When they started their staffing company, Scott and Kim Wedgeworth* hoped they might one day build it into something they could sell to supplement their retirement savings. A quarter-century later, they had built a thriving business that appraised for millions of dollars.
Now their challenge was less about supplementing their retirement and more about protecting their sale proceeds from taxes. A donor-advised fund (DAF) helped make that possible, just as it can for your clients who might be thinking of selling a business.
In addition to the benefits such as flexibility and control with a DAF, it’s also easy for clients to set up and use and they allow advisors to keep client assets contributed to them under their management.
A good time to sell
If you do have clients who are thinking of selling a business, a number of indicators suggest that the coming months will be a prime time to make a deal and reap the rewards of entrepreneurial success.
Most notably, perhaps, after a relatively quiet year for mergers and acquisitions in 2023, we’re seeing a lot of pent-up demand and substantial cash ready to buy. However, other forces are at play, as well, including the fact that some sellers might have held onto their businesses longer than planned due to post-COVID complications and less enthusiasm among buyers as last year.
In addition, there is also a general increase in optimism with where interest rates seem to be headed and higher company valuations. In this context, EY Parthenon, Ernst & Young’s global strategy consulting arm, suggests that “Being proactive, rather than waiting for interest rates to fall, appears to be an important strategy for capturing growth opportunities.”
All of this bodes well for sellers, and for the prices they can command for their businesses.
A good time to open a DAF
Clients selling a business could receive a sizable tax hit, eating into a seller’s return and reducing their opportunities to do good things with their earnings.
To the client this seems like a problem, but to a savvy financial advisor this is a tremendous opportunity to provide a smart solution that can offset taxes and help clients make a positive impact in the world.
As a charitable giving tool, a DAF delivers tax deductions, helps avoid capital gains and estate taxes, and provides a vehicle for doing good after doing well.
Because it is a fund of a public charity, a DAF allows a donor to claim a charitable tax deduction on assets contributed to the DAF. In addition, donors who contribute appreciated assets to a DAF can avoid paying taxes on the assets’ capital gains and see a reduction in the value of a taxed estate. And, of course, a DAF creates an ongoing resource for charitable giving, allowing the donor to have a voice in how charitable funds are granted out to charities over time. And, through all of this, the assets can remain under your firm’s management, and you can continue to work with your client to guide investment decisions for the donated assets.
A key point in this conversation is that a client ready to sell a business should not plan to do the deal and then contribute proceeds from the sale into a DAF. Instead, they should consider gifting some or all the business to the DAF before a sale. By doing that, the seller can gain an immediate tax deduction for the value of the contributed assets, shield themselves from some capital gains taxes and offset taxes on portions of the business sold outright.
How much of an impact could a DAF have on a deal’s tax impact? A lot.
Consider the Wedgeworths, for example. By donating $9 million in business ownership directly to a DAF before the sale was “all but certain to occur,”** they avoided $1.8 million in capital gains taxes (assuming a 20% capital gains rate). Two executives, who had been given ownership shares as performance incentives, each gifted $650,000 to DAFs, avoiding $130,000 each in capital gains taxes.
As substantial as such savings can be, that’s not the only reason for this approach. By putting proceeds from a sale into a DAF, the seller creates an ongoing and long-term resource for giving that can be used to support causes and charities important to the donor on a timeline of the donor’s choosing. This protects the seller from having to choose specific charities to receive gifts in the same year as the deal is closed, and it also creates an opportunity to involve family in a long-term philanthropic endeavor.
One final benefit to creating a DAF in conjunction with the sale of a business is that the DAF sponsor (such as our partner, Renaissance Charitable Foundation (RCF)) will handle the execution of the deal for the assets it receives and provide ongoing administration for the DAF itself, issuing grants, preparing necessary year-end reporting documents and more.
Not a good time to wait
Anybody who’s had any involvement in a business sale or purchase knows that deals don’t move swiftly, and they seldom go according to plan. So it could be easy to think, “We’ll get to the DAF when we wrap up the deal.” That could be a mistake.
While opening a DAF is a straightforward process, the process of transferring a business to a DAF can take time. Even before the transaction is initiated, the seller must get a qualified appraisal of the business and will need to ensure that the DAF sponsor is capable of handling a business deal. Meanwhile, the DAF will need time to make sure the business interest is a good candidate for a DAF contribution and to do its due diligence.
Of course, while a seller can get the greatest benefit from gifting business interests directly to the DAF, they can still leverage DAF benefits after a sale by contributing proceeds from a sale to a DAF after the transaction has closed. The resulting tax deduction can be used to offset the tax realized from the deal, so long as the DAF contribution is made in the same tax year as the business deal closed.
If you’d like to learn more about how DAFs can help your clients who are interested in selling a business, talk to our experts at Ren.
*This hypothetical story and results are based on real client successes.
**This is important to ensure that the IRS does not designate the gift as a simple assignment of income and classify it as a cash gift. Donors need to work with their accounting professionals to time the gift correctly.
