Pianotech

Chapter 9. Sale of a business. Tax issues and beyond

There will come a time when you might want to sell your business. Although this chapter will focus on selling a business when you want to retire, keep in mind that there are other times when it might become necessary to sell your business, such as moving to a different part of the country for health reasons,  getting an offer you can't refuse to pass up, or moving because your spouse has a new job.

One of the wonderful benefits of being self employed is that no one can tell you how many hours a day you have to work, or how much time off you can take. You can start your workday at noon or at 6 in the morning, and you can work until midnight, or you can quit at 3 in the afternoon. Some of you might even start the day at noon and quit at 3, or, if you are a work-a-holic, start at 6 in the morning and quit at midnight. The bottom line is, as a self-employed piano tuner, you can set your own schedule, and work as little or as much as you want.

When it comes to how many years you want to work, the same applies. No one is going to tell you when to retire.  Just as you want to take a few hours off every week to relax, and take a few weeks of vacation every year, (at least you should), you probably want to retire at a certain age, and enjoy the fruits of your labor. You can have the option to retire at age 50, or you can work until you drop dead, or age 100, which ever comes first.

While most of you probably have in mind to retire when you reach your late 60's or early 70, there are many self-employed piano tuners who, because of a lack of planning, or other unforeseen circumstances, don't have a choice. These people have to work long past the day they want to retire. They will not have the opportunity to live out their last remaining years enjoying the fruits of their labor. The reason for this is a lack of planning. They did not plan ahead for their retirement years

The St. Louis Post Dispatch had an article once about how a lot of business owners do not have a plan as to what to do with their business when they want to retire. Many self employed people work until they want to retire, and then just sort of give up their business. They either don't know how to sell their business, or have not made the necessary arrangements to do so.

That is what is this chapter is all about. We are not only going to discuss how to sell your business, but what is involved in buying a piano tuning business. What this chapter is not going to talk about are IRA's or Keogh's or cash savings account. It is assumed that your insurance agent, financial advisor, banker, or accountant has explained all these programs to you, and that you are already putting away money for your retirement years.

The reason you should sell your business is that after all the years you've spent building it up, you don't want to just walk away from it. If you've been able to make a living tuning and repairing pianos , then someone else will be able to do the same. Not only that, but the customers who have relied on you for all these years will probably appreciate a name of some one you recommend, instead of hearing you've quit and moved away. For the buyer of your business, there are advantages, too. It takes a long time to build up a tuning business, so buyers will have a ready clientele.  The buyer will not only buy a customer list, but a system of contacting the customer that has worked well for you.

There are basically two types of business sales: Stock sales and asset sales. Stock sales are only for corporations that own stock. Since most piano tuners are probably not a corporation, (unless it is a sub chapter S corp), this is not something we will discuss here. Asset sales, however, are only for those who are sole proprietors. Since this is what most piano tuners are, this is what we will discuss.

The advantage of selling an asset company is that the proprietor gets to pick and chose which assets he or she wants to sell. It allows the seller to retain personal items, but sell the items that are no longer needed or wanted. The advantages for the buyer is that he or she gets to choose which items not to buy, such as outstanding legal issues, or property lease or rental contracts. The seller might want to sell his or her trade or company name, while on the other hand, the buyer is only interested in buying a list of customers.       

In general, in an asset sale, there must be an allocation of the sale price for the various assets that are being sold or bought. As we discuss, it is the value of these assets that should be negotiated before the sale is completed.

In an asset sale, there are two types of assets: Tangible and intangible. Tangible assets in general are least valuable, unless there is real estate involved. For simplicity, we will not discuss the sale of real estate, as that is beyond the scope of this book, and should be handled by a real estate professional. Tangible assets are the items that you can hold in your hand, like tools, equipment, parts, furniture, etc.

Intangible assets are the name of the company and the customer you've accumulated over the years. Basically, the service end of your piano tuning business.

The problem with a service business like ours, as was mentioned in chapter four, Service Management, some of the definitions of a service are: it cannot be produced in advanced, it cannot be stockpiled, and it cannot be saved for future use. All you will have, after many years of tuning pianos, is a list of customers for whom you have tuned. And as we all know, it doesn't take much for a customer to leave you for an another tuner. Your clients are only loyal to you as long as you keep your prices the same and do a good job.  So when it comes to selling your list of customers, there isn't too much you can tell a potential buyer other than he is buying a list of people for whom you used to tune.

The intangible value, however, is probably the most valuable part of your business, and it goes by several different names, like Blue Sky Value, Goodwill Value, or Going Concern Value. The intangible value also includes the name of your company, the list of your customers, the internal system, and your reputation.

Although the intangible asset of your business it is the most valuable, it is also the hardest on which to put a value. There are basically two significant features on which the value of the service business are based. First is the net income of the business. The net income is the total income from tuning and repairing, less the expenses involved in running the business. If you have been doing rebuilding, and perhaps piano sales, in addition to the in home tuning and repairing, it's a good idea to separate the income, and the expenses of those aspects of your business. This is so that a potential buyer who only wants to do rebuilding, or only do in home tuning and repairs, will know the net income for those parts of your business.

Although the intangible value of the business includes the customers list, the number of customers on that list should not be used in determining the value of the business. A piano tuner might have 5000 names on the list, but only $30,000 net income. This would indicate that the piano tuner only tuned each customer once, and the customer found another tuner. And because the tuner doesn't have a lot of repeat business, in an effort to get business, the tuner is charging a lot less than the going rate. Therefore, buying that business would not be a good investment. On the other hand, the list might have only 500 names, but an income of $60,000. That would indicate that most of the customers on the list are very happy with the tuner, and used him or her over and over again, and buying that business would be a good investment.

Not only should the buyer of the business consider is the income for the previous year, but also for several years in the past. A business that has been successful three or for years in a row is more valuable than one that has been declining for a couple of years. If it has been declining, the buyer needs to ask why. Perhaps the business has been declining because the tuner is getting old and is slowing down, and a new tuner can build the business back up. Or maybe the economy in the area is on the decline, and the seller is getting out, while the getting is good. Or maybe the tuner has a bad reputation, and buying the trade name will not be a good thing. One way to get answers to these question is to talk to, the local Chamber of Commerce, the BBB, or other tuners in the area. 

The second, and maybe a more important aspect of the value of the business, is the system. The system is the way the service business has been run. Is all the customer information on three by five cards thrown in a shoe box, or is all this information in a computer? How have the customers been notified that it is time to get the piano tuned? What kind of advertising or promoting has been done in the past? How well is the tuner known in the area, and what kind of reputation does he or she have? Are there employees, subcontractors, and who has been doing the paper work and taxes?

In order to figure out the intangible value of the business, we need to multiply the net income the business generated in the last year, times a multiplier factor. The multiplier factor is based on how well the system works. A well run system is one where customers are kept in a data base in the computer, the tuner has a systematic method of notifying the costumers on a regular basis, advertises, the tuner is well respected in the community, has several part time employees taking care of the paper work, etc, etc.

The buyer is also involved with the multiplier, because the buyer of the business needs to consider is how much additional income he or she can generate from the business, compared to the income that can be produced with that business. In other words, if the buyer is brand new in town, and doesn't have a clientele, much less a system, then the existing business, will b the only source of income. In that case, the buyer would want to pay a premium price for the business. But if the buyer is only looking to expand his current business, then he or she might not be willing to pay so much for the business.

Therefore, the multiplier could be anything from .1 up to 2, depending on the need of the buyer, and the urgency of the seller.

After the intangible value has been agreed upon by both parties, the amount will be  added the value of the tangible assets of the business. The tangible assets are the tools, equipment, supplies, furniture, computers, etc. of the business. The value of those items also need to be negotiated between the seller and the buyer, but for the most part, it doesn't make much sense for the buyer to get these items for more than half the whole sale price. That is why the value of the tangible assets are usually pretty low.

The tax men cometh

Although the government doesn't want to know that a business is being sold, there are taxes that have to be dealt with.  If a sale isn't handled right, and income from the sale and expenses of the buyers are not reported properly, it might create some very serious tax consequences.

Both the seller and the buyer of a business have to file Tax Form 8594, the Asset Acquisition Statement. When a transaction is a cash sale, then all the income has to be reported as business income, and is taxed accordingly on your schedule C and on form 4797, the Sales of Business Property.  When the buyer is going to pay for the business over a period of time, then the sale becomes installment payment, in which case the Installment Income Form, # 6252 has to be filled out. When this happens, then the seller is actually lending the buyer the amount equal to the sale price of your business. But because the seller is getting the payments over a period of time, and he will be getting interest, or at least should be, because interest income is different than cash income, it has to be reported on Schedule B,

Another aspect of the tax game is how much can be deducted and/or depreciated per year. The IRS treats some values of a business's assets differently than others. The profit from the sale of tangible assets are considered ordinary income. Since most of the tools and equipment are probably more than 7 years old and have already been depreciated, the income from these items would be considered pure profit. In case there are some tools that are less than 7 years old, and have not been fully depreciated, that is a simple accounting procedure.

Your supplies are also tangible assets, but cannot be depreciated. But since you probably deducted the price of the supplies from you income tax when you bought them, when you sell them, you will have to report the sale of the supplies as ordinary income as well.

The intangible assets, however, are considered a capital gains. Capital gains are taxed less than ordinary income, especially in the higher income bracket.

As the seller, you don't want to get a lot of money for your tangible assets, because you want to keep your "profit" down.  However, you do want to get a lot for your intangible assets, because it is taxed lower.

The buyer of your business, on the other hand,  wants it the other way around. The buyer wants to pay a lot for the tangible assets because he can depreciate them over 7 years, but he doesn't want to pay a lot for the intangible assets, because he has to defer this expense over 15 years. 

So you can see, that when a buyer and seller get together, they need to make a compromise over the value of the intangible assets and tangible assets. Therefore, it is recommended that the 2 parties hire a CPA to help them work out the details.

One more thing about the sale of the business. The seller, with all good intentions, wants to retire and live the easy life. Unfortunately, several months, or even years, after you retired, you find yourself in a position, for whatever reason, that you don't want to be retired anymore. But the new tuner in town paid a lot of money for your business, and he doesn't want you back in town to compete with him and get your old customers back. That would defeat the purpose of buying your business in the first place.

Therefore, the buy-out agreement should contain a non-compete clause. A non-compete agreement protects the buyer from having the seller take away the customers he just bought. It means that the seller of the business will not be allowed to tune or repair pianos in a certain geographical area for a certain length of time. In the event this agreement is breached, the buyer of your business does have the right to sue. 

The non-compete covenant protects the buyer of the business from having the seller encroach on the business after the sale. To assure that the clause is in force, it is advisable to put a monetary figure on the non-compete clause, and make it a separate entry on the sale. Unfortunately, tax wise, it hurts both parties. Income from a non-compete clause is considered ordinary income for the seller, not a capital gain, thus taxable at normal rate. And for the seller, the expense is considered a intangible asset, and has to be amortized over 15 years,

In a nut shell, for the seller, these are the tax consequences. Tangible assets are usually sold for about half the whole value, and are considered ordinary income. Income from the intangible asset are taxed as Capital Gains. The non-compete covenant is considered an intangible asset, and is considered ordinary income. For the buyer, the tangible assets can be depreciated over 5 - 7 years and the intangible asset can be amortized over 15 years. The non-compete covenant, although regarded as ordinary  income for the seller, is considered an intangible asset, and must be amortized over 15 years.

Real life experience.

Although the value of a business might be worth $100,000, if no one wants to pay that much, it might as well be worth nothing. Piano tuners, for the most part, will be selling a business with tangible assets, (without real estate), in the $1,000 - $5,000 range, and although the value of the business might be $100,000, when some one only is willing to pay $25,000, then that is the real value of the intangible assets. 

Another concern of selling a business is where the buyer is going to get the money. Although it would be nice if the buyer could go to the bank and take out a loan for the full value, unless the buyer has some other collateral, most banks are not familiar enough with the tuning business to lend a large sum of money, using the potential income from a piano tuning business to back up the loan.  Therefore, one of the things a seller should consider is allow the buyer of the business to pay the amount agreed upon over a period of time.

Which is basically what I wound up doing when I sold my tuning business. Unfortunately, unlike what I "preached" about, I didn't plan ahead. But that was because I didn't have much time. I was offered a new job, and only had two months to dispose of my business. I also didn't have much in the way of tangible assets, because I took most of my tools and supplies with me. But I did sell my intangible assets. I want to share with you my real life experience.

The man who bought my business had worked for me 2 years, and I had known him for about 5 year. Because of our relationship, I trusted him explicitly. He didn't have the cash, nor was he in a position to get a loan, so we made an agreement to buy my business over three years.

In the process of coming up with a figure for the intangible asset of my business, I knew had a very good system and a good reputation built up over 25 years. The reputation, and the non-compete clause were more or less combined, and we agreed that $10,000 was a fair amount. But because he didn't have the cash up front, the agreement called for him to pay me $70 per week. In addition to that, he paid me 30% of all the income derived from my customers during the first year. During the second year, he paid me 25% of the income and 20% the third year. It wound up I got a little less for my business I thought it was worth, but considering that there was no one else who was willing to pay me anything, I think I got a good deal.

Perhaps you feel that your "reputation" potential is worth a lot more than $10,000, or maybe you want a bigger share of all the income. This is something you and the buyer will need to negotiate. But what is important is that the two parties agree on a compensation package.