A private business is an illiquid asset. You can’t convert it into cash, at least not overnight and without a lot of preparation. The value (wealth) is trapped in your business.
How do we access the value trapped in our business, either in total or little by little?
Let’s start with the most obvious – selling your business.
As at 30 June 2023 there were 1.0 million registered businesses in Australia, excluding self-employed workers (source: Australian Bureau of Statistics or ABS). During the year, 62,000 businesses achieved an exit at a rate of 6.2% of the total, including business closures.
At last count there were more than 3,000 small businesses listed for sale on various business sale websites. It is not clear how many of the 3,000 small businesses listed for sale actually sold. That mystery is for solving another time.
The point is, there are lots of “exits” according to the ABS in a year and we estimate that only 10% to 20% relate to the sale of a business.
For the majority, creating liquidity from a business exit (a sale) is bloody hard work and the odds are against you.
There are a few other ways to create liquidity from your business asset, including:
A. Regular distributions of profits to shareholders by way of dividends
We see lots of businesses that aim to minimise profit and in turn taxes, rather than maximising profits and providing a regular return to the owners. Ideally the dividends are franked, meaning the company has paid tax already.
B. The company buying back a portion of the shares
There are two ways to achieve this, either:
Neither of the above are complicated, albeit there may be tax implications when shares are bought back by the company. See tax comments below.
C. Management or staff buy-out
This may take the form of an employee share plan or simply part of succession planning involving the transition of ownership over time. The key is that existing shares are purchased by staff members, rather than new shares being issued.
Tax will ultimately be paid in the event of any of the above “liquidity” events. We see many business owners avoid options A to C above for fear of paying tax.
However, in the event the business is sold, tax is likely to be payable at the time in one big lump. Paying tax is inevitable for many liquidity events and should not be a driver of making a commercial decision. The objective is to create liquidity, tax is merely a transaction cost.
There are lots of ways to unlock the value trapped in your asset (business). These liquidity strategies are not just for large private or corporate businesses.