Structuring your business today for a sale tomorrow

Most owners think about selling only when a buyer appears or retirement gets close. By then, the structure of the business is largely fixed, and with it much of the tax outcome and how attractive the business looks to a buyer. A few decisions made years earlier can make a sale simpler, cleaner and more valuable.

Asset sale or share sale

There are two basic ways to sell a business run through a company or trust.

• In an asset sale, the entity sells the business assets, such as goodwill, equipment, stock and contracts, to the buyer. The entity keeps its own history, liabilities and any assets not included. The proceeds land in the entity, and getting them out to the owners is a second step with its own tax consequences.
• In a share sale (or a sale of units in a unit trust), the owners sell their interests in the entity itself. The buyer takes over the entity with its history, contracts, employees and liabilities. The proceeds go directly to the sellers.

Buyers often prefer asset sales because they avoid inheriting unknown liabilities. Sellers often prefer share sales because the tax outcome can be better and the process cleaner. A business that is well organised, with clean records and nothing unusual inside the entity, makes a share sale far easier to negotiate.

How the structure affects the tax

The CGT discount

Individuals and trusts that have held an asset for at least 12 months can generally reduce a capital gain by 50%. Companies cannot. So a business sold by a company as an asset sale gives the company a gain taxed at the company rate without a discount, and the owners then face tax again when they extract the proceeds as dividends.

If the owners instead sell their shares in the company, and they hold those shares personally or through a trust, the discount may apply to their gain on the shares. This is one reason the ownership of the operating entity matters years before a sale.

Small business CGT concessions

Eligible small business owners may be able to reduce or eliminate the gain on selling active business assets, or shares in a company carrying on the business, through the small business CGT concessions. These include a 15-year exemption, a 50% active asset reduction, a retirement exemption and a rollover. Eligibility depends on tests including turnover or net assets, how long assets have been active, and, for shares, who are the significant individuals in the business. The tests are applied at the time of sale and are easy to fail if the structure has drifted.

Do not assume you will qualify. Check eligibility well before a sale and again before signing.

The structure you have on the day you sign is the structure you will be taxed on. Planning a sale starts years before the sale.

What a buyer wants to see

Buyers, whether trade buyers, private equity or people acquiring a business through entrepreneurship through acquisition, generally look for:

• Clean financial records that reconcile to tax returns and bank statements, with personal expenses kept out.
• A business that does not depend on one person. Documented processes and a team that can run the business without the owner every day.
• Contracts in the right name, assignable or in the entity being sold, with no surprises such as change-of-control clauses.
• A clear entity. No unrelated assets, old loans, Division 7A balances or unpaid trust entitlements sitting inside the company being sold.
• Clear ownership of key assets such as intellectual property, trade marks, domain names and customer data.
• Compliance in order: tax, superannuation, payroll and employment obligations up to date.

Structural steps to consider

Separate the business from the property

If the business owns its premises, a buyer may not want or be able to fund the property. Holding property in a separate entity, leased to the business on commercial terms, lets you sell the business and keep the property, or sell them separately.

Keep the operating entity clean

A holding structure can keep surplus cash and investments outside the operating company, so a buyer can acquire the operating company's shares without paying for, or inheriting, things it does not want; see Holding and operating companies: separating risk from assets.

Clear loan accounts

Outstanding shareholder loans and unpaid trust entitlements complicate a sale and can create unexpected tax on settlement. Deal with them in the years before; see Division 7A: taking money out of your company the right way.

Review co-owner arrangements

Make sure your shareholders agreement covers drag-along and tag-along rights and how a sale is approved, so one owner cannot block or derail it; see Why every company with two or more owners needs a shareholders agreement.

Consider timing

Holding periods matter for the CGT discount and for some of the small business concessions. A restructure shortly before a sale can reset key dates or cost more than it saves. If a restructure is needed, do it early; see Restructuring an existing business.

An illustration

Consider two owners who each hold 50% of an operating company through their family trusts, and whose premises are held in a separate unit trust. A buyer offers to acquire the company's shares. Because the company holds only the trading business, the buyer can do due diligence quickly. The family trusts may be able to apply the CGT discount, and possibly the small business concessions, to their gains. The owners keep the property and lease it to the buyer. This example is illustrative only and simplifies many details.

A three-to-five-year plan

1. Decide your likely exit: a trade sale, a management buyout, a family transfer or a sale to an individual buyer.
2. Review your structure against that exit and the tax tests that will apply.
3. Separate property and surplus assets from the trading business where it makes sense.
4. Clean up loan accounts and entity records.
5. Reduce dependence on yourself, document processes and build the team.
6. Put contracts, leases and intellectual property in the right entity.
7. Prepare clean, consistent financial statements each year.
8. Have your lawyer review your constitution and shareholders agreement for sale provisions.

How we can help

We help owners prepare their structure and records for a sale, model the tax outcome of different sale options, and support them through negotiations and due diligence alongside their lawyer. To plan your exit, contact us or read about our business sales and purchases services.

This article is general information only and does not take into account your circumstances. Speak to a qualified adviser before acting on it.