for their transitions early — often years in advance of a transaction. Some of the initiatives that owners undertake to get ready for a future transition include setting up trusts that can help minimize estate and gift taxes on the eventual sale proceeds, compiling proper (preferably audited) financial records on the business, and preparing business plans and detailed documentation about how the business operates.
Planning for a transition can seem overwhelming, but business owners are not expected to do it alone. Tax, legal, investment-banking and financial-planning experts can each play a critical role in preparing an owner for an eventual transaction. Such experts can guide you through the planning process and help identify and implement the most effective strategies to optimize value.
I’d suggest reaching out to your own business advisers sooner than later to discuss your plans. They can help you better evaluate your options.
Citigroup Inc. and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by the law. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.
Smith Barney is a division of Citigroup Global Markets Inc. Member SIPC.