Selling your business for cash? Deciding how to allocate and invest the proceeds after the sale of your company is a big decision that requires careful planning. If you are expecting a sudden windfall, develop a plan to allocate the proceeds and reinvest in your future. As you weigh what to do with money from the sale of a business, consider these key points.
What should you do with the cash from selling your company?
When you own a business, your net worth is highly concentrated in one illiquid asset. A sale gives you the opportunity to diversify your investments, de-risk your financial situation, and improve your cash flow.
If you’re expecting a large cash windfall from a business sale, here’s how to consider what to do next.
- Take stock of your financial goals and timeline. Are you planning to retire? Many business owners want to keep working. What are your income needs? Are you expecting any major purchases or new business investments? How do the cash proceeds stack up against your other assets and investments? Don’t discount your non-financial goals and what you plan to do after you sell. Going from running a company to suddenly retired can be a difficult transition for some people.
- Create a formal financial plan. A comprehensive financial plan can help you analyze whether the sale proceeds will allow you to maintain your lifestyle and what variables you can play with to optimize the outcome. A strategy for managing your investments is also key: understanding your risk capacity vs appetite, balancing a need for a current income stream and future growth, and ways to be more tax efficient in taxable accounts.
- Put the plan into action. With the help of a financial advisor, cash proceeds from the sale of your business can be invested in the financial markets. It’s also important to implement other parts of your plan, such as ways to reduce tax from the sale, estate planning, charitable giving, and other goals.
Financial planning and investing the proceeds from a business sale
Any time you’re investing a lump sum in the market, there’s a lot to consider. A liquidity event is a great opportunity to develop a long-term investment plan. As a business owner, growth was probably a top priority. After the transaction is complete, consider ways to protect and grow the wealth you’ve built.
Will you retire after selling the business?
Not every entrepreneur wants to retire after selling their company. But for those who do, sudden wealth won’t automatically mean you’re on track to live the lifestyle you want in retirement. How much you’ll need depends mostly on your expenses, not savings.
To illustrate, consider the following simplified example, which exclude factors like inflation, market volatility, etc.:
You receive $20 million dollars from selling your company and 30% goes to federal capital gains taxes and state tax. Right after closing, you spend $5M cash on a new home and other expenses. At the beginning of each year, you withdraw $1M from your investments to meet income needs. Assuming a 6% annual return, your investment account is depleted in year 13 – before even factoring in annual taxes or market volatility.
If, instead, you spent $3M at closing and reduced withdrawals to $750,000 per year, the hypothetical money would last for 30 years. The cash at closing is the same – but spending drives the outcome.
If you are concerned about running out of money, reducing expenses can go a long way. As you consider the best ways to utilize sudden wealth, remember that spending drives what’s possible financially.
A key part of deciding what to do with the money after the sale of your business is understanding your risks and options. To feel confident that it isn’t too early to retire, your plan should include a Monte Carlo simulation to account for market volatility. This is the best way to stress-test a retirement plan.
Investing cash after selling a business
Figuring out how to enter the market can be challenging if you’re sitting on a pile of cash.
Holding cash just because the S&P 500 is setting new highs is a mistake on several levels. First,
when investing, it’s critical to make decisions based on long-term expectations, not short-term market moves.
Second, past performance is not indicative of future results. Setting new highs doesn’t necessarily mean the market has peaked and a correction is imminent, just as a pause during a sharp selloff doesn’t mean there’s not still further to fall.
Further, historical data doesn’t support the idea that investing when the market is high is likely to produce lower future returns. In fact, investing on days where the market closed at a new all-time high can actually produce better returns than investing on a day where the market didn’t set a new record.
Planning for capital gains tax from the sale
Before you can decide what to do with cash after selling a company, you need to know what the after-tax proceeds will be. The tax consequences from the sale can be highly complex. Here are just a few factors that make calculating taxes after the sale so nuanced:
- Asset sale vs stock sale
- Purchase price allocation of individual assets (federal capital gains taxes versus ordinary income)
- Terms of the deal: cash, installment sale, seller financing, earn out, equity rollover
- Multi-state tax implications depending on the footprint of the business
- Structure of the business (C corporation, S corporation, partnership, LLC)
- Potential to qualify for qualified small business stock
- Tax laws in the business owner’s home state, including special surtaxes such as the Massachusetts Millionaire Tax
Work with your legal and tax advisors to understand the tax implications from your exit. During negotiations, there are ways to reduce tax for the seller, but they don’t happen by default.
Reducing tax after selling your company
On the personal side, there are still planning opportunities to consider when trying to reduce tax after a large payout:
- If your company is a C corporation, you might be able to sell your business tax-free if you qualify for Section 1202 – qualified small business stock
- Review your taxable investment portfolio to see if there’s an opportunity for tax-loss harvesting
- If charitable giving is a goal, making a big donation the year you sell your business (and are paying tax at the highest marginal rates) can really pay off. For example, donor advised funds are a great tool to help investors maximize the tax benefits of charitable giving.
- If there’s real estate involved, weigh the pros and cons of doing a traditional 1031 exchange or 721 exchange utilizing a Delaware Statutory Trust (DST) to defer gains from the sale of investment real estate. These are complex and nuanced vehicles with liquidity and investment risk, and cost components, that should be evaluated thoroughly
- If pending legislation passes, it could present another opportunity to consider a qualified opportunity zone fund to defer gains from the sale of a business. However, even if passed, there are still many factors to consider before going this route, including investment risk, liquidity, and cost
Additional Articles by Darrow Wealth Advisor Kristin McKenna in Forbes:
Business Brokers Share Tips On How To Maximize The Sale Price
How To Sell Your Business: What To Do Before, During, And After The Sale
Hold off on big purchases until you have a plan
Business owners should delay major expenses or cash outlays until they fully understand the tax implications of selling a business and have considered their financial goals. This includes how to invest the proceeds.
After a major windfall, it’s easy to feel the cash burning a proverbial hole in your pocket. One knee-jerk reaction is often to pay off a mortgage or buy a new home with cash.
As with nearly everything in life, there’s an opportunity cost that comes with each decision we make. Whether you share the urge to live without a mortgage or simply aren’t sure where else to put extra cash, realize prepaying your mortgage isn’t always a good idea. If you have a low interest rate, using the money to pay off your mortgage early might be a mistake.
As interest rates rise, it may be more difficult for new buyers to take advantage of the leverage spread. The opposite is also true: the lower the interest rate on the loan, the more advantageous it can be to get a mortgage and invest cash in the market.
Invest in your estate plan
Your estate plan is likely to change considerably after selling your business. Work with a trusts and estate lawyer to draft a plan that suits your situation and family goals. Considering your assets and projected income needs, discuss options to meet your charitable goals and ways to reduce your taxable estate with gifts to family, if inclined.
Also consider techniques with trusts to accomplish various goals. For example, revocable living trusts can allow you to continue to control your assets and avoid probate while irrevocable trusts offer superior asset protection, but you often lose full control.
As with any financial strategy, it’s essential to ensure alignment with your overall objectives and priorities. Avoid making decisions purely for tax reasons.
Financial advisor for business owners (current and former)
You can only spend a dollar once. So it’s critical to have professional support when deciding what to do with the money from the sale of your business. Our Private Wealth Management Program aims to help business owners manage their personal finances while running a company and eventually successfully transition to retirement. If you’ve recently sold a business, speak with a Darrow Wealth Advisor today.
[Last reviewed October 2024]
