When it comes time to sell their businesses, we find that many owners think that selling to a third party is their only option, but it may not be! There are a number of internal exit strategies that may be available and potentially more appropriate for your particular situation and business.
One of the distinct advantages of selling or transferring your business internally: You may already have a buyer or successor with a working knowledge of the business and an interest in acquiring it.
Since an internal buyer has probably been involved with the business for a substantial period of time, he or she has helped shape its culture and position within the community. Additionally, in an internal sale, the owner often has the flexibility to remain involved as long as he or she desires, which provides time for the buyer to adjust to a new role and receive mentoring and support from the former owner.
Internal transfers generally occur at a lower gross price than an external sale, but with proper planning could produce a greater net sale price due to tax and fee minimization.
These sales are often funded through business profits or in the case of a leveraged buy-out, third party financing. Often, the successors do not have much, if any, capital to of their own to invest and the seller may not receive a large amount of the sale proceeds up front. Owners may keep control and minimize taxes if they sell their ownership stake slowly over time. The values normally associated with these types of transfers are fair market or investment value if the business is profitable enough.
There are some great advantages to an internal sale for many owners including potential tax savings and flexibility, but it still requires advanced planning and preparation, such as identifying and preparing a successor and being sure the business and owner are ready for the pending transition.
The most common internal transfers are a family transition, management transfer, and employee stock ownership plan (ESOP). Below, we will provide a brief overview of some of the characteristics and suitability for the management transfer and ESOP.
MANAGEMENT TRANSFER:
Owners reward loyal employees by selling the business to them. This may be a one-time event or a gradual sale over time.
Business Value: Fair market or investment value
Funding Sources: Business profits, bank debt, manager capital
Owner Involvement Post Sale: Negotiable but often 3 to 5 years
Tax Implications: Can be structured to minimize taxes by selling shares over time and securing capital gains treatment
Business and Owner Suitability:
• Current owner wants the option to stay in control longer
• There are key employees who think like owners and can be groomed to operate the business
• Business is profitable enough to fund buyout or borrow funds if employees do not have capital
• Business may or may not be marketable to outside buyers
ESOP:
An ESOP is a qualified retirement plan that is created when an owner sells all or a portion of his/her business shares to a trust on behalf of all of the company’s employees. Employees earn shares annually that are converted to cash when they retire. Owners may choose to continue to run the company as long as they desire.
Business Value: Fair market value
Funding Sources: Business profits, bank debt
Owner Involvement Post Sale: 5 to 10 years
Tax Implications: Can be structured to minimize taxes by selling shares and securing capital gains treatment. S Corporation ESOPs do not pay income taxes to the extent that the ESOP trust owns the shares. C Corporation owners may defer paying tax indefinitely by investing the proceeds in Qualified Replacement Property.
Business and Owner Suitability:
• Current owner who want the option to stay in control longer
• Culture conducive to having all employees as owners
• Company has minimum of 20 employees, $3M of business value, and $500K of annual cash flow
ADVISORS YOU WILL NEED:
An internal sale must be carefully negotiated and structured to minimize taxes and fees and will require the buyer(s) to be included in the process over the course of many meetings, until an agreement is reached. For an internal sale, you will most likely need the following advisors:
• Business transition advisor
• CPA with experience in tax planning for business sales
• Corporate or transaction attorney
• Personal wealth advisor
Contact the team to schedule a FREE consultation to discuss your future exit!
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