3 Strategies For Selling Your IT Service Business

By Rayanne Buchianico, ABC Solutions, LLC

This is the second of a multi-part series on exit strategies authored by Rayanne. Click here for part one, click here for part three, click here for part four, and click here for part five.

After years of building your business and planning your exit you finally decide it is time to move on and now need to determine how to structure the exit. There are a few options we will explore over the coming weeks.

• sell your company
• transfer to a family member
• sell to an employee
• keep the business as an absentee owner

The natural starting point for an exit series is to discuss selling your company. The remainder of this article will focus on an out-right sale of your business to another person, often a stranger. However, you may find a local competitor or even an employee who may be willing to purchase your business. Whoever the buyer, let’s discuss how to structure the sale and the ripple effect it will have on your business and taxes.

Finding Your Buyer

There is no shortage of companies looking to acquire MSPs in today’s market. Many companies are in growth mode due to the stimulated economy. Acquiring a company is a quick and easy way to increase the size of your business. If you decide to hire a selling agent or broker, consider using one inside the channel as opposed to a generic business broker. You will have more exposure to true potential buyers. You may also find a local competitor who is willing to pay for your business. Some MSPs know and trust their local competitors, others do not. You should know your market and who you can approach.

Be realistic in your asking price. I know you want to retire, but you will have better luck selling a business if the asking price is reasonable based on your operations. Have your due diligence documentation ready. If your financial records are clean and your documentation is in order, you will save a lot of time later and your company will appear organized and well-managed. This will help boost any premium selling price you are asking.

Structuring The Sale

Assuming you have found a purchaser and agreed on a price and terms, the scariest part is how to structure the sale. How will this affect your income tax returns? There are some steps you can take during the business sale to ease tax burdens. Let’s walk through each component.

When selling a business, you are often not selling “one asset” but rather “multiple assets.” Those multiple assets have different tax treatments and must be calculated separately. When selling your business, you will need to classify each asset into a group:

• cash and equivalents, including investment accounts and accounts receivable
• property held for sale to customers — inventory
• depreciable property — equipment, furniture and fixtures, vehicles, etc.
• real property — property owned by the company for use in the business
• intangible property —goodwill, covenants, amortizable property

When structuring the sale, you need to decide which of these items are included with the sale of the company. Generally, if performing a stock sale, the buyer will purchase the stock of the company, the name, all the assets, and all the liabilities. One owner leaves, another owner steps in and takes over where you left off. This does not happen often.

You will likely find the buyer doesn’t want your debt and many of the assets on your depreciation schedule such as your car and outdated computer equipment. This is okay. You may not want to sell your car anyway or perhaps you’ve grown attached to a piece of furniture.

• Important tip: This is your business. You can sell all of it or part of it any way you want. You get to make the rules on what goes and what doesn’t go.

You will need to provide a list of all equipment included in the sale along with the current “Fair Market Value” for each piece of equipment. The FMV becomes the buyer’s purchase price for that equipment and your selling price for income tax purposes. Any gain after depreciation recapture will be taxed at capital gains rates and treated as Section 1231 asset if held longer than one year. Section 1231 losses are fully deductible as an ordinary loss. Consider this when valuing your fixed assets and intangible assets. If your assets are fully depreciated, or mostly depreciated, the sale will result in a gain.

Sale of inventory is ordinary income as it would be if you sold it to a customer. Consider this when valuing inventory for a business sale. If you over-inflate inventory values or sell obsolete inventory to the buyer, you do so knowing you will pay full fare to the taxman. Before selling, clean up your inventory list and ensure the values on your balance sheet are accurate.

Intangible assets are where you may have some flexibility. Any Goodwill or Covenants you have on your balance sheet will generally not be transferred to the new owner. New Goodwill and Covenants will be developed during the sale. The sale of a customer list is a capital asset. If you place a greater value on the customer list, you can have a large majority of the sale price taxed to you at capital gains rates which is a more preferred rate than ordinary. Goodwill is also taxed at capital gains rates. Non-Compete Covenants are treated as ordinary income. Keep your Covenants at a minimum whenever possible. A Non-Compete Covenant is usually present in most sale documents and should be given a value, but not a high one. All start-up and purchasing costs to the buyer are amortized over 15 years. The actual name and value of the intangible assets will make little difference to the buyer. Use this as a negotiating tool.

When considering an outright sale, be sure to do a little calculation so there are no surprises at the end. Overall sales price, minus debt pay-off, minus estimated income taxes, equals net cash to you. If it’s a number you can live with, sign away.

Timing Of Sale

Another simple trick to selling your business is to split the sale price into two calendar or fiscal years. This is not always possible, but if the sale of the business is transpiring toward the end of the year, have 50 percent paid in one tax year and 50 percent paid in the next. This will defer the tax due to the following year, and two payments may bring you into a lower tax bracket than one lump sum, saving a few tax dollars. Just be sure to put the tax money aside in an interest-bearing account and make estimated tax payments throughout the year to cover it.

A little planning can go a long way when structuring the outright sale of your business. As always, speak to an attorney and accountant to help you through the details and make sure you understand exactly what each clause of the sale means to you and your net proceeds of the sale.

About The Author

Rayanne Buchianico owns and operates ABC Solutions, LLC, an accounting, tax, and business systems consulting firm serving all industries and specializing in IT firms throughout the United States. She is also a partner in Sell My MSP, a listing service connecting interested buyers with motivated sellers of IT firms. Rayanne is passionate about nurturing the transformation in owners of small businesses who become more comfortable and savvier with the financial aspects of their business.