Determining When to Accept a Buyout Offer and When to Walk Away: A Case Study

Our team frequently engages in conversations with business owners about how to know whether a buyout offer is “right.”  Whether the number offered for your business is sufficient to meet your personal financial goals is subjective and depends on a wide variety of factors, so it’s not as simple as saying “X” number of dollars is a “good offer.”

While no business owner is immune to making tough choices, selling the company you’ve put your heart and soul into is one of the most complex and difficult decisions you can make. Still, when an offer comes along that seems too good to pass up, it can be tempting to take the money and run.

Unfortunately, failing to evaluate a buyout offer from all angles can result in missed opportunities for growth and financial gain. In some cases, it can even lead to costly missteps and long-term regrets.

To illustrate these complexities, following is an illustrative case study based on a composite of experiences we’ve had with actual business owners.

The Offer

At 55 years old, Dave owns 51% of a specialty food manufacturing business, which he founded and grew into a trusted brand with a $10 million revenue run rate and an 18% EBITDA margin. His two investors hold the remaining 49%.

A renowned multinational food manufacturer recently offered to buy Dave’s company for $15 million in cash, reflecting the company’s current valuation. They also proposed an incentive scheme where Dave would receive $750,000 for every $1 million increase in revenue above the current $10 million run rate, aiming to encourage growth post-acquisition. This would potentially increase the total valuation to $20 million, contingent on achieving specific revenue milestones beyond the current rate.

Given the company’s trajectory and its last year’s revenue, Dave is confident in the business’s continued growth. If the company grows its revenue significantly under the new ownership, his share from the additional revenue incentives could substantially increase his personal earnings.

Dave shared that if he were to accept the buyout offer, he’d likely invest $5 million immediately to fund his eventual retirement. Even though this would afford him the freedom to pursue other ventures in the meantime, he wants to ensure he’s considering the deal from all angles.

Business Owner Considerations

At first glance, the multinational corporation’s buyout offer may seem like a great opportunity. But before he makes his decision, there are several factors the CornerCap team would encourage Dave to consider, including:

• His long-term goals
• The deal’s tax implications
• Potential risks and blind spots.

Dave’s Long-Term Goals

First, Dave must consider whether the offer is in line with his long-term goals for himself, his family, and his business. While investing $5 million is certainly a comfortable starting point for retirement, cashing out now means potentially sacrificing a much larger future payout. If he’s confident in the business’s growth prospects, even waiting a year or two to sell could get him to a much larger exit number.

Tax Implications

Dave’s business and home are based in South Carolina, and he is currently in the highest federal tax bracket. If he sells his business, he must consider the potential tax consequences, which could include:

• Long-Term Capital Gains Tax. Dave has held his interest in the company for more than one year, so any profits from the sale would be subject to long-term capital gains tax. Since he’s in the top federal income tax bracket, the long-term capital gains tax rate of 20% applies. Additional taxes, such as the Net Investment Income Tax (NIIT) of 3.8%, could also apply if Dave’s income exceeds certain thresholds, potentially bringing his effective rate to 23.8%.
• State Taxes. South Carolina taxes capital gains at the same rate as regular income, but with a beneficial provision for long-term capital gains. Given that the top marginal income tax rate in South Carolina is currently 7%, the effective state tax rate on long-term capital gains would likely be considerably lower after applying the exclusion.
• Depreciation Recapture. When certain assets, like equipment, vehicles, or buildings, are sold for more than their depreciated value (the book value), the IRS requires the profit on the sale to be reported as income. This income is subject to depreciation recapture taxes, which can impact the overall tax liability from the sale of a business.
• Estate Tax. Currently, South Carolina doesn’t impose a state-specific estate or inheritance tax. However, depending on Dave’s overall net worth, the value of the business may be subject to federal estate taxes if he passes away.
• Alternative Minimum Tax (AMT). Dave may also be subject to the alternative minimum tax (AMT), a separate tax system designed to ensure high-income individuals pay a minimum amount of tax.

Of course, specific tax implications will vary by business owner, location, and sale terms. Nevertheless, with proper planning, Dave can minimize his overall tax liability and preserve more of his payout.

Potential Risks and Blind Spots

It’s important to have an objective third party in your corner to help you see around corners and avoid potential risks associated with selling a business:

• Valuation Risk. Many factors can influence the valuation of a business, including market conditions, competition, and the overall economy. If Dave accepts an offer that is significantly lower than the true value of the business, he may leave money on the table.
• Deal Structure Risk. In Dave’s case, an all-cash offer may be the best possible scenario. Nevertheless, it’s important to ensure the deal structure benefits the seller as much as it does the buyer.
• Market Risk. The market can be unpredictable, and economic downturns or other market disruptions can impact the value of the business. Therefore, the timing of the sale can significantly impact the outcome.
• Tax Risk. Again, there are significant tax implications associated with selling a business. Failure to structure the transaction in the most tax-efficient way or engage in proactive tax planning can result in a higher tax bill than necessary.
• Reputation Risk. If the buyer fails to operate the business successfully or engages in unethical behavior, it can reflect poorly on Dave and damage his reputation. This, in turn, could affect his future success in business, including his earnings potential.

It’s important to note that selling a business doesn’t just come with financial risks.; however, identifying these types of risks is where our expertise lies. Before making a major financial decision, it’s also important to consider the emotional toll selling a business may take.

In Dave’s case (which is often the case for others like him), his identity is very much tied up in being a business owner. When this changes, it can introduce a host of unexpected challenges that take time to overcome. Before accepting a buyout offer, Dave should also have a plan for how he’ll spend his time post-sale.

Recommendations & Action Items

For an actual vs. theoretical business owner like Dave, here is how CornerCap would have supported his decision making process.  Once we helped Dave identify his long-term objectives and the potential tax consequences and risks of selling his business, the next step would be to develop a plan to help him achieve his financial goals.

First, we would look for ways for Dave to stay engaged in the business while also benefiting from an immediate liquidity event. For instance, if he could negotiate keeping an ownership interest of 10%, he could potentially benefit from a second liquidity event at a higher multiple.

Alternatively, since Dave’s business is structured as a C-Corporation, he may want to consider a Grantor Retained Annuity Trust (GRAT). Here’s how a GRAT works:

• Dave would transfer a portion of his equity to a GRAT while retaining an annuity interest.
• The annuity interest would then pay Dave a fixed amount each year for a set number of years.
• At the end of the term, any remaining assets in the GRAT pass to its beneficiaries—for example, Dave’s children—free of gift and estate taxes.

Lastly, we identified strategies that could help Dave minimize his overall tax burden if he accepts the buyout offer. One option is for Dave to establish a donor-advised fund (DAF).

A DAF is a charitable giving vehicle that would allow Dave to make a large charitable contribution and receive an immediate tax deduction for the full amount of the contribution in the same tax year. Dave could then recommend how to invest the funds within the DAF and distribute them to eligible charities over time.

As such, a DAF would allow Dave to potentially reduce his tax liability resulting from the sale by taking an immediate deduction for his donation. Then, he could develop a strategy for distributing grants in the years that follow.

The Benefits of Working with a Wealth Advisor

One of the benefits of working with a wealth advisor like CornerCap is the real-world experience we can draw upon to help business owners like Dave tackle complex decisions.

Because we’ve helped numerous business owners navigate buyout offers, we can identify risks and recommend solutions that owners like Dave may not have considered, helping them make informed decisions about their future financial landscape. Additionally, should a business owner like Dave pursue a buyout offer, CornerCap can guide them through the negotiation process, working to keep the deal aligned with his goals and risk tolerance as terms shift along the journey (which they inevitably do in the transaction process)

Ultimately, a wealth advisor is a long-term financial partner, helping you make smart decisions to create the life you want. If you’re a business owner facing a tough decision or simply looking for more guidance on how to manage your personal finances alongside your business, CornerCap can help. Contact us to find out how we can you build a wealth management plan around your story.